Problem: It is not so much a problem I have that requires a ‘cure’, but rather I am seeking pointers that will help prevent potential problems in the future.
I run a construction company that turns over just under £10 million per year. The type of work we do is quite varied, ranging from [large] residential extensions to commercial and office property. Like any other company in the building sector, the company has suffered over the past 12 to 18 months with material cost inflation and cash flow being squeezed. Fortunately, though, we have not had any bad debts, but the profit for the company has disappeared and I am very concerned for the future – if a client goes bust on us, that would have dire consequences for the company.
Going forward, can you give me any pointers as to how better I can protect the company, and even start to turn in a profit?
Response: You are very sensible in your approach – prevention is of course far better than cure.
Currently, contracting companies (and of course procurers) are having a very tough time. They have to contend with material cost inflation, skilled labour shortages and liquidity issues – and working on the construction industry, I have witnessed all of these problems.
From my point of view, there are 2 important factors that a contractor on any project must consider: 1) ensure that a written contract is in place prior to any works being carried out; and 2) ensure it remains cash flow positive. All of my other ‘pointers’ that I discuss below, can be said to be sub-factors of these 2 main factors.
Having a written contract in place may sound straight-forward, but the number of times I have come across contractors where they have commenced works without any proper written contract in place: and it is not just a case of ensuring a written contract is in place, but to also understand the terms and conditions.
Given the high inflation cost of materials (in 2022, building materials prices were 25% higher than they were in 2021), on contracts where you have a lengthy duration (and I would define a lengthy duration as 6 months or more), then you must seriously consider whether you can afford to take the risk if the contract is going to be fixed price for the duration.
If you cannot take the risk, ensure that the contract contains a fluctuating clause – all of the main standard agreements deal with fluctuation provisions in different ways. For example, the JCT Intermediate Building Contract includes a fluctuating provision in the Contract Particulars, whilst the NEC has secondary option X1 on price adjustment for inflation which can be used in NEC4 ECC, PSC and TSC – it can also be included as an additional condition of contract in the shorter NEC contracts.
Since the 1980’s, fluctuating provisions have largely been ignored by contracting parties: in those days, the formulae for calculating fluctuations was known as the NEDO formula (an acronym for the National Economic Development Office), which is now the Price Adjustment Formulae Indices which is administrated by BCIS (Building Cost Information Service), whom publishes general indices for building, civil engineering and maintenance projects.
Even on contracts that have relatively short-time scales, consideration should be given to a fluctuating clause, especially where there is specialist equipment such as used in M&E installations.
As to cash-flow (and remember that old adage – turnover is vanity, profit is sanity but cash-flow is king!), it starts by doing a credit-check on the client. You can then consider ways to reduce your risk (for not getting paid or client insolvency), for example, monies on account, monies paid into a trust account (and drawn down via a third party payment certificate), more regular valuations (ie, every 2 weeks), and quicker payments (ie, within 5 days of the due date). Of course, a client may not be too willing to part with its own cash earlier than usual, so perhaps an incentive (like a discount), could prompt agreement.
Also remember that you can include a provision in the contract to suspend performance for non-payment. Such a provision is not needed where the contract is with another business (the right to suspend is implied by the Housing Grants, Construction and Regeneration Act (as amended)) – and don’t be hesitant is using this right – it could save the company!
© Michael Gerard 2023
The advice provided is intended to be of a general guide only and should not be viewed as providing a definitive legal analysis.
Author background
Michael is a Solicitor, Chartered Builder & Registered Construction Adjudicator, and is a director at Michael Gerard Law Limited, a solicitors practice regulated by the SRA.