Being sat on by a hippo

The demise in May of main contractor Melville Dundas has, once again, highlighted the repercussions of insolvency. Melville, which was one of Scotland's largest private construction companies, left debts of £20m, and is thought to have forced into liquidation at least one subcontractor, which was owed £100,000. And it follows the high-profile insolvency last year of Bickerton – the subject of a Serious Fraud Office investigation.

Despite a background of steady growth in construction output, business failures are on the increase. Construction insolvencies in 2001 numbered 2001. Last year it was 2334. This year, the figure is expected to reach almost 3000. This worrying trend demands a renewed effort to provide protection for construction firms affected by insolvencies upstream in the supply chain.

There is a fundamental issue at stake here. Most main contracting organisations, which sublet much of the work in the industry, are poorly capitalised. For the most part, their liabilities exceed their assets. The liabilities-to-assets ratio is one test by which many of these organisations could be considered insolvent. The consequence is that soundly run businesses (mostly small and medium-sized business) to which work is sublet are put at risk by large, badly run businesses.

Insolvency law is designed to operate in such a way as to create efficient outcomes. When sound businesses are put out of business by those that are not, this can hardly be described as efficient.

How can subcontractors and suppliers accommodate the risks that, unknown to them, are frequently assumed by the Melville Dundases of this world, or created by Bickertons? In principle, subcontractors and suppliers should not be expected to absorb such ridiculous risks. Furthermore, they are not in any position to protect themselves against insolvencies upstream by contract or by insurance. Retention of title provisions are not allowed in standard contracts. In fact, the JCT has a provision (which is unworkable) that prevents the subcontractor denying that title to its goods has passed to the main contractor in the event that the main contractor has an architect's certificate covering those goods. Moreover, once items of equipment, goods and materials are incorporated into the building or structure, title is lost.

Firms should not be driven to commit acts verging on the criminal in order to protect themselves

Credit insurance is prohibitively expensive, and it is virtually impossible to obtain such insurance in respect of more than one upstream payer. Credit references on many main contracting organisations will often reveal that they are good only for minuscule amounts of credit.

And longer payment periods increase the risks involved – which means that the money most at risk is retentions. Evidence presented to the parliamentary trade and industry select committee last year indicated that 25% of building services firms each lost more than £50,000 in retentions over the past 10 years because of insolvencies upstream.

Firms affected by the insolvencies of their payers should not be driven to commit acts verging on the criminal in order to protect themselves. If I had just delivered to site a piece of equipment worth £50,000, I wouldn't stand by and watch the value it represented evaporate before my eyes. Yes, I could suspend my contract for non-payment or have endless rows with the liquidator over title. But, by then, it would have been too late – my supplier would already be on my back.

The Enterprise Act 2002 is unlikely to affect the construction scene in any dramatic way. It is concerned to promote recovery through administration but this depends on the availability of sufficient assets: the likelihood of any assets remaining on the insolvency of many main contracting organisations is fairly remote. Even if assets were available, they are unlikely to be distributed to subcontractors and suppliers.