Protection against insolvency: Cash back

Building recently highlighted the alarming rise in construction industry insolvencies; more than 10 firms a week are going into insolvency. Thousands of firms - especially SMEs - are squeezed between waiting longer and longer for payment and banks’ unwillingness to extend credit. Incidentally, banks are now excusing their lack of lending to the industry on the grounds that industry payment practices are so poor and predicted cash throughputs cannot be guaranteed.

Insolvency protection has been a hot issue in the industry for many years. Over 17 years ago Sir Michael Latham recommended statutory trust funds for inclusion in the Construction Act but this was not acted upon. In 2009 my own organisation put down an amendment in the House of Commons to improve the protection offered by the act. It had the support of the Tories and Lib Dems but was defeated by 69 votes because of the previous government’s majority.

The amendment sought to extend the statutory right of suspension for non-payment. Let’s say a firm had 90-day payment cycles. Ten days into the cycle it learns that the paying party is in serious financial difficulties. The amendment would have enabled the firm to request that the paying party provides adequate security for payment - such as a bank guarantee or payment bond - failing which it could suspend its contractual obligations immediately rather than waiting until the end of the 90 days.

Many jurisdictions - for example, Canada, United States, France, Germany, Switzerland and Australia - have a measure of statutory protection to deal with insolvency risk. This acknowledges that construction, compared with other industries, is far weaker when it comes to protecting itself against insolvency risk. This is exacerbated by poorly capitalised clients and contractors.

The bleak insolvency picture has prompted the government to drive forward with project bank accounts (PBAs). Two of the largest departments - the Defence Infrastructure Organisation and the Highways Agency - have made policy decisions to use PBAs on all their construction works. Almost £2bn worth of work is now going through PBAs. The government is hoping to double this figure within the next couple of years. Once money is deposited in the PBA, it is ring-fenced by a trust fund and is paid out simultaneously to the supply chain. Furthermore, tier 2 contractors on public sector works should be paid within 19 days of the due date under the main contract (23 days for tier 3 contractors).

The new Construction Act now provides firms with an improved array of weaponry when it comes to minimising losses from upstream insolvency. It applies to contracts entered into on or after 1 October 2011 (1 November for Scotland).

Here is my checklist to help firms keep on top of their cashflow:

• Make sure you operate the new statutory payment notice procedures which are aimed at defining the amount due at the date for payment.
• Make full use of the more flexible statutory right of suspension which enables you to suspend any or all of your obligations. For example, you could cease to maintain in place a performance bond.
• Seek payment bonds/bank guarantees whenever possible.
• If you are denied payment because of the insolvency of a third party payer, (for example, the client), challenge any pay-when-paid clause on the ground that it is an unreasonable exclusion clause under the Unfair Contract Terms Act 1977.
• Remember that pay-when-certified clauses and cross-contract set-off are outlawed under the amended Construction Act.
• Retentions are a scam; they are always at risk where there are upstream insolvencies. The new Construction Act outlaws provisions that make release of your retentions conditional on the issue of some certificate under another contract.
• Consider alerting credit reference agencies when your payer seeks to extend payment periods; they will downgrade their credit rating meaning they may change their mind.

In the current climate there is no room for sentiment when it comes to managing cashflow and keeping afloat. But statutory insolvency protection must remain on the agenda. Millions of pounds worth of construction works continue to be procured by firms whose liabilities far exceed their assets. As a first step there should be a statutory requirement that procurers provide evidence (before any construction work can commence) that they can fund the work and will retain the necessary funds in place over the duration of the project.

Rudi Klein is a barrister and chief executive of the Specialist Engineering Contractors Group

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