Protecting subcontractors against rising insolvency in construction

With established builders entering external administration despite a construction boom, what does this mean for your subcontracting business? 

HERE ARE A FEW THINGS YOU THOUGHT YOU’D NEVER HEAR:

• People fighting in supermarkets for toilet paper
• Half the population forced to stay at home
• Used cars costing more than a brand-new vehicle
• Builders going bust in a construction boom

The world has certainly changed in recent years!

However, there’s one thing that stays the same no matter what happens:

Cost price must be less than sell price to make a profit

In August 2021, the Australian Bureau of Statistics figures confirmed that Australia is in the midst of a real estate boom with national prices up almost 19% year on year.

This has led to an exponential increase in construction activity, where employment levels in the construction industry account for around 8.8% of Australia’s total workforce.

Sadly though, the media has recently reported that several high-profile builders such as Pindan, Jaxon and Schlager Homes have entered external administration.

How is it possible that so many established builders are entering external administration when a construction boom is underway?

The answer is cost.

For example, the nature of the building industry means a builder can submit a quote long before a contract is awarded and the building is completed. For a builder who prices a job in late 2020, the project may not start until mid-2021 with completion not expected until early 2022.

But in the time since initially quoting the fixed priced job, the prices of timber, cement, steel, glass, sand, and most importantly labour, have risen more than 20%.

Going back to the landowner or developer for an increase in the contract price is usually met with a definitive NO!

Therefore, the increased cost turns a forecasted profitable job into a financial burden. If you then multiply this by the several jobs an average builder will take on at the same time, this places large stress on the viability of the business.

THE EFFECT OF ADMINISTRATION ON SUBCONTRACTORS

Pindan and Jaxon had several ongoing government projects when they entered administration.

The administration would undoubtedly increase the cost of the project to the government and in turn affect the financial situation of the subcontractors who had been engaged to work on the various projects. 

For this reason, the WA Government recently announced a roadmap for implementing new Security of Payment reforms that aim to protect subcontractors.

They include speeding up payment times, providing a faster dispute resolution process, and greater protection of subcontractor monies in the event of a contractor’s insolvency.

When assessing tenders, the WA Government now considers these factors in selecting a head contractor for construction projects:

• Whether the respondent is financially secure.
• Whether the respondent has a poor payment history.
• If the offered price is reasonable.
• The respondent’s past work performance.

Head contractors are also required to make a statutory declaration that subcontractors have been paid all the money they are due.

While these are welcome changes, there is an extra step that government agencies, councils, and even subcontractor entities can take to provide further assurance of a builder’s capacity to pay.  

A trusted third party can conduct a discreet and independent assessment to confirm:

1. The contractor’s financial position (cash flow and balance sheet positions) as it stands prior to tendering, and during the project.
    
2. The contractor’s payment on past projects and the current project (determined by comparing progress claims and direct engagement with subcontractors).
    
3. The reasonableness of the tender and offered price, factoring in the increase in cost over long projects.
    

While it’s wise to conduct these assessments before entering into any new construction project, they can be done at any time throughout the project if a government or subcontractor entity becomes concerned about the solvency of the contractor.

It’s no doubt a difficult time for builders and subcontractors alike, however, there is help available.

If you’re concerned about cash flow as a builder, getting paid as a subcontractor, or the ability of a contractor to complete a job as the developer, have a chat with a financial expert.

They can assist you in navigating the complexities of your situation to provide a clear, practical way forward.

To learn more about how RSM can assist with discreet, cost-effective and timely independent assessments, simply contact your local RSM office.