NEWS & INSIGHTS

Construction insolvencies have been almost constant during the past 12 months but there is a light at the end of the tunnel.

Australian Bureau of Statistics data released last week showed there had been 1782 external administrations in the financial year to date (March 14) in the construction sector, compared with 1331 last year and 715 the year before.

It may look bad at first glance, says Andrew McCabe, partner at insolvency practitioners Wexted Advisors, but not all insolvencies are equal.

“The 1782 external administrations in the year to date need to be considered in light of the 450,000 construction companies in Australia.

“Further, you need to consider the size of these external administrations, that is, is it a company with one employee and a Ute, or is it a St Hilliers with hundreds of staff? The majority of insolvencies in the building construction industry have fewer than five employees.”

It skews insolvency statistics, he says, but there is reason to hope.

“Will we see more? Yes, in the short-term, although the return to normalised pre-Covid levels of external administrations in the construction industry, should not be a surprise.”

The collapse of St Hilliers put projects, including a Newcastle apartment tower and Bernborough Ascot Retirement Village in jeopardy.

And will we see more Tier 2 builders, more St Hilliers, going under?

“Unfortunately, as these builders approach the end of their three-year fixed price contracts, having weathered the storm of inflation, higher labour costs and supply issues, the delays and cost over-runs are continuing to impact builders as these projects are finalised over the six months.”

However, chief executive of the Australian Constructors Association Jon Davies says that we should see a decline.

"Insolvencies are reducing as the number of contractors with high exposure to fixed lump sum price contracts decreases, although this could worsen if the ATO seeks to aggressively pursue outstanding tax debts," he says.

Changing relationships

Power is shifting towards builders. Hutchinsons Builders head Scott Hutchinson told The Urban Developer’s Queensland Property and Economic Outlook this year that the company is only taking on about 20 per cent of the work offered.

“Margins were fairly low and competitive before Covid but now the number of builders at that level with that experience is fewer,” McCabe said.

As a result, former head of strategy, now chief executive officer, of development industry payments platform IPEX Paul Reid says it’s important to go above and beyond initial due diligence.

“There is all this work in due diligence at the start but once a contract is awarded, that’s the end of it, there’s no ongoing monitoring and things can change so quickly,” Reid says.

“It is a difficult one—the builder isn’t going to keep submitting financials; once they get the job they get on with it but builders have multiple jobs at any given time and the general issue is that everything is pulled out of one account, including cost escalations they didn’t plan for.”

Rork Projects went into administration this year due to “a tsunami of impossible economic conditions”.

McCabe agrees.

“With any construction business it comes down to the management of cash flow.

“Because margins are low and lumpy in terms of payment cycle and retentions, you ideally need multiple projects overlapping, some starting or finishing at the same time to manage working capital and smooth out cash flow.”

Typical red flags can include stretching subcontractor payments, renegotiations trading terms from 30 days to 60 days, as well as not paying superannuation or tax, he says.

“During Covid, many businesses did not pay tax debts, including payroll tax and used the ATO effectively as a bank. Post COVID that has changed and the ATO and revenue offices are clawing back outstanding taxes.

“The stretched payment terms and outstanding tax has led to an increase in subcontractors seeking and obtaining payment plans to manage working capital.

“We were voluntary administrators of a construction company who received a payroll tax debt of $10 million, for payroll tax, penalties and interest over a 10 year period.  Due to the size of the debt and low payment plan offered, the ATO declined the payment plan and the Company had limited options other than to restructure through a voluntary administration.

“The ATO is getting tougher, and we are seeing an increase in small business restructurings, liquidations and voluntary administrations at the subcontractor level.”

Individual state regulations can also impact the volume of administrations.

“Queensland is stricter on those that go insolvent. If you are a director of a Queensland-based construction company that goes into external administration, the company’s Queensland Building and Construction Commission (QBCC) licence is generally cancelled, which is not the case in NSW and Victoria.”

Derisking projects

Despite the easing of headwinds, it remains a struggle to attract a builder, but part of what can make a project appealing to a builder is transparency and the sharing of risk.

“Generally, all parties are looking to de-risk a project from as soon as possible. Everyone is passing the risk downward, with the builder in the middle, in the event a sub-contractor collapses they must retender projects often at the expense of their profit margin and any liquidated damages for time delays” says Mr McCabe.

“To remain afloat, many builders worked with developers to share the risk in order to complete projects...some developers provide price escalation relief and waived liquidated damages claims to ensure the builder continued in order to complete the project. ”

According to Australian Constructors Association's Jon Davies, there is a simple way of dealing with risk that cannot be priced, or when the risk far exceeds the estimate base return on a project.

“Provisional sums [cash included in the building contract sum to cover work or materials] have been around since before I started out in the industry as a quantity surveyor but fell out of fashion in the stampede towards full risk transfer.

“They can be applied to most existing forms of contract and are easy to administer. They could be brought up to date by applying incentivisation regimes to minimise the use of the sums,” he says.

Davies adds that better dispute resolution processes pre-empting these issues, and ensuring builders are paid on time will help.

Another option to ensure that individual projects are protected in the event of an insolvency is to ensure that holding companies are siloed from each other.

Reid says that is conceptually part of what the platform does, and IPEX has built a positive intent pipeline of more than $3 billion for the next 12 to 24 months.

“We don’t know what other contracts they sign and other projects they’re involved with, but we keep the money intended for that project and make sure that is reaching the project it is meant to reach,” he says.

McCabe says that it can be a tricky process to silo projects into separate holding companies or businesses.

“Perhaps that’s something they should do but if you’re splitting your business, you’re also splitting up your balance sheet.

“If you are tendering for a project, a builder will want to demonstrate a strong financial position, and this is usually obtained on a consolidated balance sheet.”

ACA’s Jon Davies says this is not a beneficial solution, however.

“We are strongly opposed to the introduction of cascading statutory trusts for exactly the reason that it will significantly impact cash flow without addressing the problem they are designed to solve—insolvencies,” Davies says.

As well, siloing companies can also lead to practices bordering on phoenixing.

“There is a cross contamination risk across other projects, if another project goes bad, what is the flow-on impact?” McCabe says.