Payment difficulties and bankruptcy during an ongoing construction project – what you need to know

When payment is withheld – your rights as a contractor, subcontractor and supplier

The standard contracts AB 04 and ABT 06 give the contractor the right to suspend the contract in the event of non-payment – but certain conditions must be met:

• The claim must be a clear and due debt (i.e. the invoice must have fallen due for payment).

• You must notify your client in writing before suspending work.

• The failure to pay must be substantial – a small outstanding amount is not sufficient.

• The suspension may last for a maximum of one month, and at the end of the month you must give written notice as to whether you will resume work or choose to terminate the contract.

If you are a subcontractor, the same right applies, but you must also notify the main contractor in good time so that they can fulfil their obligations further up the chain. If you fail to provide this notice, you risk the main contractor terminating the contract with you.

As a supplier, your right to withhold performance is governed by ABM 07. If there are strong grounds to believe that the other party will not fulfil their obligations, you may demand that acceptable security be provided. If security is not provided without delay, you are entitled to terminate the contract. The right to terminate also applies in the event of insolvency or bankruptcy.

An important caveat: before taking any action, you must assess whether the client is actually in default or whether they are entitled to withhold payment – for example, due to counter-claims, liquidated damages, an agreed portion of the contract sum or defects in the works. If the payment has been correctly withheld, no right of termination arises.

Termination – the most drastic measure

Termination is the most powerful option, and it is also the riskiest. Termination is, in principle, irrevocable, and the situations in which there are nonetheless grounds for termination are primarily the other party's bankruptcy, suspension of payments or other signs of insolvency (i.e. that the other party is "insolvent").

As a client, financial difficulties on the part of your contractor often become apparent when subcontractors and suppliers suspend their work, which in turn causes delays to the project. The right to terminate arises when the delay is so significant that it is clearly impossible to complete the works within the contractual timeframe, and the delay is also of material importance. The extent of the delay may be assessed against the purpose of the works; this means, for example, that a delay in the construction of a new school may be considered material even if the delay itself was relatively minor, provided that it resulted in the school not being ready by the start of the term.

In the event of the insolvency of either the client or the contractor, the other party has the right to terminate the contract. A condition that must be met before termination takes place is that an explicit enquiry must be made to the insolvency administrator (or to the other party if insolvency has not yet occurred) as to whether they wish to fulfil the contract and are prepared to provide security. If security is provided, the contract cannot be terminated on the grounds of insolvency or bankruptcy.

Upon termination, there is a right to compensation for cost increases and damages, and termination is generally a requirement under the terms of the insurance policy and in order to be able to prove the claim in the bankruptcy proceedings. Upon termination, a valuation of the works must be carried out. The valuation must be based on the nature of the work carried out and the contract sum as the value of the contract works as a whole – not merely the cost of completion. This is an important distinction which is significant for the possibility of compensation from the bankruptcy estate/insurance company.

Recovery (clawback) – when the bankruptcy estate demands repayment

One of the most hotly debated aspects in the wake of, amongst other things, Serneke's bankruptcy is the clawback claims that the insolvency administrator has made against subcontractors and suppliers. The purpose of the clawback rules in the Swedish Bankruptcy Act (konkurslagen) is to ensure that payments which have unduly favoured one creditor at the expense of others can be recovered. In this context, the following provisions should be highlighted:

Chapter 4, Section 5 of the Bankruptcy Act has the broadest scope of application and may, in principle, apply to payments made up to five years prior to the bankruptcy, but the rule requires that the recipient understood, or ought to have understood, that the bankruptcy was imminent and that the payment was improper. It is primarily on this provision that Serneke's clawback claims rest – and the burden of proof on the insolvency administrator to demonstrate that the conditions are met is onerous. No court rulings have yet been issued in these cases, and overly far-reaching conclusions should not be drawn from the claims that have been made.

Chapter 4, Section 10 of the Bankruptcy Act applies to payments made within three months prior to the bankruptcy that were made using other than customary means of payment, made early, or in amounts that significantly impaired the debtor's financial position. The key question is whether the payment is "ordinary" – and this assessment is made on the basis of the individual circumstances and industry practice.

An important distinction is that between an advance payment and an early payment. An early payment refers to a debt that has already arisen and is paid before it falls due – this is one of the criteria set out in Section 10. An advance payment, by contrast, is made before the other party has performed its obligation at all, and falls outside the scope of the clawback rule.

What you should do

Whether you are a client, a contractor or a supplier, there are concrete steps you can take to strengthen your position:

• Check the security provided – under AB 04/ABT 06, agreed security must be provided within two weeks of the contract being concluded. Ensure that the security is in place and correctly drafted. Properly provided security can be the difference between genuine protection and being left with no room for manoeuvre.

• Act swiftly when warning signs appear – if you see signs of financial difficulties on the other party's part, check the security immediately and review your contractual rights.

• Keep a running record – ensure that notices, demands and communications with the other party are made in writing. This is crucial should a dispute arise.

• Seek legal advice before suspending or terminating – misjudging the conditions may give the other party the right to terminate the contract and bring substantial cost claims against you.

• Take clawback claims seriously, but do not be intimidated – if you receive a clawback claim, carefully review the actual circumstances surrounding the payment. Such claims are not always well-founded, and in many cases a heavy burden of proof rests with the insolvency administrator.