REUTERS | Jumana El Heloueh

Construction insolvency: how solid is the house of cards?

Even in the best of times insolvencies are part of the construction industry but, until now, they have not been a major part of this recession. However, do the high profile collapses of Connaught and Rok signal a change and, if they do, what can clients do to protect their interests?

Lies, damned lies and statistics?

Interpreting statistics is a dark art at the best of times, but trying to predict trends in the current market is a tall order. On a positive note, according to the Office for National Statistics (ONS), the total volume of construction output in the third quarter of 2010 rose by 4.0 per cent compared with the second quarter of 2010.

Less cheerfully, Insolvency Service statistics show that, while construction contractor insolvencies peaked in the second quarter of 2009, the most recent statistics show that there were still 33% more construction contractor insolvencies than in the second quarter of 2007.

So, were the recent high profile demises of Connaught and Rok truly surprising?

Eyebrows are raised with Connaught because, after all, how often does a FTSE 250 company fail? However, there was speculation last year that Connaught’s accounting practices were not sufficiently prudent in relation to the revenue of its long term contracts.

In Rok’s case, only three years ago it was a company that had a market value of over £400 million although, by the time its shares were suspended, the value had fallen to a little over £30 million.

What does history tell us?

Hindsight is a wonderful thing but we haven’t needed much of it to see that things weren’t quite right at Connaught and Rok. There had been rumours. Alarm bells should probably have been ringing for a while. But this is a difficult area. No client will want to restrict its supply chain due to rumours, especially if those rumours later turn out to be unfounded. There are probably also clients who would not want to contribute to the failure of a business caused by a lack of market confidence.

What should clients do?

There are a number of things that clients should do:

Analysing copies of the last three years of accounts. Obtaining company accounts is all well and good, but they have to be interpreted and the supply chain selection process needs to reflect the findings.

Credit checking the supply chain. As a matter of course, advisers should be checking that clients are running their own credit checks or arranging for checks to be carried out where the client does not have the wherewithal in-house.

Keeping a track of things. It has never been more important to monitor construction works and implement the contracts regulating them. It is vital to look out for the tell-tale signs that things are not all as they should be. For example, what should clients do if the supply chain is pressing for advance payment for materials or equipment held off site? There will be times when this may allow the successful completion of the project but there may be other times where a client finds itself dealing with the administrators of an insolvent supply chain member. All of a sudden there is a retention of title dispute that delays (or possibly even prevents) components that are needed to complete a project on time.

Security. In some quarters, bonds and parent company guarantees are seen as an either/or option but that is not the case:

  • Bonds provide some fallback in that a percentage of the contract sum may be recovered under the bond but remember that the bondsman will probably have carried out its own credit and other checks before providing the bond. If a member of the supply chain is unable to provide a bond that should be a cause for concern.
  • Parent company guarantees do not have the comfort of back-up from outside the supply chain and there is always the concern that when one part of an organisation fails, the rest often does. A parent company guarantee may become worthless in an insolvency. However, company structures are not usually that simple and some parts of the Connaught business were a going concern.

While suggesting eternal vigilance sounds melodramatic, this is the time for it.

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