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.