Construction Industry Insolvencies – One Step At A time

Fighting For Subbies Rights

The authors of this paper "Construction Insolvency In Australia" have done a good job researching why it is so easy for builders to liquidate. It's lucrative for those who organise the liquidation including the builder, pre insolvency advisors, lawyers and liquidators.

It is not in any way beneficial for subcontractors who are almost always unsecured creditors.

Credit must go to the authors Jeremy Coggins, Bianca Teng and Raufdeen Rameezdeen.

Lets look at their analysis one step at a time and today we will look at the predominance of trade credit.

Reasons for the construction insolvency problem

It is due to a combination of characteristics which are found in the construction marketplace that insolvency has proliferated in the industry. These characteristics include:

• the pyramidal contracting chains on construction projects;
• a predominance of trade credit throughout the construction industry;
• the unsecured creditor status of building contractors and suppliers for work done and/or goods supplied;
• poor payment practices;
• underbidding leading to the prevalence of tight, or even zero, profit margins in the construction industry;
• illegal phoenixing activity;
• undercapitalised firms, which are not financially resilient; and
• poor strategic business management skills of many, particularly smaller, contractors.

 

Predominance of trade credit

Construction firms take much more trade credit from their suppliers (two to three times as much, depending on the measure used) as a proportion of their balance sheet than do firms in the rest of the economy (Ive and Murray, 2013). In 2012, in his inquiry into NSW construction insolvency, Collins, (2012) found that the average contractual payment terms between principal contractors and their subcontractors in New South Wales fell somewhere between 45 and 80 days, and in the worst cases extended to between 90 and 120 days⁵.

This commercial pressure to extend trade credit terms to principals is passed on down the contractual chains in the construction industry, as each tier in the chain attempts to obtain ever generous credit terms from firms in the tier below in order to finance their works. This results in the perverse state of affairs whereby the smallest and most vulnerable construction businesses effectively end up financing the construction works on a construction project. Consequently, smaller construction contractors are exposed to extremely poor cash flow and high risk of payment default which accentuates the likelihood of insolvency.

The prevalence of trade credit in the construction industry may be explained by the dominant bargaining position of principal contractors who, as providers of future revenue to their subcontractors, wield considerable influence in commercial transactions with them. Ive and Murray (2013) refer to this as ‘dominance hypothesis’, and note that under ‘dominance hypothesis’ subcontractors may lose money by providing credit to their principals at a cheaper rate than they can obtain it.

Trade Credit

One of the key points made is "a predominance of trade credit". Many builders fund their projects using unsecured trade credit. Some builders and developers only partly fund a job then use credit with subcontractors and suppliers to finish the project before liquidating the company.

They then have a finished project and no debt, they simply liquidated the debt away. The corporate regulator ASIC is weak and underfunded. They have had ample evidence in a number of construction industry insolvencies to prosecute by they sit on their hands and do nothing so where do we turn?

Builders use credit provided by subbies to construct their own unit projects. There are many examples of  builders underfunding a unit project and using creditors money to get it to completion then liquidate the company absolving the director of the debt to creditors.

If you hear the words from a builder "we are developing our own unit complex", run a mile in the opposite direction as fast as your legs will carry you. Almost every time I heard that in 2017 a liquidation was to follow.

In many cases the director will shift assets on the advice of his pre insolvency advisors then after the liquidation, declare bankruptcy to defeat even the secured creditors with unsecured subbies at the bottom of the pile.

How can subbies protect their company?

We don't have all the answers but there are measures that can be put in place to lessen the damage if a builder you are contracted to does liquidate.

1. Trade Credit Insurance is not that expensive now and premium payments can be spread over 10 months. Acquire Trade Credit Insurance gives you peace of mind, it costs you nothing to get a quote but it may save your business.
2. Do not take a job on for a builder you cannot insure. You insure your house, how do you pay for your house? Correct, the money you earn from your business so it should be a given that you insure the business that provides you with an income that supports your families lifestyle.
3. Drive a hard bargain in your contract negotiations such as no Liquidated Damages, short payment terms and no retentions. Under the ACCC, we are required to give a warranty on all products we sell so put that argument to the head contractor. Why do you expect us to double up by holding retentions?
4. Do not sign contracts with long payment terms, retentions and liquidated damages unless it is completely necessary.
5. The ideal situation is to work on projects where the contractor uses Project Bank Accounts which we hope one day will be standard on all jobs.
6. Read and understand the contract you are signing and don't start the job until you have a copy of a contract signed by the builder with an end date on it.

We have a recent case where a builder is trying to back charge a subbie for many thousands of dollars of work he had done by another trade because the first subbie was allegedly getting behind schedule, yet the contract did not have a finish date on it.

In the meantime, we and our friends at Subcontractors Alliance will continue to put pressure on builders to do the right thing and on the Government and regulatory bodies to take action when evidence of fraud is put in front of them.

An example of how this helps is the pending public examination funded by the state Labor Government  of the directors of Queensland One Homes and Cullen Group Australia. It will be a packed house on the day those examinations take place.

Congratulations to the Government for recognising the need to get some justice for creditors and congratulations to Les Williams from Subcontractors Alliance for his work in making this happen.