Sector - Finance & Legislation
Reacting to the recession in the construction industry: What are the dangers?
In a period of recession, the construction industry, like so many others, will be scrutinising all spending and prioritising cash flow above all else.
The good news in the current market is that there is no shortage of work, with both developers and developments continuing at pace. Although difficulty securing funds is hitting the headlines, funders are lending at competitive rates. The industry has come out of a period of real disruption in the labour market.
However, as this industry relies on cashflow considerably more than others, directors may face pressure to continually sign up to new projects to keep the cycle moving. This increased pressure can lead to oversight when it comes to reviewing contracts and potential corner cutting activities concerning compliance or materials, all of which can create major liability problems in the future. In such a volatile and competitive marketplace, both developers and contractors may agree to tighter margins than they need to, undervaluing themselves or giving discounted quotes, in order to maintain cashflow.
The issues that the construction industry currently faces are compounded by other factors including skills shortages and the continued increases in the costs of materials and labour. This becomes a particular issue as margins on construction projects can be as low as four per cent, and payment schedules are often unaligned with outgoings, meaning developers and contractors alike can be left waiting for funds to be released, and both often have to fund expenditure before receiving any income. As such, some construction projects operate at a loss, with what is a risky aim to recover throughout the project.
With the potential for the recession to further disrupt raw material supply chains, the industry could expect to see an increase in delays, as well as price spikes, making this recovery process even slower. Equally, many developers and contractors agree to projects months in advance, and subsequent price rises in terms of materials and labour could mean that the project begins at a loss on both sides. Once the quote has been accepted, a contractor will generally have a legal obligation to complete that project at that price and exiting early could lead to financial penalties and reputational damage.
In recessionary environments, disputes typically arise, as companies are more likely to find reasons to challenge valuations, delay and/or loss and expense claims in order to recuperate as much money as possible, or to put off making due payment. Parties on every side of the contractual chain should therefore consider taking extra precautions as they review contracts to ensure they are aware of their risks and obligations in order to protect their position.
Another precaution contractors can consider is to ensure that their agreements include clauses that account for potential delays caused by supply chain disruption, and agree a period of time where the quote can be revisited to account for increased costs or inflation. These clauses should take into account all risks to the business, such as spikes in material or labour costs, whilst also recognising a contractor’s obligations to the employer with the aim of minimising financial exposure should the project have a delayed start date for example. The contract should also make it clear that if the start date is altered due to unforeseeable delays, the end date can be updated to match, removing the risk of additional time pressure and an obligation to complete the project in an unreasonable timeframe.
Ultimately, it is imperative that the contract needs to work for both parties. There are conversations that can be had, and a recession is one of those times when concessions may need to be made in negotiations order for both parties to be content moving forwards.
To ensure that all contracts are fair for both the employer and the contractor, professional legal advice should be sought on all sides. Though I would obviously say it, this activity is business critical as there are real risks to companies which can be mitigated here.
Even though the current economic climate may seem grim, parties should remain level-headed when agreeing to projects. Maintaining a steady cashflow is vitally important, which makesensuring that contracts can be fulfilled without causing irreparable financial damage equally vital in this volatile time. Ensuring that a wide range of scenarios are covered in the contract and seeking professional advice when required will be key to minimising risks and safeguarding businesses as far as possible as the recession begins to hit in earnest.
Article submitted by David Morris, legal director and construction specialist at law firm, Shakespeare Martineau
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