Protecting your rights in a tightening construction sector
Andrew Dixon, Commercial Director – Specialist Finance, Aldermore
Amidst an economy that has been shrouded in uncertainty for the past couple of years, there is evidence that conditions are getting tougher in the construction industry. Recent figures from accountants KPMG revealed that the number of construction firms falling into administration leapt by over half during the third quarter of 2019, as factors such as rising material costs, labour prices and project delays increased pressure in the sector.
One of the effects that Aldermore has been hearing more about from our SME clients is that the larger contractors are managing their own cash flows more assertively. There have been press reports of “endemic late payments” by some main contractors. There also appears to be an increased use of mechanisms in contracts to tighten up on payments. This includes Pay Less Notices, where a contractor will inform a sub-contractor – often at very short notice, even just days before payment is due – that they will be paying them less than they have billed for, due to disagreement over the value that has been delivered during that month or billing period.
Clearly, this puts pressure on the sub-contractor who has staff to pay and expenses to meet. It can lead to a dispute situation where the sub-contractor is caught between needing to carry on working on site in order not to breach the terms of the contract and the need to protect their financial interests by contesting the Pay Less Notice.
It can even contribute to pushing firms under. Recently, Leeds-based firm Wetheralds went into liquidation, with director Mark Murphy reported as saying: “Pay Less Notices and major firms not paying are driving firms out of business.”
Pay Less Notices are more common in the closing stages of a project when calculations of accumulations and margins become clearer as the final accounts are compiled. They are also common where there have been variations to contracts as a project has progressed. Frequently, a main contractor will ask a sub-contractor to carry out additional work not in the original contract, with the promise to agree pricing and payment later on. The sub-contractor is effectively obliged to perform the extra work without a price formally agreed.
Pay Less Notices and payment disputes also often arise where there have been delays during the project. A contractor may apply penalties for liquidated damages where a delay to one aspect of the construction has incurred a cost for them elsewhere. Due to the complex inter-dependencies of any construction project, determining who is at fault can be difficult and open to interpretation.
All of these factors mean that dealing with a payment dispute is not straightforward. As often as not, the end result is a process of arbitration – which can be lengthy, tortuous and costly. This only puts more pressure on the small sub-contractor. Sometimes the pressure can be so intense that they accept a much lower offer than their original claim, simply to end the arbitration process and receive some funds to keep the business running. This may wipe out any profit they were due to make on the project and even leave them nursing a loss.
With these situations becoming more common, it is essential that SME contractors ensure they are taking all the steps they can to protect their position. So, what should you be thinking about?
Aldermore have set out some advice and guidance for construction firms in our guide 5 steps to construction success. Firstly, it means going into any project with your eyes open and forecasting cash flows and expenses as carefully as possible in advance. Make sure you are aware of what could hinder cash flow and if there are going to be significant outlays in advance, try to negotiate credit terms with your supplier. When it comes to invoicing, make sure your applications for payment are clear and concise. Provide a template that shows what you are asking for and how you have calculated that sum. Provide an estimated final account and clearly define variations. Be clear about when payment is due and also make reference to the final payment date in your applications.
Another key aspect is to continuously track work progress against the project plan. Make sure you know where you are and how work is going. If there are delays, obtain evidence and document it. For example, if you are unable to commence work because another sub-contractor has not completed their work ahead of you, go on site and take photographic evidence of this and ensure the relevant notices are submitted in line with the contract.
If things reach an arbitration situation, it is vital to obtain professional advice. This can make all the difference to the outcome. Sometimes, sub-contractors choose to represent themselves without any quantity surveyor and simply weaken their own case by failing to bring evidence with them or present facts clearly. A good quantity surveyor can help marshal your evidence and give independent weight to your case. Sometimes, firms are put off from engaging a professional advisor because of the cost of doing so – but frequently a surveyor will be able to review the available evidence quickly and make a recommendation up front, saving both time and cost overall.
Peter Vinden of The Vinden Partnership, who represents many small construction firms in disputes, advised: “Unfortunately, payment disputes are on the rise, fuelled by contractors who are seeking to use their supply chain in order to help finance their own business. On a practical note, it is vitally important that you properly vet the contracts you are entering and that you understand the implications of amendments made to the standard forms of contract offered up to the unwary. All construction contracts will contain provisions that allow for the issue of a Pay Less Notice in respect of sums already certified. It is up to you to negotiate the shortest period possible for the issue of a Pay Less Notice from the date of certification to help give you visibility, certainty and control over your own company’s cash flow.”
No party, large or small, wants to get into a dispute – but the fact is that they are increasing. Inevitably, they can present real working capital challenges. There are, however, funding mechanisms that can help you work through this. At Aldermore, we remain absolutely committed to supporting and lending to SMEs in the construction sector and are always willing to talk to businesses about their needs. Construction Finance enables clients to access finance against uncertified applications for payment – bringing almost immediate liquidity into the business.
Today sees a challenging construction market against a wider backdrop of economic uncertainty. Yet there is support and advice out there to help firms navigate the challenges they face.