Unfortunately, the construction industry and the insolvency profession are close cousins. Despite attempts by regulators to monitor the financial wherewithal of licenced builders, the fact remains that there is a very real risk that a contractor you deal with could go into liquidation.
And if that happens, the consequences for you can be significant.
Most recently, we’ve seen this with several large contractors in quick succession – Privium, Condev, Probuild to name a few. When they fall, they tend to cause a lot of damage to the subcontractors who were relying on their bills being paid to make ends meet.
In this article we’re going to discuss a few ways you can try to minimise your risk. We’ll also run through the critical information you need to know about the administration and liquidation process should you get entangled with a company in financial distress.
We’ll deal with three main areas:
- Project delivery;
- If your Contractor Goes Under.
Somewhere in the multiverse, where fairies fly through the air and the streets are paved with gold, you can sign a contract which offers you all the rewards and none of the risk.
Back in the real world, though, you are usually somewhat limited in what you can negotiate with a head contractor. Sometimes this is because their own head contract restricts what they can negotiate on, and sometimes it’s simply because they have a better bargaining position.
That said, there are a few areas where you can sometimes try to tweak the specifics so that your risk is lowered and any alarm bells ring loud and clear. Of course not all of these are always possible, but sometimes a small change here and there can make a large difference in the final result:
- Payment Increments – probably the largest risk is that your client will go into liquidation owing you a lot of money. One way to try and manage this is to look at when and how you can issue invoices or payment claims under the contract – the more often, and the faster timeframes for payment, the less exposure you should have provided you are administering the contract well.
- Outlay timing – when do you have to pay for any materials and how long will it take you to get paid for them? Having a massive up front outlay which is only ultimately recovered in the final payment claim leaves you vulnerable. The more you can spread out your materials costs or speed up payment sufficient to cover those materials, the better.
- Material Storage and Security – it’s common, and sometimes necessary, for goods you purchase to be stored on site. The problem is that you neither own nor control the site. So ideally if you need to buy a large quantity of materials and leave them on the contractor’s site, you should have a clause in your contract giving you security over those goods for as long as you are owed any money under the contract. You can (and should!) then register that security on the PPSA. If you don’t do these things, an administrator or liquidator could potentially take the goods you have paid for, as we describe in this article here.
While contract negotiations can help, the way you manage your contract throughout the project will have a significant impact on how much, if any, damage you might suffer should your client experience financial distress.
There are two main areas to be on top of – one business, one legal.
When to Draw the Line?
From a business perspective, one of the most important facets of project delivery is for you to have a good idea of when it’s time to bail. Terminating a contract or suspending works is no small issue, and certainly not one to do without legal advice. But sometimes it’s the only choice.
That means you need to understand the amount of risk your business can carry on any given project before it becomes untenable to continue. Are you putting all of your resources into a single job? Did you price the job so that all the profit is at the final claim? If material costs increase do you have contract provisions to accommodate the rise?
And, most relevantly for our discussion here: if payments are late, or reduced, how much are you prepared to tolerate before the risks outweigh the potential rewards? Is it one late payment, or two, or three? What happens if “late” becomes “unpaid”?
More often than not, when large contractors go under we find that they have been making promises of payment to subcontractors for some months. Many of those subcontractors were obviously concerned about the late payments, but didn’t necessarily have mechanisms in place to know when to draw the line.
The problem looks like this:
- Month 1 – you buy materials and invest labour into the project. You submit a progress claim for month 1.
- Month 2 –
- You continue to buy materials and invest labour into the project. You submit a progress claim for month 2.
- The Contractor doesn’t submit a payment schedule or response to your month 1 claim. You send a reminder and they say there were some delays in processing.
- Month 3 –
- You continue to buy materials and invest labour into the project. You submit a progress claim for month 3.
- The Contractor confirms your month 1 payment claim and indicates payment is forthcoming.
- Contractor queries some items on your month 2 payment claim and asks you to re-submit.
- Month 4 –
- You continue to buy materials and invest labour into the project.
- Towards the end of the month, the contractor appoints administrators.
At this point you’ve been carrying overhead, project costs and outlays for 4 months.
So the question is this: can your business survive if you don’t get paid for that 4 months on that project?
If not – you should have drawn the line sooner.
The second area to monitor closely in project delivery is contract administration.
It’s tempting to let good contract administration slip in the interests of “maintaining a commercial relationship”.
Avoiding making claims you are entitled to, letting scope changes sail through without variations, and wearing the cost of otherwise claimable delays in the interests of the commercial relationship often seem like a good idea because these things could annoy your client.
