Why are Australian Construction Firms Failing? 3

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Monday, May 4th, 2015
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Even as building conditions pick up, the construction sector in Australia continues to be dogged by high rates of business failure and a shocking impact upon unsecured creditors such as subcontractors.

External administrators were appointed to no fewer than 764 companies within the building sector throughout Australia in the six months to December alone, ASIC data indicates. During 2013/14, ABS data shows that 52,945 operating businesses left the sector, implying the third worst ‘exit rate’ (15 per cent) of any sector throughout the Australian economy.

Horror stories keep coming. Creditors could lose an as-yet unknown amount in the latest collapse of the Integrated Construction Management Group, which went into liquidation on April 17.

Kingsway Financial Assessments head of business information Robert Jochelson said subcontractors are often the worst impacted party.

“Subcontractors are definitely the biggest losers and fund the industry from the bottom up,” he said. “They are largely unsecured and often trapped in the contracts where they are afraid they will be in breach of their contract if they stop work even if they have not been paid, despite the fact that the head contractor has breached the contract by not paying them.

“They can get strung along from month to month with promises of payment and this increases the amount of money they eventually lose if the company fails.”

While opinions about the cause of failure vary and a relatively high rate of business entries and exits may seem normal for an industry characterised by low barriers to entry and a high number of very small entities, sentiments expressed by Jochelson as well as a number of parties who put forward submissions before a Senate inquiry into construction sector insolvency carry a number of common themes, including:

  • Contractors being forced to bid for work at unsustainably low margins simply to retain enough work in order to keep their workforce intact
  • Insufficient due-diligence on the part of some principals to ensure head contractors bidding for work have the appropriate financial backing to see the project through
  • Poor business management and cash flow management
  • Trying to grow too fast without appropriate systems and resources in place
  • Pressure on subcontractors to agree to unduly onerous contract conditions and excessive payment terms
  • Late payment from contractors to subcontractors and poor record keeping on the part of either party

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The pressure on contractors and subcontractors is a particularly common refrain. The Electrical Trades Union, for example, said in its submission that a recent depression within the construction industry (with the exception of housing more recently) had “promoted an unfair transfer of risk to main contractors, where main contractors need the work and feel forced to take on more risk on projects through inequitable contract conditions.”

The Air Conditioning and Mechanical Contractor’s Association, meanwhile, complains that “the structure of the commercial building and construction sector, typically characterised by a top-down chain of contractual relationships, propagates an environment whereby risk is disproportionately allocated to subcontractors.”

Renowned construction sector advisor David Chandler took things a step further, saying the industry is beset by deep structural problems, including unsustainable workplace relations practices, a reluctance to change and a procurement culture which is “combative at every level.

Chandler described many enterprises in the sector as being “organisations whose business strategies are either non-existent or flawed,” and added that many are “unsustainable and simply represent terminal outcomes waiting to happen.

He said the sector costs 20 per cent more than it should and has delivery times which are 40 per cent slower than justified and an on-site workforce input which is 30 per cent more than needed. If nothing is done, he reckons more than 150,000 jobs throughout the industry could be lost by 2025 as rates of import penetration rises to as high as 40 per cent.

What can be done? Industry groups such as Master Builders Australia want more emphasis on business management skills during training as well as greater consistency in harmonisation of regulation across the country to reduce construction costs and delays. The ETU wants financial and management skills to be introduced at the point of qualification, more financial probity checks when assessing licensing applications and a clearer definition of and increased sanctions and penalties for phoenix activity.

The idea of imposing the mandatory withholding of retention payments in construction trusts to safeguard money owning to subcontractors – a recommendation by the Collins Inquiry in New South Wales which the government in that state is trialling – is popular with debt collection experts but opposed by industry lobby groups such as Housing Industry Association on the basis this would restrict the ability of principle contractors to use money received from progress payments in a flexible manner.

Again, Chandler wants the industry to go further, and has called for all public and private sector projects worth more than $5 million to conform to a national construction productivity and modernisation strategy by 2020. He said the Senate Committee could follow the model of the Singapore Government’s Economic Strategies Committee and work out a broad road map for construction productivity.

While not all business failure is avoidable, a broad consensus appears to be that insolvency rates within the construction sector are too high and that underlying structural factors leading to this need to be addressed.

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3
  1. Andrei

    Very simple, leverage of the business is not regulated. Think of it this way, all banks have a leverage limit (i.e how much they can borrow vs what the have). Construction companies are not regulated that way, they can essentially leverage (i.e. 'borrow' creditors i.e subcontractors) money to simply unsustainable levels, so even a small disruption in their cash flow makes them essentially insolvent. This is your problem. Security of Payment act attempted (amendment 2014) to address this by requiring a statement to be signed by directors that all subcontractors have been paid unless there as a dispute in relation to the amount due. The Act imposes penalties personally on the directors should they falsely make such statement. Im curious to see how ICMG's directors will be held liable, i have my doubts.

  2. Hi Andrei,

    Yes, that will be interesting. Thus far, as far as I am aware, there are no suggestions that the directors of the company at ICM did anything wrong. It will be interesting to see if any evidence or suggestion of wrongdoing emerges in this case.

  3. Grant Spork

    "The industry is combative at every level." That is the experience of most participants. If monies for subcontractors were held in trust, an an independent tribunal could be called in to resolve disputes, insolvency rates would decline. What is also a characteristic of the construction industry is that trades that start projects are often more stable and get paid more consistently, those who are finishing trades often fins their accounts challenged with false claims of lateness and defective work, also a much higher rate of insolvency. Such a profile of insolvency would indicate the problem is that head contractors game the system and that a trust fund and compulsory security of payments clauses would go a long way to reduce insolvency for sub-contractors.