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Kenny Craig, RBR Advisory Partner, offers his thoughts on the construction sector post-Carillion and discusses the challenges of handling insolvency appointments in this field.

As Insolvency Practitioners, we know two things about the construction industry; never trade post-appointment and debtor recoveries will be negligible compared to book value, way below other sectors. But why is this the case and what are the implications when analysing or auditing the accounts of the average contractor or sub-contractor?

Typically the industry operates on a fixed price tender basis, with contracts awarded by the client to a main contractor who manages the project but engages sub-contractors to do much of the work, such as roofing, electrical, plumbing, painting etc. Other players can include architects, surveyors, project managers and site agents with payments made monthly upon QS valuation and architects certificate.

As the contract progresses, the scope of work can change for a multitude of reasons, be it the clients changing their mind, mistakes, project mismanagement, H&S issues, deficiencies in the original drawings or genuinely unforeseen problems like those commonly found in the ground or with old buildings. Such changes are known as “variations” and whilst the industry has improved greatly in the instruction and recording of such work, pricing and therefore payment remains highly contentious.

At a construction conference I attended many years ago, we were told that some 50% of time on a site is down-time. This startling statistic combined with the number of players involved and a natural resistance to paying over budget contributes to the blame culture and a combative, rather than collaborative, approach which has been hard-wired into the industry for decades.

Jobs won on competitive tender leave little room for manoeuvre so sub-contractors rightly expect to be compensated for unscheduled additional work at a premium. Such variations can also undermine the performance and therefore pricing of the original contract work, an issue particularly difficult to argue if the sub-contractor is already committed on site. Even when properly authorised and documented, if the price cannot be agreed, it cannot be paid, so it tends to roll up until the end of the contract, along with retentions, other disputes and the final month’s certified payment. This means that a significant % of the overall contract value can be left hanging on one final payment, leaving the main contractor with a client problem and the sub-contractor vulnerable to what is commonly known as subbie-bashing.

This is where the sub-contractor is offered a fraction of the balance sought in the Final Account with the promise of new contracts, the alternative being no payment and a long and costly legal action, with no new work meantime or possibly ever again! Not a palatable situation in a low margin industry with bills to pay and mouths to feed, so the pressure to accept is massive. The main contractor has similar pressures with the client, but being able to pass the pain down to the sub-contractor in this manner or informally apply a pay when paid policy, allows them scope to deal with the client in time. In fairness they will also argue that the sub-contractor is overstating their claim.

The problem for auditors can be where the directors fail to recognise the losses, either deliberately or otherwise, carrying the unpaid or irrecoverable amounts as claims in the balance sheet. These tend to feature highly in the balance sheets of insolvent construction companies, despite having been passed by the auditors in previous statutory accounts. Struggling companies are less likely to be able to fight their corner so it’s a vicious circle. The generic balance sheet term for all debtors and WIP is “sums recoverable under contracts” which cover certified monthly payments (debtors), WIP, retentions and claims. Once a company goes down, all sums due are effectively a “claim,” certified or otherwise as debtors seek to both minimise their loss and genuine cost of disruption as well as exploit the position for maximum gain, leaving our QS to pick up the pieces. This “kitchen sink” approach muddies the waters as to what was genuinely recoverable or not in the first place. And so it moves on with many subbies going to the wall and the poorer main contractors eventually running out of time also.

"As Insolvency Practitioners, we know two things about the construction industry; never trade post-appointment and debtor recoveries will be negligible compared to book value, way below other sectors."

Relatively recently we saw a contractor go down after losing a £3m claim at the final hurdle of adjudication, having turned down a £600k settlement. This involved another household name plc who then refused to pay anything, advising that the sub-contractor was “at it” all along. The David v Goliath bias seemed to continue when in deciding whether to sue, we were refused a FOI (even on appeal) to see what the contractor had actually been paid by the client, a Government body no less. Whatever the merits, some work had been done and it’s hard to believe in a system which can produce this sort of drastic scenario.

There was some reference to these issues in the Carillion aftermath, with one Scottish accountancy firm even calling for some sort of government clearance fund, so perhaps some changes are in the pipeline. In the meantime anecdotal evidence is far from positive and it’s hard to see what new rules will be strong enough to bring about meaningful cultural change in an industry dominated by the paper mountain (digital or hardcopy) where adjudication, arbitration and legal action is so difficult, so the recent offhand comments of an experienced QS suggesting that the industry is awash with fictitious claims is worth bearing in mind when reviewing the next balance sheet.

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