According to a recent Deloitte report, the construction sector accounts for the highest number of insolvencies compared to any other sector, with around 25% of all insolvencies.
Within this issue lies a tendency within the property industry with property funds investing their investors’ money (that could be coming from pension funds, etc) into property development projects that can't demonstrate the contractors' insolvency risk has been eradicated - and hence no mechanism has been implemented to de-risk payments to the supply chain.
This is highly unethical and needs to be urgently addressed. It means contractors and SMEs don’t have the reassurance and transparency that funds will not be misappropriated. Without a guarantee that small business contractors will get paid, this has created uncertainty and mistrust on an industry-wide level.
Building projects are all about cashflow, however it’s no longer appropriate to invest in projects that can’t demonstrate ESG – which stands for environmental, social and governance. Project investors have a critical role to play in ensuring ethical payment practices including offsetting scope 3 emissions created from project activities.
For these and other reasons, the UK government implemented its sustainable economic recovery plan - having recognised the need to transform the payments system for the property and construction sector, and ensure swift payments to small businesses and contractors. It has also advocated the transformation of digital payments and the use of project accounts to de-risk payments in its Construction Playbook plan.
An example from Australia last year highlights the potential impact of the risk here in the UK. There, one of the country’s largest property developers and builders (Grocon) collapsed with a property fund managed by Impact Investments, losing over $20m of self-managed super fund retirees’ money, paid to Grocon for works completed by their subcontractors - who never received payment, and it’s still unclear where the money went.
The risk of underlying insolvency and misappropriation of funds needs to be addressed further to avoid a similar situation in the UK to re-align the funding of building and construction projects and restore industry trust.
To achieve this, certain barriers must be addressed.
The first relates to property developments which are typically based on a ‘project-based structure’. Here projects involve multiple firms, and a head contractor purchasing services from other contractors for ‘sub-projects’ creates complicated project hierarchies.
Due to the payment risk that this hierarchical payment chain creates, traditional sources of finance are often not available. This has created a culture of larger contractors using money owed to their subcontractors on ‘sub-projects’ as their free working capital. The result is delayed payments and business collapses causing high rates of non-payment in the sector - which propels the boom and bust culture the sector is well known for.
The Deloitte report also highlights that at least 35% of assets in the sector are made up of accounts receivable. This is more than any other industry and highlights the extent of the counterparty risk faced in the sector.
A new breed solution
The solution to these challenges is a new and evolved breed of project accounts that are now available.
In the past traditional project accounts have presented certain challengers including:
Head contractors being unable to use money owed to their subcontractors as free working capital as funds are ring-fenced to a specific project to ensure project delivery.
Laws that don’t allow for ‘pay when paid’ provisions in contracts, meaning head contractors having to source and pay for their own working capital to pay their subcontractors on time, even though they may not yet have been paid by the client.
Traditional bank PBAs having high levels of legal documentation and heavy manual admin to manage payments and multiple different bank project accounts per project.
However, the new breed of Project Accounts addresses these pain points by digitising the payment process and addressing the complete request to payment process.
With digital onboarding of project participants and digital requesting, approving and releasing payments from project accounts, the process becomes streamlined, seamless, transparent and simple.
They also remove risk and fraud with digital processes that includes assessing payment risk of the project owner to ensure they have the funds to pay for the project
In an ideal world, investors should only be investing in projects that can demonstrate they have systems or technology in place that can provide the transparency over payments to the supply chain. This creates a culture of trust, allowing project participants to get on with the job and projects completed sooner, and with less disputes.
Projects will be delivered at lower cost and with subcontractors no longer required to add 5-10% premium to quotes to compensate for the non-payment risk.
The UK property and construction industry now urgently needs more supply chain transparency over payments, what’s been approved, what’s holding things up and the ability to provide immediate payment on approved invoices.
On the plus side, there is a massive shift in community awareness of the need to do something and the willingness to achieve change is already starting to happen.
*Louise Stewart is the CEO of ProjectPay