A bleak picture

Data by a leading insolvency specialist shows that 5,919 United Kingdom (UK) construction companies find themselves in dire straits, with a further 72,257 companies (representing 20 percent of the total number of construction companies in the UK) in a less critical but still concerning state of financial distress.  In the UK, there have been a record-breaking number of construction sector insolvencies in the past 12 months, with the sector now making up the greatest contribution to the UK's insolvency figures in 2023 - representing 17 percent of all insolvent firms.

Given profit margins for various stakeholders in the construction supply chain tend to hover at low single figures, major economic events and unstable markets can have a serious effect.

Rising inflation, high energy costs, repayments of loans taken out during the pandemic, the inflationary impact on costs of equipment and materials have contributed to cost overruns and longer lead times. The sector has also seen increasing commoditisation in which contractors engage in a "race to the bottom" to secure contracts at all costs, sometimes neglecting issues such as social purpose and net zero compliance.

In the UK, Tolent collapsed into administration owing GBP43 million after losses on its development at Milburngate and Metnor went into administration, leaving creditors owed GBP10 million at the time of its collapse. Analysts think that the domino effect brought about as a consequence of major insolvencies could lead to GBP1 billion in bad debt in the sector by the start of 2024.

Here in Hong Kong, Aggressive Construction Engineering, a subsidiary of Great Harvest Group, has lost its operating licence with effect from 16 November 2023, following a fatal accident last year. It was told it had a month to settle its projects, which included developments in Kwun Tong and Sai Ying Pun. The potential upstream and downstream consequences could be significant.

Complex issues

When employers, contractors, sub-contractors and other members of the construction supply chain face financial difficulty in Hong Kong, and office-holders are appointed, they and other stakeholders often have to confront a range of complex challenges arising from Hong Kong's insolvency regime.

Key insolvency considerations that we see arising in the construction sector are:

• Lack of familiarity with insolvency law.
• Director liability (there are numerous offences that can affect directors such as fraudulent trading and the rule about antecedent transactions).
• Matters of voidable dispositions where monies are paid out close to a company becoming insolvent.
• Issues of direct payment and treatment of retention monies.
• Project delivery and ongoing upstream/downstream liability.
• Operating licence issues.

Particular issues which have arisen recently in the construction sector have included treatment of transactions entered into post-winding-up and retention monies.

Disposition? That's unfair!

The question of unfair preference in the context of a winding-up came before the Court of Final Appeal in Re Hsin Chong Construction Co Ltd [2021] HKCFA 14. The CFA found that the disposition of Hsin Chong's residual rights and interests under a joint venture agreement after the commencement of a winding up, was void.

One of the members of the contractor JV had agreed to acquire the company's residual rights and interests in the JV and applied for an order that the transaction should not be invalidated by virtue of section 182, Companies (Winding Up and Miscellaneous Provisions) Ordinance.

The Court of Final Appeal overturned the decisions of the lower courts and declared the dispositions void. To do otherwise, the CFA ruled, would prejudice the interests of the company's body of creditors.

…and those retention monies…

In a separate decision concerning the Hsin Chong collapse, the Court of Appeal considered whether retention monies received by a construction company in respect of nominated subcontractors, should form part of the contractor's estate in the context of liquidation.

The Court of Appeal in Re Hsin Chong Construction Co Ltd (Provisional Liquidators: Application for Directions) [2021] 5 HKLRD 212, found that the retention monies should be paid to the nominated subcontractors and should not form part of the general estate.

Whilst there were conflicting authorities on the question of whether trust monies should be paid into a separately bank account, the Court of Appeal found that, provided the monies could be clearly identified, keeping them in a separate fund was not strictly necessary.

The Court of Appeal found the provisional liquidators had properly raised the question and, whilst the court was not there to take commercial decisions on behalf of liquidators, where they encountered difficulties during the course of administration the court could provide guidance so the PLs were not left "floundering".

Cross-border effect

The issue of retention monies also arose in a case connected with the cross-border restructuring of Hong Kong Airlines. The plaintiff in Hip Hing Construction Co Ltd v Hong Kong Airlines Ltd [2023] HKCFI 1430 sought from the court a declaration that the defendant held more than HK$56 million as retention monies on trust for the plaintiff pursuant to a clause in the General Conditions incorporated into the contract between the parties for the construction of the Hong Kong Airlines training centre at the airport. The plaintiff was the main contractor engaged by the defendant for the construction of the project.

Summary judgment was entered against the defendant for HK$192 million, with leave granted to the defendant to defend the balance of the claim. A winding up petition was presented against the defendant. Subsequently, the Hong Kong court and the English court sanctioned a scheme of arrangement and a restructuring plan (see Hogan Lovells alert Parallel lines – Hong Kong Airlines undergoes English and Hong Kong restructuring).

The plaintiff demanded that the defendant pay over the retention monies before any of the assets were distributed to its creditors. The court considered the question of whether a trust had been created over the retention monies in favour of the plaintiff and whether the plaintiff was entitled to an order from the court compelling the defendant to pay the retention monies into a separate bank account pending determination of the originating summons.

Madam Justice Mimmie Chan referring to the Court of Appeal decision in Re Hsin Chong ruled that the course which would involve the least injustice would be to grant a mandatory injunction to compel the defendant to set up a separate account in order to preserve and ringfence the sums in dispute.

Experience counts

Those who may be familiar with classical insolvency situations, may not have experience of the intricacies of how insolvency can impact the typical construction supply chain structure and need to call upon specialist advice. It may take years to recover money owed by the company in liquidation, if any still remains.

Hogan Lovells has extensive experience and a long track record in insolvency and deep sector knowledge of and expertise in the construction sector. When a construction company runs into issues, we advise companies ahead of the insolvency scenario and office-holders and other stakeholders in the event the worst happens.

We have advised well over 100 construction groups across the full spectrum of contentious and non-contentious matters and in advising all types of court or regulator-appointed office-holders across all sectors. We have an enviable track record of achieving successful outcomes for stakeholders with a strong track record of delivering value.

Authored by Janice Cheng, Byron Phillips, and Nigel Sharman.