The Effect of Contractor Insolvency on Construction Projects

Overview

• This Comparative Note is intended to give an overview of the insolvency regimes across the key jurisdictions in the region being Bahrain, Oman, Qatar, the UAE and Saudi Arabia, in relation to the effect of contractor insolvency on a construction project.
• None of the jurisdictions have insolvency laws which specifically relate to the construction industry therefore this Comparative Note will review each jurisdiction's relevant insolvency law (where applicable) and apply the law to the region's standard construction industry practices.
• A prevalent theme in construction contracts is the scenario whereby a main contractor and/or subcontractor endeavours to progress works against a backdrop, which seemingly indicates it is operating within a fragile financial environment. That environment generally derives from late or non-payment and/or cash flow restrictions. Such entities may have been in that predicament during the tender phase only to see it exacerbated once the contract was awarded. Alternatively, the main contractor and/or subcontractor came into the project with a healthy financial backdrop only to be hindered by events arising during the contract term. All too often, they will be permitted or compelled to carry on, neither of which is commercially conducive to a successful project.
• Overall, whilst the jurisdictions in general now allow for settlement and/or restructuring, an employer needs to assess the time and costs implications when considering whether to continue with the main contractor or terminate them under the construction contract and appoint a new contractor to complete the remaining works.

Definitions

• Balance Sheet Test: The test for Insolvency whereby a business' current liabilities are assessed to be greater than its assets.
• Cash Flow Test: The test for Insolvency whereby a business is unable to pay its liabilities as they become due.
• Insolvency: In general terms where a business fails either the Cash Flow Test and/or the Balance Sheet Test (as applicable).

Practical Guidance

Over the past couple of years, the GCC has seen a wave of new insolvency and bankruptcy laws introduced. With the exception of Qatar, all other jurisdictions in this Comparative Note have introduced a new bankruptcy law. Whilst Qatar has yet to take this step, it is currently anticipated that they will be looking to introduce a new bankruptcy law over the coming year or so.

One of the many reasons why updating the bankruptcy laws has become key in these jurisdictions, is the need for inward investment. Modern, fit for purpose bankruptcy laws give investors in the region confidence by providing mechanisms for distressed companies to reorganise their structure and repay creditors with the possibility of continuing to operate.

The risk of insolvency is something that all employers should be aware of. It can happen at any stage during a project and can have a knock-on effect on, not just finishing on time, but the costs of completing the project.

Bankruptcy regimes

United Arab Emirates

The UAE was the first of the jurisdictions to implement a new bankruptcy law implementing Federal Decree-Law No. 9/2016 on Bankruptcy in 2016. It applies to all commercial companies excluding those registered in the DIFC and ADGM as they have their own comprehensive insolvency regimes.

Federal Decree-Law No. 9/2016 has three mains parts to it:

• protective/preventative settlement;
• insolvency with restructuring; and
• insolvency with liquidation.

Under the protective settlement regime, debtors are able to reach an agreement with creditors, with the assistance of the court, for the settlement of its debts. This is available to businesses that are not yet insolvent but are facing financial difficulties.

Federal Decree-Law No. 9/2016 recognises both the Cash Flow Test and Balance Sheet Test as measures for Insolvency.

Federal Law No. 9/2016 was amended by Federal Decree-Law No. 35/2021 Amending some provisions of Federal Decree-Law No. 9/2016 on Bankruptcy, to clarify the circumstances under which the debtor’s directors and managers may be held personally liable for the company’s debts.

For entities established within the DIFC, DIFC Law No. 1/2019 DIFC Insolvency Law, came into force in June 2019. The legislation provides for the implementation of rehabilitation plans as proposed by creditors and shareholders (under article 31 of DIFC Law No. 1/2019), administration by way of appointment of an administrator (under articles 32 and 41 of DIFC Law No. 1/2019), winding up procedures (articles 51-116 of DIFC Law No. 1/2019) and cross-border insolvency proceedings as adopted from the UNCITRAL Model Law on Cross Border Insolvency^{[1 p.7]}.

