How Can We Stop Unviable Companies Winning Gov’t Contracts? 3

Monday, August 29th, 2016
liked this article
Lovegrove Solicitors – 300 x 250
construction government
FavoriteLoadingsave article

From the viewpoint of a politician, little will raise your interest in construction sector insolvencies more than having media reports broadcast that thousands of subcontractors were likely to receive no payment at all for work they performed on government-funded road projects.

Thus it took only three days after liquidator Mark Robinson advised creditors, including more than 1,000 subcontractors who were collectively owed at least $85.8 million by failed builder Reed Constructions largely in respect of government funded road projects, that they would likely receive no payment at all in August 2012 before then NSW finance minister Greg Pearce ordered the wide-ranging Collins Inquiry into construction industry insolvencies throughout the state. Suggestions that the company may have indeed been trading whilst insolvent for several months added to the political urgency.

Alas, Reed has not been the only government employed contractor to experience difficulty. Around the same time as Reed, Ararat Prison builder St Hilliers was forced into administration. More recently, media reports have suggested that Western Australian building company CBD, which went into administration in July, had 17 government contracts on its books worth $17.6 billion, and that Perth Children’s Hospital builder John Holland owed tens of millions of dollars in late and non-payments to subcontractors.

Of course, it should be acknowledged that the building sector does have a high rate of insolvency overall and that a certain number of contractors who are employed on government projects will inevitably fail. Nevertheless, questions must also be asked about some of the ways in which tender selection and monitoring processes can be improved, along with whether or not certain tests of financial probity such as director involvement in previous corporate insolvencies should serve as a point of disqualification in terms of the awarding of government contracts.

Johann Kenny, a chief ratings analyst within the credit ratings team at VEDA, says the need for greater diligence and analysis in this area has grown as some of the less cost effective businesses which have been able to survive in a favourable environment for building activity may struggle when work dries up and the greater volume of public sector projects going through leads to greater numbers of contractors and subcontractors needing to be assessed.

Kenny and VEDA’s head of ratings services Brad Walters suggest improvements could be made across a number of areas. First, they say, it is important to reduce the level of reliance placed upon past experience and make greater use of forward looking analysis provided by independent ratings agencies. The adoption and use of established procurement frameworks would also address current assessment inconsistencies, guiding an appropriate level of financial due diligence in the evaluation of tenders.

Finally, greater effort should be expended in terms of ongoing monitoring of financial capacity throughout the course of projects, Walters says – adding that such monitoring is not always as tight as it could be notwithstanding the fact that many agencies engage in ongoing monitoring of operational aspects of projects.

Other commentators suggest efforts in this area are generally good, though improvements can always be made and some insolvencies will occur irrespective of how thorough processes are. Joseph Barbaro, a construction lawyer and partner at Corrs Chambers Westgarth, said the majority of government clients generally have robust systems in place to assess the suitability of prospective contractors.

When performing these assessments, Barbaro says there are a number of indications which could be considered to be potential red flags. Contractors who have expanded quickly and taken on a number of significant dollar value projects simultaneously could be looked at more closely in terms of their ability to manage the cash flow impacts of all of these projects on a concurrent basis – a particularly important factor given the delayed nature of payment within the sector and the impact this can have even on high quality builders.

Contractors who have been involved in a significant number of disputes relative to the number and value of contracts which they had undertaken could also be looked at closely as these could potentially be a sign that the contractor in question is having difficulty in procuring the necessary resources required in order to deliver on its existing portfolio of work and is potentially under a position of financial stress, Barbaro says. Where contractors are hesitant or unable to provide guarantees from financiers or parent companies, he adds, questions might indeed be asked about why this is the case.

Beyond that, Barbaro agrees with Kenny and Walters about the importance of ongoing monitoring, saying that doing things such as confirming that subcontractors are indeed being paid and that information being provided on statutory declarations is indeed correct help to identify problems early. Including the contract mechanisms by which subcontractors can be paid directly as opposed to through the head contractor, meanwhile, can help avoid the situation whereby subcontractors lose out due to a failure on the part of head contractors to fulfil their obligations, he says.

“There is due diligence at the time you contract and there is ongoing due diligence which I think probably can be done a lot better throughout the industry generally,” Barbaro said. “You do the due diligence when you enter into a contract. Due diligence does not stop once you have signed a contract. It has to continue once you have signed a contract for any tell-tale signs upon which you can actually act.”

Of course, the broader situation is complicated by further factors. Many contractors are part of a broader corporate group, which may give the entity in question resources to draw on but also raises the potential for asset shifting between companies and for cash to be diverted to needs elsewhere within the group. This makes it necessary for contractors to be assessed in the context of their broader corporate group in addition to as an individual company.

