One of the principal areas of focus for the review is: "A reassessment of the relative rights and remedies of secured and unsecured creditors in insolvencies to include the Crown as a preferential creditor." From the point of view of construction companies – especially for those lower down in the payment chain – this is interesting stuff.
There is nothing more galling and frustrating for specialist contractors than to be confronted with the demise of a main contractor following the appointment of an administrative receiver to the main contractor's company. The subcontractors know the prospects of recovering what they are owed is zilch and there is nothing they can do about it. They have no control over the receiver who is, in effect, an executioner appointed by a lender (usually the company's bank) with a floating charge over the company's assets.
The execution is swift and effective. Unlike the majority of the company's creditors, the receiver will have been warned about the company's precarious financial position well in advance. It will go in when told that the main contractor has just received a fat cheque – that could fund payments to subcontractors. But this executioner can ignore the wishes of the creditors – its duty is to the bank that appointed it.
As the DTI/Treasury review acknowledges, the receiver has little incentive to maximise returns on assets over and above those required to repay the bank and pay its fees and expenses. The fact is that, once the receiver has departed with its spoils, there is often nothing left for anybody else, and the company will go into liquidation. It is no wonder that the UK system is very friendly towards secured creditors compared with other major industrialised countries. This is not my view – it was the conclusion of research conducted as part of the government review.
Some would argue that it is only right that the banks are able to obtain security for their lending. Indeed, other creditors can also make appropriate arrangements to obtain security, such as reserving title to goods and materials until payment. But, as everyone in construction knows, this argument is simply rubbish.
The standard forms (ICE, JCT and government contracts) seek to deny subcontractors any possibility of reserving title to goods and materials until payment. In any event, such title is lost once goods and materials have been incorporated in the building or structure. This is why some jurisdictions in Canada, the USA and Australia provide contractors with a statutory means of obtaining security, such as provided by building or mechanics' liens.
- In insolvency, the receiver tends to act in the bank’s interests
- This has damaging economic consequences
- There are signs that the government may act to make the system fairer
And why should banks be given a privileged position over other creditors? Does it make economic sense for a bank to plunder the assets (such as they are) of a main contractor with the consequence that dozens of subcontractors are either forced to incur further borrowing at high interest or go out of business with projects being disrupted and jobs lost? The cost consequences of receivership are likely to exceed the value of the assets retrieved by the bank. Consequently, in economic terms, this state of affairs is wholly unsatisfactory.
The DTI/Treasury review also addresses the issue of whether debts due to the Crown should continue to enjoy preferential status. Such debts include income tax deducted by employers under PAYE, deductions made by contractors from payments to subcontractors, National Insurance contributions and VAT. Between £60m and £90m of preferential debt is recovered in insolvencies.
But, as the review accepts, if the Crown's preferential status were removed, it would just mean that the banks would be able to grab much more. The abolition of Crown preferential status is, therefore, unlikely to benefit the position of unsecured creditors to any great extent.
The conclusion must be that the preferential status of holders of floating charges must also go. Isn't it about time that they became exposed to risk just like most businesses in the industry? They will still be in a far stronger position to impose an appropriate price for taking on the risk of insolvency of a customer than would be the case for most contractors.
The DTI/Treasury review now opens up the prospect of the removal of the floating charge security or making its enforcement subject to a number of conditions, in order to promote fairness among all creditors.
Rudi Klein is a barrister and chief executive of the Specialist Engineering Contractors Group.