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Subcontractors should be on
high-alert after Interserve’s troubles

Subcontractors should be on high-alert after Interserve’s troubles

Published: 25th February 2019
Area: Corporate & Commercial
Author: Kate Onions

Interserve seems to have avoided collapse this time around, but subcontractors should still be wary when entering into contracts with large clients.

The construction sector has seen a rise in multi-million-pound contracts that are operating on thin profit margins. Shareholders want to see a return from their investments and this has caused them to prioritise high turnover activities above higher profit margins. If issues arise, the pressure is firmly pushed further down the supply chain, leaving subcontractors working for nothing or even a negative profit on some occasions.

Even so, contractors and subcontractors are still lowering prices in order to keep themselves competitive in a sector where work is fiercely fought over. Consequently, subcontractors are opening themselves up to potentially devasting financial risks.

Here’s what you need to know:

Interserve’s troubles

Interserve was on the verge of collapse at the end of 2018, but has since secured temporary funding, enabling it to continue trading. Although positive in the short-term, the reported £600m debt means the funding could simply be delaying the inevitable.

The difficulties of the current economic climate mean that to escape this situation, Interserve seems to have two choices:

1 – undergo  a major restructure; or

2 – substantially reduce the size of the business

Across the  construction sector companies should be considering splitting into separate commercial entities who each take on sensibly-sized projects in different sectors to minimise risk. This way, profit margin increases, and businesses are provided with additional protected from financial collapse.

Risks to subcontractors

Subcontractors, employers, and construction professionals are hit hardest when a large construction or outsourcing business collapses. A short-term protection strategy is often used by large contractors, that causes those lower in the payment chain to be suffocated of money. Months of unpaid invoices pile up and cash flow grinds to a halt.

To avoid this happening, some subcontractors are refusing to engage with large contractors. Credit must be given to subcontractors who adopt such an approach for standing up to large contractors.

In reality, this is not always a sustainable option for the majority of subcontractors and some feel that they must accept any terms presented to them in order to keep the business afloat.

However, being selective about which terms they agree to is a smart move. Choosing a contract that suits them, based on their size and ability to complete their work obligations, is vital and will ensure long term success.

Carrying out legal assessments

Assessing whether a contract has overly demanding payment terms, or the company has a chance of future financial issues, is essential to making the correct choice for subcontractors. Due diligence checks can uncover these problems at an early stage, making it clear to subcontractors that they should not enter into a deal based on the proposed terms.

A business that has nothing to hide will happily give a subcontractor’s legal advisor rights of access to management accounts. Therefore, asking if this can be part of the evaluation process is a smart move. If they refuse, this suggests that there are underlying problems which they are seeking to hide and working together should probably be avoided.

Financial management is key

Maintaining good financial management when a contract has been entered into is essential. Subcontractors need to ensure they are making interim applications for payment on a regular basis and in line with the contract terms. Unpaid applications must be followed up without delay. This could be done by calling the main contractor to chase the payment, issuing a notice of intention to halt works until payment, the threat of a ‘smash and grab’ adjudication (if there is no payment or pay less notice), or a combination of these actions.

Continuing works in the hope that eventually payment will be received is not wise. It merely puts the subcontractor at further risk if the main contractor becomes insolvent.

Contractual agreements

Clear communication between all parties is needed. Those lower down the supply chain should be working in cohesion with the arrangements that the subcontractor has made with the main contractor. For example, in the context of upstream insolvency, ‘pay when paid’ clauses could be agreed, so that all parties can be paid on time.

Having a retention of title clause within a contract is also a smart move. That way, if goods and materials supplied by the subcontractor are not paid for, or if the main contractor goes under, the subcontractor has the right to regain possession of said goods. However, agreeing to a retention of title clause is only appropriate for some types of work and is subject to certain exceptions.

What to do if the worst does happen

Unfortunately, subcontractors can find themselves in an unwanted situation with their main contractor when they are already well into a contract. Gaining external legal advice should be the first port of call if a contracting party enters administration or liquidation. Ensuring paperwork is up to date and correct is also vital. Securing any plant and materials on site should be the subcontractor’s next priority, particularly if it is on hire or required for other projects.

If a main contractor goes bust, subcontractors can be owed large amounts of money. Acting on this early by submitting a proof of debt claim as soon as possible is advised. Those who ask first, and loudest, often get paid faster.

Valuable lessons can be taken away from Interserve’s financial troubles, as well as the collapse of Carillion. Assessing the risks of contracts before entering into them is as important as ever for subcontractors. Being selective is the best way to ensure their business is not brought down by a major client collapsing overnight.

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