Similarly, the ADGM Insolvency Regulations 2022 are prescribed for entities established within the ADGM, providing for administration, receivership, winding up, protection of assets under liquidation and administration and cross-border insolvency.

Saudi Arabia

The KSA Bankruptcy Law, Saudi Arabia Royal Decree No. M50/1439 (Saudi Arabia Cabinet Decision No. 264/1439 on the Approval of the Bankruptcy Law) was introduced in 2018 and applies to both individuals and corporations, as well as non-Saudi investors having assets in KSA or conducting business through licensed entities. Similar to Federal Decree-Law No. 9/2016, it was enacted to modernise the legal mechanisms surrounding Insolvency. It also allows for protective/preventative settlement and Insolvency with restructuring or liquidation.

The procedures prescribed under Saudi Arabia Royal Decree No. M50/1439 (Saudi Arabia Cabinet Decision No. 264/1439) include preventative settlement procedures whereby a debtor may request suspension of claims for up to 180 days, financial restructuring under the supervision of a financial restricting officer appointed by the court, and liquidation in the event of Insolvency or bankruptcy.

Bahrain

Bahrain Law No. 22/2018 on the Issuance of the Reorganisation and Bankruptcy Law was also introduced in 2018 and is applicable to any commercial company not licensed by the Central Bank of Bahrain. Similar to both Federal Decree-Law No. 9/2016 and Saudi Arabia Royal Decree No. M50/1439 (Saudi Arabia Cabinet Decision No. 264/1439), it was enacted to focus on modern legal mechanisms to restructure a business in distress. Companies may be subject to restructuring or liquidation proceedings and such procedures may involve distribution of assets located both domestically and outside of Bahrain. 

Bahrain Law No. 22/2018 also introduces cross-border insolvency mechanisms for the enforcement of foreign judgments subject to any reciprocal treaty arrangements being in place.

Oman

Oman has recently issued Oman Sultani Decree No. 53/2019 Promulgating the Bankruptcy Law, which came into effect in July 2020. The structure of Oman Sultani Decree No. 53/2019 is similar to that of the UAE. 

Oman Sultani Decree No. 53/2019, similar to Federal Decree-Law No. 9/2016, sets out a preventative stage under the term “restructuring” (provided that the debtor is not in liquidation at the time a request for bankruptcy is made) as well as providing for the tenets of insolvency with liquidation and protective settlements.

Qatar

There is no specific insolvency law in Qatar meaning the regime is formed from frameworks found in legislature. Bankruptcy is a court led process in which a company will be liquidated. The Qatar Financial Centre does however have its own insolvency regime.

Qatar’s bankruptcy regime is comprised of a local regime set out in Qatar Law No. 27/2006 on the Issuance of the Commercial Transactions Law (under articles 606-846 of Qatar Law No. 27/2006) and the QFC regime established in 2005, which is set out in the QFC Insolvency Regulations and is applicable to entities established within the QFC freezone (a separate legal jurisdiction similar to the DIFC in Dubai).

Under the local regime, an administrator is appointed to manage the bankruptcy proceedings with a view to achieving repayment of debts to the extent possible. Qatar Law No. 27/2006 contains no provisions relating to foreign bankruptcy proceedings.

The QFC regime is based on common law principles and offers a more comprehensive regime, recognising non-QFC bankruptcy procedures including foreign proceedings. This allows for non-QFC courts to cooperate with a QFC tribunal for the distribution of assets in cross border bankruptcy procedures. 

Effect of insolvency on construction projects

Contractor insolvency is a significant risk in any construction project. While it is usual for a construction contract to allow an employer to terminate the contract upon insolvency, bankruptcy, liquidation, receivership, or administration of the main contractor, often it fails to account for the effects of financial difficulties, or the impact on the project as a whole.

