Project bank accounts: Private practices

Poor payment practices are endemic in the construction industry. Sir Michael Latham’s recommendations in 1994 – which culminated in Construction Act 1996 – were aimed at that issue and achieved some measure of success. But those determined to abuse the payment process found ways of evading the new laws – as the court cases that the act generated demonstrate. Then there was the Late Payment of Commercial Debts (Interest) Act) 1998, which provided a rate of 8% above base for late payers, but this seems to have had little impact.

As with so many reports before it, the Office of Government Commerce’s guide to best fair payment practices for construction procurement trenchantly makes the case for change: it estimates that the widespread adoption of its fair payment practices could save the public sector more than £750m – although admittedly, this is a benefit analysis based on interviews with contractors and their suppliers.

In truth, even though the figures may be as optimistic as they are unverifiable, there is nothing very surprising about this. One of the much-vaunted advantages of the construction management procurement route is that clients are able to ensure much quicker payment to the supply chain. Rather than payment cycles of upwards of 40 days as money cascades down the supply chain, contractors are paid within fewer than 15 working days from application. This – and the promise of repeat business – keeps prices from key trade contractors competitive and the private sector would say that it achieves savings in excess of the 2.5% levels noted in the OGC report.

So how does the OGC propose to make this transformation given the repeated failures of the past? Well, it has a number of idea …

• It suggests that all projects include a fair payment charter – but that will not deter the defaulters.
• It suggests targeting payment to the supply chain within 30 days – but the government has tried to achieve this before.
• It advocates shorter payment periods, greater use of milestone payments and the inclusion of past performance on payment as a key prequalifying criterion for contractors. Sensible but not innovative or earth shattering…
• But the main recommendation is progressively to introduce project bank accounts where “practical and cost effective”. Put simply, this requires the client to set up an account and to make payment of amounts due under the main contract directly into it. Before the client’s money hits the account, the contractor must prepare a breakdown of the main supply chain payments included in its valuation. Under the operating mandate for the account, the authorised signatories for the client and the contractor then release funds directly to the supply chain in the amounts contained in the contractor’s breakdown.

The account itself is governed by a trust deed under which the key subcontractors can claim the money if the contractor becomes insolvent.

It is still the contractor that determines amounts due to subcontractors. And there are no real proposals for dealing with its sticky fingers

There is no obvious reason why these project bank accounts should not also operate in the private sector. Apart from the administrative costs of setting up the account, there is little in the proposals that should cause clients any anxiety. They are not being asked to pay money in advance, they are not being asked to change the valuation/certification processes under the main contract and they are not being asked to make any judgments about disputes between the contractor and its subcontractors.

But, given this, just how effective will these proposals be?

• They will prevent contractors sitting on the cash. To the extent that this was funding some bad contractors’ operations, maybe they will need to increase their tender prices and be driven out of the market.
• But it is still the contractor that determines amounts due to subcontractors, and set off and contra-charges operate in the same old way. There is no real proposal for dealing with contractors’ sticky fingers.
• The account does not provide any real comfort in the case of client insolvency since the amount paid by the client into the project bank account is only the amount that is due to the contractor already.
• The trust arrangements are designed to protect only key subcontractors who are party to the trust deed and are of doubtful legal validity on an insolvency – even assuming that there is surplus cash in the account at that point.

So from the private sector clients’ perspective, project bank accounts are an interesting idea and one that they would undoubtedly support if persuaded that the account would improve the industry and not just be an additional administrative burden. But the main impact is on the main contractors and it would be interesting to have their views. So perhaps we will hear from you in Building’s letters pages?