Assessing contractor solvency in your construction supply chain

27 April 2020

Duncan Clubb, Partner, Business Restructuring |

Those operating in the construction industry are acutely aware that their supply chain networks are an area that they can’t afford to overlook, particularly around subcontractor and supplier arrangements. Contractors who rely on subcontractors to perform work should be mindful of insolvency issues which are a systemic issue in construction.

Insolvency in the construction supply chain can be detrimental to project outcomes, ultimately increasing costs and delaying project timelines. Over the past decade, the construction industry has accounted for approximately a quarter (20-25%) of all insolvencies in Australia. While there have been several legislative attempts to overcome phoenix operators and impose penalties for directors, the issues continue to occur.

Given the historical context and based on the findings of the BDO Construction Survey 2020, participants would do well in firming up their processes for assessing the financial viability of their subcontractors and suppliers.

While all surveyed participants undertake some kind of contractor due diligence, in 75% of cases, it is often adhoc. In the last 12 months, 50% of those surveyed said they only undertook performance reviews when work was completed. Furthermore, 40% of the surveyed participants had suffered a financial loss due to subcontractor or supplier insolvency. The financial impact of these losses varied from less than $50,000 up to $500,000.

Preventative measures to manage subcontractor and supplier risk should be a priority. This involves taking the appropriate steps before entering contracts, during a contract period and after the contracting process to protect from credit risks and counterparty insolvency.

You should also protect yourself by registering each of your interests on the Personal Property Securities Register (PPSR) and/or making sure you get credit Insurance where possible. This is critical for construction where plants and equipment are one of the highest overheads for construction businesses.

Rather than waiting until the end of the process to perform an assessment, operators should be undertaking a pre-contract due diligence. When entering agreements, the approach should be to think more like a bank, by ensuring a holistic view of the business is taken, and that you aren’t making decisions in the absence of financial information.

This entails assessing the various risks associated with the contractors, by taking a look at their size, structure and balance sheets, alongside their prior performance and experience in delivering similar sized piece of work. For example, a small business operator typically has more risk than a government subcontractor.

Given the competitive and fast-moving nature of construction, when assessing contractors cash flow and balance sheets, your judgement should not only be based on historical evidence but also forecasts. Warning signs of insolvency may include a weak balance sheet with limited liquid assets, a net asset deficit, a growing trade creditor balance, high turnover of senior personnel or something as simple as r a quote that seems too good to be true.

Now more than ever, construction contractors should be assessing their contracts and the impact Coronavirus will have on their current arrangements - due to a slow-down from changed practices and reduced productivity. While many sites are doing the right thing by slowing down to ensure the safety of their people; technically they may find themselves in breach of contracts if project timelines go over their agreed arrangements. Unless amendments are made now, as soon as a liquidated damages provision is instigated under a contract – this will need to be shown on your books and if there is significant amount of liquidation damages on your books, you may be trading while insolvent.

Access the BDO Construction Survey 2020

If you would like further information on assessing your contractors, contact our team.