How construction can lead the way for accountants on the insolvency front line

Few industries have more experience of boom and bust than construction. But even by its battle-hardened standards, the collapse in demand unleashed on the construction sector by the Covid-19 pandemic has been truly brutal. In April, the first full month of the UK’s lockdown, output across the industry collapsed by 40% according to the ONS, and 86% of firms surveyed for the Construction Purchasing Managers’ Index reported a drop in activity. Construction enjoys another dubious honour; in the 12 months before coronavirus hit, nearly 3,100 construction firms went bust in England and Wales – a higher casualty rate than any other industrial sector. As construction reels from the Covid crisis, the industry is now bracing itself for another wave of insolvencies. As a sector which has been here before, what can construction teach accountants and insolvency practitioners about minimising the fallout during the coming months? Double jeopardy Its heavy reliance on business confidence means construction has always been a volatile sector, prone to peaks and troughs. But unlike previous recessions, in which multiple factors combined to stop developers wanting to build, the Covid-19 crisis has seen a single factor trigger a simultaneous drop in both investor demand and construction firms’ ability to service that demand. With conventional building techniques requiring large numbers of people to work together on-site, construction doesn’t lend itself easily to social distancing or remote working. Fortunately, construction was one of the first sectors to see lockdown restrictions lifted and sites have now reopened in England, albeit with workers operating under strict restrictions. Nevertheless, widespread stoppages in construction work and shortages of building materials have led to serious delays and are likely to trigger contract disputes across the supply chain. Contract crunch While many construction projects are underpinned by standardised contracts – those published by JCT and NCE are the most common – the question of liability for any breach of contract, or what compensation must be paid for a delay, is likely to hinge on who ordered work to cease. Supply chains in construction tend to be long and complex, with the end customer sitting atop a tree that includes a main contractor and multiple subcontractors, as well external experts such as architects, surveyors and project managers. While it’s essential that everyone in the chain reviews their contracts and complies with any conditions requiring them to give notice of changes to the delivery schedule, they should be wary of assuming that simply pleading force majeure will exempt them from their contractual obligations. For a business to declare a force majeure event, there must be a specific clause in the contract detailing what constitutes force majeure. Typically this will include dramatic and unforeseen events such as war or earthquake, but there’s no guarantee that disease or epidemic will be included. Building defences While some of the challenges construction firms currently face are unique to the sector, others will be universal. Wherever businesses are in distress – whether from non-payment by clients or a failure by suppliers to deliver – contract disputes and claims are likely. For now, some pragmatic players in the construction industry are showing forbearance with creditors and suppliers, inspired by the sense that “we’re all in this together”. But such truces are unlikely to hold for long. With many construction firms in a precarious position even before the crisis hit, some will be driven to take drastic action in an effort to turn around loss-making projects. In such cases, companies, their advisors and their accountants should assess, act and adapt to this unprecedented situation, as follows: Act early and decisively: by engaging with suppliers and clients, and appointing specialist help where necessary. Be honest and transparent: by providing up-to-date, accurate and concise information to clients about the impact on project delivery. Contractors should also communicate regularly with their lenders, as banking and debt covenants may be breached – and it’s essential that funders are kept onside. Understand their rights and obligations: by reviewing all contracts and establishing whether they allow for extra time, or additional costs to be charged, to complete the work. Feel the force: if a contractor is using a force majeure clause to defend against a legal challenge from a client, they will need to convince the court that the event was beyond their control and has hindered their performance of the contract. Above all, they must show they have taken all reasonable steps to comply with their obligations. Build your way out of the crisis: have a plan for bringing furloughed staff back on stream gradually, and ensure self-employed subcontractors are paid promptly for their work to help them stave off insolvency. Clearly, any construction firm under pressure should make full use of the emergency support being offered by the government. Away from the headline-grabbing support measures, there are some equally valuable changes to tax rules that companies should investigate. While the automatic deferrals of VAT payments are useful, care should be exercised as VAT liabilities will still be accrued while the can is kicked down the road. The changes to wrongful trading regulations have already given struggling companies a freer hand to act, and proposed further reforms to insolvency legislation – which would offer firms a moratorium while they consider their options and prevent suppliers from cancelling contracts – could all prove invaluable tools for turnaround specialists. Ultimately the casualty rate will be reduced if all players in the supply chain are pragmatic with each other. Better to collaborate, renegotiating contracts or retendering where appropriate, than taking the nuclear option of a legal challenge. While the pandemic will inevitably drive some contractors to the edge of the abyss and will force a sharp recalibration of property values, construction companies and their accountants who are willing to think calmly and rationally – and take expert advice – will be better placed to weather the storm. Ben Harwood, Head of Asset Recovery at Naismiths