Unfortunately each decision to do so erodes your profit on the project – piece by piece. And if your profit is gradually decreasing along the way, then every invoice which might go unpaid in an insolvency event is going to do even more harm to your business because you’ve got less margin on the job to play with.
Put it this way – as a normal project finalises, do you think the head contractor is going to let defects go unrectified in the interests of that commercial relationship you’ve worked hard to preserve? Of course not. They expect you to deliver what you agreed to deliver. Likewise, you should rightly expect to be paid what the contract allows you to be paid.
The better choice is to manage the contract well, preserve your rights, and do so in a way that still preserves or improves the relationship. This comes down to effective and open communication with the head contractor.
So what happens if you’re mid-project and the contractor announces they will be going into external administration?
The first thing to do is to understand the different types of external administration. We discuss those here.
Let’s say in this case that the contractor has appointed administrators, and will likely go into liquidation.
Administration/Liquidation Process in a Nutshell
Here’s a fairly normal mud-map of how the administration will unfold:
- The administrators will write to you, saying you should not do any further work without their express approval.
- There will be a first meeting of creditors within a few days of their appointment. This will give you some basic background information about their appointment, but not too much information will be known at this point.
- In Queensland, the QBCC will issue a show cause notice and likely cancel any building licence the contractor held. This can sometimes be avoided, but not usually.
- Without a licence, the contractor will be unable to pursue projects on foot, and the principals across the board will either terminate or take the work out of the contractor’s hands (subject to their own legal advice of course).
- For unpaid amounts owing to you, you will submit a “proof of debt” in the liquidation – this is where you set out what you say the contractor owes you.
- Within a few weeks, there will be a second meeting of creditors (including you if you decide to attend). The administrators will make a recommendation about the future of the company – for our example, they will recommend liquidation. The creditors will vote and, if passed, the administrators will become liquidators.
- After some time, the liquidators may declare a dividend and pay creditors a portion of what they were owed. If this is more than zero, it tends to be cents in the dollar.
Liquidators have essentially one task – to liquidate the assets of the company (including claims against others) and distribute the proceeds to creditors. They are entitled to be paid their own fees and expenses off the top. Some types of claim get priority over others (notably secured creditors like banks, and employees).
So beyond what we’ve described above, once the liquidators are in what can you try and do to minimise your losses?
Have your Paperwork in Order
Having a claim that aligns with the contract, makes sense, and has all the associated paperwork is going to smooth the way for your claims in the liquidation.
If the maths doesn’t work, or there is something missing then at least know about it in advance in case you are questioned about it.
Ordinarily a liquidator will only take a fairly quick look at claims at first. They really only need to make a full assessment before paying out a dividend – which could be a long time down the track.
But getting your own side of things in order is a good place to start.
Utilise your Securities – If Any
If you have a registered security interest over anything of value that was still in possession of the company, then you need to be taking steps to either:
- get it back so you can use it on other work; or
- allowing the liquidators to sell it on the basis you keep the proceeds of sale attributable to those materials.
Of course, bespoke materials rarely have any value to third parties, but if a new contractor on the job could use it there might be a chance of some recovery.
It can be hard on larger projects for an incoming contractor to secure new trades to complete the work.
And, of course, the path of least resistance is to contract you to just keep doing what you were doing.
So in some cases you’re have an obvious opportunity to attempt to negotiate a balance contract price that addresses some of the non-payments. Of course, the incoming contractor will want you to carry the risk of your previous work, but done right such a negotiation can be a win/win scenario.
While adjudication has become the dominant form of collection activity, many States still have the ability to pursue a subcontractor’s charge.
The basic idea is this:
- you lodge a notice of charge;
- the principal is required to withhold payments from the contractor (in this case, the liquidator) and will most likely pay that money into Court;
- you commence Court proceedings to get that money paid out to you. If there are other subcontractors who have done the same, the money will be paid out pro-rata having regard to the total available.
The good thing about this is that unlike simply waiting your turn in the liquidation, you actually have a security interest over the principal’s money – that is, you get a higher priority to payment. As a result you don’t need to line up with the other unsecured creditors, which can often be fruitless. There can, sometimes, be delays in the Court proceedings coming to an end while the Principal works out the contract, but it can often still be a more successful way to go.
Importantly, subcontractor’s charges must be lodged within strict timeframes – so it’s important to get legal advice ASAP to ensure you get your claim in.
Live to Fight Another Day
If you can do good deals, understand your trigger points, administer your contracts well and avail yourself of opportunities for payment, then your client/contractor going under doesn’t need to drag your business down with it.
If you need help with any of these steps, feel free to reach out.