Sector - Finance & Legislation
Interserve’s troubles a warning sign for subcontractors
Even 12 months after the collapse of Carillion, the construction industry is still feeling the effects. The contracting giant’s demise has highlighted a number of serious industry issues which need to be addressed sooner rather than later.
Multi-million-pound contracts with wafer thin profit margins are becoming more common in construction than ever before – large contractors must account to shareholders and understandably, these investors want to see a return. Pressure to see this return has led to some large contractors driving high turnover at low profit margins and consequently, if anything goes wrong, they often find themselves working for nothing, or worse still, a negative profit.
However, in an intensely competitive sector, contractors are driving down prices, focusing on turnover and volume, rather than profitability. The result of this: contractors are claiming that they can deliver everything a client wants and more, for a bargain price.
Touted to be the next big collapse at the end of 2018, Interserve has since managed to secure temporary funding and continue trading. Whilst this news has been positive in the short-term, with a reported debt pile of c. £600M it may only act to delay the inevitable, preserving the company’s situation for the moment, until the funding runs out and financial hardship comes around once again.
In the current economic climate, it is difficult to see how Interserve can trade out of this situation, other than by undergoing serious restructuring or considerably reducing the size of the business. Rather than operating as one entity, companies across the board should be choosing sensibly-sized projects and running separate commercial units focusing, firstly on profit margin and not the vanity of turnover and secondly, on different sectors to minimise risk.
When a large construction or outsourcing business goes under, it is the subcontractors, employers, and construction professionals that suffer the most. In order to protect themselves in the short-term, large contractors, such as Carillion and Interserve, have a tendency to stretch payment terms for their subcontractors. This often stifles those lower down the payment chain, causing them to struggle for breath amongst months of unpaid invoices, seriously jeopardising cash flow.
Caught in a vicious cycle, subcontractors are growing wise to the risk of aggressive sub-contracts from main contractors, in many cases refusing to engage in them. However, in the middle of tough trading conditions, building up a pipeline of work is important, and it is sometimes necessary to engage in whatever sub-contracts come along, regardless of their terms.
Despite this, subcontractors must be selective about which sub-contracts they bind themselves to – it is essential that they make a common-sense assessment, based on their size and ability to fulfil their work obligations under such agreements.
In particular, care must be taken not to enter into sub-contracts with overly-onerous payment terms, or with main contractors who could experience financial difficulty in future. To guard against this, undertaking thorough due diligence checks at an early stage (ie. before the sub-contract is tendered for and certainly before a sub-contact is entered into) is key – credit checks on businesses are crucial to gaining insight into where their exposure is and can give useful hints about whether trouble may be on the horizon.
Whenever entering into new sub-contracts, subcontractors should ideally push for a clause allowing their legal advisors right of access to management accounts upon request. If the main contractor has nothing to hide, this should not be an issue and specialist insight into the company putting a contract up for tender can highlight any risk areas early on.
Once a sub-contract is entered into, subcontractors must ensure that they exercise good financial management; meaning that they need to be on top of making interim applications for payment regularly and squarely in accordance with the terms of the sub-contract, and following up on any unpaid applications, as appropriate, without delay. That follow up might be a phone call to the main contractor to chase payment, a notice of intention to suspend the sub-contract works until payment, the threat of a ‘smash and grab’ adjudication (if there is no payment or pay less notice), or a combination of these.
One thing’s for sure, simply continuing to carry out the sub-contract works where payment(s) are outstanding in the blind hope that payment will be forthcoming is not the smart move, as it will see the subcontractor becoming more exposed to the risk of main contractor’s insolvency.
The contractual supply chain doesn’t always end with the subcontractor. Large subcontractors will often have sub-subcontractors and should make sure that their own arrangements with parties lower down the supply chain are in cohesion (ie. back to back) with the arrangements between themselves and the main contractor. This could include ‘pay when paid’ clauses which operate in the context of upstream insolvency, which provide that the subcontractor will only pay its own subcontractors once payment has been received from the main contractor.
If subcontractors have concerns about a main contractor’s financial position, it is worth trying to agree advance payments, that is, money paid up front instead of money for works carried out – this is a good way of managing risk, however, may only be possible if agreed in advance of the sub-contract being entered into and where either a good commercial relationship already exists or the sub-contract works are those that the main contractor is unlikely to be able to readily procure elsewhere.
Depending on the type of work that a subcontractor undertakes, and the work that they are responsible for, having a retention of title clause within the sub-contract is often a wise move. This would then, subject to certain exceptions, entitle a subcontractor to regain possession of goods or materials that they have supplied to site but not been paid for, or in the event that the contracting party goes under.
However, as with all things, hindsight is a great thing and many subcontractors could find themselves in a difficult situation with their main contractor well into the course of a contract. In the first instance, if a client has entered into an administration or liquidation, seeking external legal advice is essential, whilst making sure all paperwork is up to date, as best as possible. If the subcontractor has a large amount of plant and materials on site, securing it should be a high priority, particularly if it is on hire or may be needed for other projects being undertaken.
As tempting as it may be, it is important not to terminate the sub-contract without considering the wider situation. Subcontractors should make contact with employers, insolvency practitioners and other parties interested in the project, such as funders, to see if anyone is willing to take the project to completion, using the subcontractor to carry out the sub-contract works. This could involve taking over the current sub-contract or putting a new one in place.
In situations where a main contractor goes bust, subcontractors can be owed a significant amount of money. As early on as possible in the process, subcontractors should submit a proof of debt claim, for any monies owed to them. At this stage, being brash is no bad thing. In insolvency situations with lots of creditors clamouring for repayment, it is often those who shout loudest who get paid first.
Interserve appears to have avoided collapse – for the moment. However, there are valuable lessons to be learned from both its financial worries, and the collapse of Carillion. Subcontractors, in all situations and industries, should be extremely wary of the types of contracts they enter into. If it looks too good to be true, it probably is. Being more selective at the outset will be extremely helpful, should a major client go bust overnight.
Article submitted by Andrew Taylor, head of the restructuring, recoveries and insolvency team and Kate Onions, partner in the construction team at law firm, Shakespeare Martineau.
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