Supply chain: Facing the abyss

The Carillion saga has exposed, yet again, the precarious nature of the balance sheets of the top UK contractors. Billions of pounds worth of work is procured by tier 1 contractors, which often have the temerity to demand performance securities from their supply chains whilst denying them any security for payment.

While this week’s analysis of Carillion’s woes indicates that failure is unlikely, nor is it likely to be imminent (indeed, one commentator describes it as “too big to fail”), the firm’s recent results will still send a shiver down the spine of many suppliers. The collapse of any one of the UK’s big contractors would be disastrous for the industry and more particularly for the thousands of companies in their supply chains.

The shock collapse of major Northern Ireland contractor, the Patton Group, in November 2012 took down parts of its supply chain with it. Ten million pounds worth of retentions were never recovered. Patton’s suppliers marched on Stormont to demand action. Eventually the Northern Ireland Executive mandated project bank accounts (PBAs) on centrally procured projects over £2m. Arguably, Northern Ireland’s construction industry and economy still has not fully recovered from this debacle.

Given this state of affairs there appears to be some ill-informed views that it is for the industry to deal with these problems. Presumably through unenforceable prompt payment codes, charters and road maps? I’m sorry to say that those dishing out such comments are living in La La Land. There is a climate of fear that runs through the industry that prevents any effective riposte to poor practices. Research carried out by Bibby Financial Services has indicated that 55% of subcontractors do not believe they can influence the terms of agreements with main contractors.

We do not need a review here. Sir Michael Latham, 23 years ago, recommended that cash retentions should be held in trust

A recent report of the Economic References Committee in the Australian senate on construction insolvency summarised the state of the construction industry in a way that could easily be applied here. It said: “The structure of the commercial construction sector, serious imbalances of power in contractual relationships, harsh, oppressive and unconscionable commercial conduct play a major role when combined with unlawful and criminal conduct and a growing culture of sharp business practices [in contributing] to market distortions.”

The committee concluded that a strict statutory fair payment framework across the whole of the Australian construction sector was necessary to deal with these embedded problems.

In UK construction SMEs are burdened with an annual debt of £25bn, roughly a quarter of the industry’s turnover; this is unsecured debt. Attempts by public bodies to put in place PBAs to ensure faster payments have been obstructed by some of the large companies. I have direct evidence of this. And we wonder why the industry has an image problem, doesn’t innovate enough and whose share of insolvencies are out of all proportion to its share of GDP. A £1.4m turnover firm has told me that they could double in size over a two-year period if they were regularly paid within 30 days.

Following the report of this Senate committee the Australian Federal Government announced a review of security of payment legislation in the various states with the aim of harmonising and tightening up the legislation. The review is due to be completed by the end of the year. I was recently contacted by one of the reviewers in relation to mandating PBAs across Australia.

Here in the UK we have had substantial experience of PBAs. The overriding benefit is that payment times have been reduced to as little as 12 to 15 days for supply chain firms (lengthy payment cycles increase the exposure of SMEs to the risk of upstream insolvencies). They are non-bureaucratic and cheap to set up and operate. The Government Construction Strategy, published last year, acknowledged that they were the most effective way of ensuring fair payment.

However, we do not need a review here. Sir Michael Latham, 23 years ago, recommended that cash retentions should be held in trust; he also recommended statutory trusts for progress payments. These recommendations were never implemented.

The government is reviewing the Construction Act (I wrote about this last year; “Payment niggles”, 1 April 2016). Any amendments to the act should:

• Mandate project bank accounts for all public sector projects over £2m in order to remove the blocking tactics of some tier 1 contractors
• Require that any party deducting cash retentions must deposit them in a statutory protection scheme
• Include 30 day payments (reflecting a similar statutory requirement in, for example, Ontario, Sweden and western Australia).

We cannot continue to foster an industry that rests on desperately insecure financial foundations. Tightening up our own payment legislation is the most effective way to drive changes in business models that stubbornly remain dependent upon supply chain funding.

Professor Rudi Klein is chief executive of SEC Group and president of the NEC Users’ Group