With the introduction of pre-insolvency debt restructuring measures under Federal Decree-Law No. 9/2016, Saudi Arabia Royal Decree No. M50/1439 (Saudi Arabia Cabinet Decision No. 264/1439), Bahrain Law No. 22/2018 and Oman Sultani Decree No. 53/2019 it is important for all employers to watch out for tell-tale signs that a main contractor is struggling financially. Such signs include:

• reduced personnel on site;
• slow-down in progress of the works;
• key building supplies and materials not being present on site at the relevant time; and
• inability to provide suitable performance security such as bank guarantees, disputes with sub-contractors over nonpayment and requesting up-front payment.

In contrast, as Qatar Law No. 27/2006 does not have any pre-insolvency mechanisms nor does it provide for restructuring, it is unlikely that the restructuring of a main contractor would be possible.

As a general rule, contractors that are under financial stress are permitted to carry on works. In practice, employers may become aware of the financial difficulties facing their contractor, and in the event of insolvency, termination is often the only course of action available under the terms of their contracts. There is no such “help me to help you” solution prescribed in standard form contracts.

Some employers elect to address the issue by injecting additional money into a project, however there is no guarantee that such investment would not be allocated to other projects or be utilised towards settlement of debts with lenders. On projects financed by way of bank loans, lenders may insist that an assignment of all proceeds from the project is established which would require the contractor to execute a deed of assignment with notice to all project stakeholders and subcontractors. Such arrangements can be fatal for project completion as lenders and contractors prioritise the re-payment of loans, default of which is likely to have other serious implications for the contractor.

Any application to the competent court for preventative settlement is likely to enable an employer to terminate the construction contract at will. The main considerations an employer should take into account when doing so is whether the time and cost of allowing the contractor to continue outweighs the time and cost of appointing a new contractor to complete the project.

Once formal bankruptcy proceedings are issued under Federal Decree-Law No. 9/2016, Saudi Arabia Royal Decree No. M50/1439 (Saudi Arabia Cabinet Decision No. 264/1439), Bahrain Law No. 22/2018 and Oman Sultani Decree No. 53/2019, formal restructuring or reorganisation is possible subject to there being sufficient assets available to facilitate continuation of the business. Given that the bankruptcy legislations have only come into force relatively recently, all interested parties including project stakeholders, contractors and legal practitioners will be monitoring developments closely to see how each of the proceedings are brought forward and dealt with by each jurisdiction.

If a main contractor is successfully restructured following such proceedings, it would allow them to continue on site to work towards completing the project. However, a restructuring process may take considerable time and as such an employer may nonetheless consider termination and replacement of the contractor to be appropriate.

Comparative Table

Related Content

Legislation

United Arab Emirates

• Federal Decree-Law No. 9/2016 on Bankruptcy as amended by Federal Decree-Law No. 35/2021
• DIFC Law No. 1/2019 DIFC Insolvency Law
• ADGM Insolvency Regulations 2022

Saudi Arabia

• Saudi Arabia Royal Decree No. M50/1439 issuing Saudi Arabia Cabinet Decision No. 264/1439 on the Approval of the Bankruptcy Law

Oman

• Oman Sultani Decree No. 53/2019 Promulgating the Bankruptcy Law
• Book 5 - article 578-786 of Oman Law No. 55/1990 Promulgating the Commercial Law
• Oman Sultani Decree No. 18/2019 On the Issuance of the Commercial Companies Law
• Oman Sultani Decree No. 4/1974 Related to the Promulgation the Foreign Capital Investment Law

Bahrain

• Bahrain Law No. 22/2018 on the Issuance of the Reorganisation and Bankruptcy Law

Qatar

• Book 6 - articles 606-846 of Qatar Law No. 27/2006 on the Issuance of the Commercial Transactions Law
• Qatar Law No. 11/2015 Promulgating the Commercial Companies Law (insofar as it provides for dissolution and liquidation of companies)
• QFC Insolvency Regulations 2005

Notes

1. ^ [p.3] https://uncitral.un.org/en/texts/insolvency/modellaw/cross-border_insolvency

This article was orignally published by LexisNexis Middle East.