Insolvency protection: Reform or bust

Ten construction firms are going bust on a daily basis. Almost 6,000 firms have failed in the last two years. Construction continues to be the worst affected industry sector as far as insolvencies are concerned.

The causes are not hard to find. Across the industry firms are poorly capitalised especially the largest companies which sub-let most of the work. Ever-lengthening payment periods and other unscrupulous devices for wringing more credit and cash out of one’s supply chain are now widespread. There is no longer the cushion of bank lending - it has dried up. You know your payer is likely to go bust in a few months time but there’s nothing you can do to protect your retention - which, legally, is yours. You cannot use the statutory right of suspension to make a pre-emptive strike.

Some time ago I drafted a parliamentary question in connection with the building of a training centre at Wilmslow for Cheshire Police. The selected builder was Pierce Construction. The project was £10m and Pierce was worth minus £4.5m. Pierce went into insolvency. As a result, two long-standing engineering firms went bust. They had been engaged by Pierce.

There is no longer the cushion of bank lending - it has dried up. you know your payer is likely to go bust in a few months time but there’s nothing you can do to protect your retention - which, legally, is yours

Jobs were lost and the taxpayer had to pick up the costs. The question I asked was: why did Cheshire Police appoint an insolvent firm to do this work? But they are not the only clients doing this.

In August this year the State of New South Wales in Australia announced an inquiry into construction industry insolvency chaired by a lawyer, Bruce Collins QC. Mr Collins is leaving no stone unturned in his inquiry. All possible solutions for protecting the supply chain in the event of main contractor insolvency are being thoroughly tested.

Mr Collins has just published a paper canvassing possible options. He states: “The inquiry is presently of the view that subcontractors are not adequately protected”.

Possible options include:

• Limiting the time taken to discharge payments Other Australian states already do this. A Queensland statute, for example, stipulates a 25-day payment period from submission of a payment application.
• A statutory trust provision to safeguard progress payments Statutory trust provisions already exist in some US and Canadian states. In general these impress trust status on subcontractor payments received by the main contractor from the client. Payments for onward transmission to the supply chain have to be placed into a trust account.

In this regard, Mr Collins has also been talking to the UK government about project bank accounts.

• All retention money to be held in trust “On the moral scale of things it is difficult to resist the immediate conclusion that when it comes to retention funds, reform is necessary,” says Mr Collins.
• The Construction Contracts Act 2004 in Western Australia already requires retention funds to be held in trust. In some other jurisdictions such as France and some US states there is a statutory requirement for retentions to be held in a stakeholder account.
• All contractors to be licensed Queensland already has a statutory licensing scheme which involves rigorous financial checks on all contractors. This has reduced construction insolvencies in Queensland.

We now wait to see what happens in New South Wales but there is a real possibility that most (if not all) of the options listed will be taken up.

In October 2009 my organisation, SEC Group, sponsored an amendment to the (then) government’s bill to amend the Construction Act. This would have enabled a payee to suspend their work in the event of the payer failing to provide adequate security for payment such as a bank guarantee. If the payee had a 90-day payment period, they would not have to wait 90 days to see whether or not they would be paid. If they had concerns about the payer’s solvency after, for example, 30 days, they could suspend work if the payer - at that point - failed to provide security for payment.

The amendment was lost by 69 votes. It is now time to re-visit insolvency protection in the UK.

Professor Rudi Klein is a barrister and chief executive of the SEC Group