25 September 2019

Insolvency risk in construction - be proactive

The decline of the mining industry signalled the beginning of the end of the recent building boom in Australia, leaving the construction industry highly exposed. The economic risk is huge, given construction accounts for almost 10 per cent of employment, according to ABC News.

thumbnail construction insolvencies2-1This year's Commercial Risk Outlook Report by accountancy firm SV Partners puts the construction sector at the top of the at risk list, with nearly 2,000 businesses likely to be affected, and almost 40,000 construction sector jobs lost already in the past year.

The SV Partners report identifies some of the key causes for business failure as being

  • inadequate cash flow
  • flawed strategic management of the business
  • poor financial control.
Red flags include
  • problems with suppliers
  • highly leveraged assets
  • the inability to raise further equity.

The good news is that there is demand for good development sites and projects offloaded by stressed operators, meaning the ability to survive challenges is what will keep a building contractor afloat.

Why the construction sector is at risk

The problem in construction is that multiple businesses can be involved in delivering a project, creating a flow-on effect when a major contractor hits trouble. Changes to Australian insolvency laws have been introduced this year, giving creditors increased powers to control outcomes but also providing a let-out clause for the termination of contracts if the insolvent company undertakes restructuring.

Law firm LegalVision states that the pyramid structure of head contractors engaging subcontractors who pass smaller projects to specialists and suppliers disempowers the businesses carrying out the actual work on a construction project and alienates them from the ultimate source of payment for their services.

“The end result is a transfer of financial and project management risk downstream to subcontractors, while cash flow continues to sit upstream. This structural power imbalance means business failures higher up the chain cascade down to bottom-layer parties, increasing the risk of insolvency further down the line.”

Sole operators are especially vulnerable. Under business law they are personally liable for financial or tax debts, there is no distinction between their business and personal assets; anything in their name, including joint assets, can be used to pay business debts. 

Set yourself up for survival

According SME-focused Dynamic Business, individual companies should look to protect themselves. “They can do this by carefully choosing which businesses they trade with, what terms they offer and, ideally, getting trade credit insurance to insulate themselves against non-payment by partners who may be affected by the growing rate of insolvencies.”

Business.gov.au advises exercising caution when entering into new business relationships, including taking on a client, engaging with a supplier and hiring a contractor. The key pillars are:
1. doing background research
2. negotiating a contract
3. obtaining relevant insurance*.

Half an hour on a computer using a site such as CreditorWatch should dig up any bad debts, while a carefully drafted contract can manage or mitigate liability in potential insolvency risks. The contract should clearly assign responsibilities, ownership of materials and the ability to protect your interests where insolvency looks likely, according to LegalVision, which has published a checklist of safety measures for both principal and subcontractors.

In addition to nailing down contractual rights, it is advisable to keep written records of all transactions and conversations, and to register securities and interests to establish priority of claim in the event a contractual party becomes insolvent.

If this does happen, don’t waste time.

  • Lodge all claims as soon as possible.
  • Exercise your contractual rights to demand payment or to remove work from the party concerned.
  • Get legal advice on the best approach to getting paid and limiting your own liability.

Protect yourself

Click the link to watch our video about building profit into construction contracts.

Having the appropriate insurance cover in place is essential to your financial survival. One of Gallagher’s Australia-wide construction industry experts can tailor your business insurance cover to your specific needs.

Learn more about our expertise in   construction insurance