Moreover, building regulation and transparency with regard to financial probity more generally is patchy across states. In Queensland, for example, directors of construction companies which enter insolvency are generally barred from acting in a critical decision making capacity with regard to another construction company for a period of three years in the case of a ‘first strike’ and on a permanent basis in the case of a subsequent insolvency. In addition, a quick search of a company name on the QBCC website will reveal records of the company’s history, disciplinary record, any disqualifications the directors may have had, and the details of any actions/decisions and so on with regard to security of payment legislation. Such requirements generally do not exist elsewhere, and such information is generally harder to find in other jurisdictions.

As to other things which could be done, anonymous sources spoken to for this article suggest breaking down larger developments into smaller jobs which are less financially stretching for even large contractors and ensuring that the tender selected is in fact based on realistic prices and offers for the job in question as opposed to merely accepting the lowest bid.

As to whether companies whose directors have been involved in previous insolvency should be barred from public sector work, opinions differ. Whilst one source suggests the Queensland model with regard to financial probity and construction contracting could be adopted across all states, Barbaro cautions against the adoption of absolute disqualifying factors when awarding contracts at an individual agency level. Where the law allows people to legally trade, he says, it would be dangerous for individual agencies to apply absolute disqualifying factors. At any rate, Barbaro argues, tenders should be assessed against a range of considerations of which director involvement might be one but should not be the sole factor.

Furthermore, a significant number of firms bidding for federal government projects will be larger and sometimes publicly listed outfits. Some of the more extreme probity issues such as pheonixing tend to be more prevalent amongst smaller contractors, Barbaro notes.

Head contractor insolvencies on government projects cannot be avoided altogether. By undertaking diligent efforts, however, public sector agencies will be able to maximise the chance that they make sensible decisions when selecting contractors for work on government funded projects with regard to financial viability and probity considerations as well as considerations about operational capability.

FavoriteLoadingsave article


 characters available
*Please refer to our comment policy before submitting
  1. Stephen Beaty

    Another driver is that government Procurement specialists are often pressured to accept the cheapest bid, use any savings on additional supervision, but the depth of on going due diligence you suggest just doesn't occur. If a strategic alliance contract can be open book, then every other contract model has the opportunity to be open book, it just needs to be added into the tender terms and conditions.

  2. Les Williams

    Walton had $337 m worth of work in early 2013 and was trading insolvent then. He actually won government and large commercial work during that time. Due diligence and robust systems my backside. It is amazing how we can find respectable terminology to describe what in most cases with construction industry insolvencies is simply fraud.
    In Qld recently a white goods company director was given 9 years in jail and his fellow director 7 for insolvent trading, breaches of directors duties and fraud. Most of these construction industry insolvencies are pre-packaged liquidations and phoenix transactions that target significant subcontractors unsecured money. They are protected by liquidators and ASIC reporting is compromised.
    In QLD since late 2013 there have been 11 Tiers 2 construction company liquidations costing 2600 subcontractors $120m and not one prosecution. Clients lodge spurious claims and the liquidator doesn't investigate.. Subcontractors recovery is $0 and the liquidators fees usually equal to the recovery made from clients and the system milked for a number of years. Check one of the liquidations mentioned.
    Statutory declarations are not worth the paper they are written on or these pre-packs would not occur. Nobody is charged. In QLD company directors banishment from the industry has been reduced to 3 years whilst their victims are affected for life. It is time that the role of liquidators is investigated. They have removed ANA's from the marketplace because of a perceived apprehension of bias but allow company directors to shop for liquidators and fleece subcontractors for hundreds of millions. We have to stop finding bullshit excuses and sanitising these insolvencies — they are fraud

  3. David Chandler

    Andrew, the biggest impediment to governments being exposed to failing contractors is their progressive loss of informed buyer capability. This has resulted from the pressure of private sector lobbying that by closing down the old poor performing public works agencies the private sector could do it better. In retrospect the solution may have been different if the question had been asked 'what is the problem we are trying to solve?' and then setting out 'how would the problem solved, be measurably better?' My view is that a root cause analysis of the problems would have turned up poor project scoping, poor documentation, poor tender pre-qualification measures and egregious contract conditions that attempted to shift the risk of these shortcomings to the contractor through contracts such as GC21. This contract like others that tried to cross over from the traditional lump sum contract to quasi D&C without any clear definition of documentation status started a procurement journey into the unknown for client, contractors and suppliers. There has never been a more important time to reconstruct some of government capital works procurement capabilities. The most pressing reason is the industry's abysmal productivity performance and unchecked rising costs. A modern version of a public procurement agency would know how to track the best performers in delivering more efficient projects. An informed client would take a fresh look at how the industry's underwrites and performance sureties could work better for everyone. Then it would be possible to refresh the pre-qualification process and the current bureaucratic driven tender process to make sure the best builders got the work.
    The private sector could learn from such a rethink.