Back to Basics: Post-Covid recovery of the construction industry

Suzanne Wood and Adam Stanley survey the outlook for construction industry cash flow as the sector takes centre stage in the post-Covid recovery programme. The construction industry is at the forefront of the government’s plan to stimulate and drive economic recovery in the UK and, while industry reaction to the Autumn Budget has been mixed, the government’s commitment to much-needed upgrades to social infrastructure, transport links and local community amenities remains clear. However, as the support and assistance from government-backed financial interventions and emergency statutory restrictions starts to be withdrawn, the management of cash flow by construction companies will be a key component to their survival and the success of this recovery plan. Sites open for business Like all sectors, the construction industry has been affected by Covid-19 and at a time when many were already trying to navigate a way through withdrawal from the European Union, with concerns not just around labour shortages and material supplies leading to higher base costs, but whether construction projects would have to be halted altogether. As is often the case in such adversity, agile adjustments to manage the unprecedented challenges and ever-changing restrictions due to the pandemic were necessary and arrived quickly. The initial doubts and uncertainty regarding the operation of construction sites were promptly overcome through compliance with the Construction Leadership Council’s Site Operating Procedures – adjustments to gang allocations, shift patterns, procurement processes and welfare facilities among others meant that developers and main contractors quickly had construction sites open again. However, the question lingered – would labour and materials be available, and how would supply shortages and rising prices affect cash flow throughout the supply chain? The emergency response The government recognised these types of pressures early in the pandemic and introduced significant financial interventions to secure the survival of businesses, such as the furlough scheme, and emergency statutory measures to support cash flow and limit insolvencies during the pandemic. In addition, the CLC was quick to detect the potential issues caused by the management of payment in the construction supply chain, where more than 90% of the industry is comprised of SMEs, and the risk that companies would seek to invoke contractual clauses penalising any failure to make payment in line with the agreed terms and/or initiate adjudication proceedings to “grab cash” where contractual notices were not served and/or payments not made in line with contractual mechanisms. The CLC made it clear that every business in the sector, large or small, and from material manufacturers to product suppliers, had a critical role in making sure that cash continued to flow throughout the industry. In short, parties were urged to find a fair and commercially viable way of working together in the short term to get projects completed and to support the long-term health of the sector, rather than focusing on strict contractual rights where there was frequently a difference between what a building contract dictated and what was achievable on site over the course of the various lockdowns and restrictions. With the same aim, government assistance was introduced in June 2020 in the Corporate Insolvency and Governance Act 2020 to protect companies in financial distress from creditor action. This was accompanied by a series of recommended actions, including making payments “at risk”, with the option to revisit contractual entitlement at a later date. This meant that, even in circumstances where project participants were unable to resolve contractual disputes over pay, companies in financial distress remained temporarily protected by cash continuing to flow. The 2020 Act contained measures that fall into two categories: (i) permanent measures to update the UK insolvency regime, and (ii) temporary measures to insolvency law and corporate governance to assist businesses during the pandemic. The majority of the temporary business protection measures were given retrospective effect from 1 March 2020 and multiple extensions to the temporary measures were granted by the government in a continued attempt to assist businesses. These included: (i) suspension of serving statutory demands; (ii) restrictions on winding-up petitions where unpaid debt is due to Covid-19; and (iii) suspension of the wrongful trading rules. These were however, only ever temporary restrictions which have already been phased out, with the wrongful trading rules suspension expiring on 30 June 2021, the relevant period for the suspension on serving statutory demands expiring on 30 September 2021 and the restrictions on winding-up petitions expiring most recently on 1 October 2021. Therefore, creditors may once again issue winding-up petitions against debtors, albeit subject to the current debt threshold for a winding up petition now being £10,000-plus and the new requirement that creditors must seek proposals for payment from a debtor, giving them 21 days to respond, before they can proceed with a winding-up action. The return of the winding-up petition is indicative of the government’s tapering measures which aim to restore normal function to the economy and a steady pace – there is a need to promote the survival of viable businesses but an equal need to root out debt-ridden companies beyond saving to move the recovery phase forward. While this is something which is ultimately required, it carries significant risk where statutory demands and winding-up petitions can often be adopted as “weapons” as opposed to options of last resort to identify and appropriately address “zombie” companies beyond rescue. The requirement to invite debtor proposals on repayment is helpful in this respect, albeit the proposals must be “to the creditor’s satisfaction”. While it is currently unknown how the court will assess whether a creditor is acting reasonably in rejecting an offer on the basis that it is unsatisfactory, it is unlikely that the court will allow creditors an unfettered discretion to reject a reasonable offer of repayment, especially where such a rejection could be based on entirely unreasonable grounds. These new provisions are, however, only scheduled to remain in force until 31 March 2022, after which they may also come to an end. It is therefore far from past the time where construction companies need to work collaboratively to ensure mutual survival and recovery of the sector and economy as a whole. Pressure on the supply chain ecosystem “Supply chain” is the term used to describe the interconnected network of companies and suppliers that exist symbiotically to turn materials, products or services into a finished product/development – developers, main contractors, professional services consultants, sub-contractors and suppliers are all part of the construction supply chain ecosystem. As has been long known, what happens to one part of this ecosystem is felt by many other parts. While there was not significant slowing of on-site operations, labour supply/resource management has certainly been disrupted by furloughs, self-isolation requirements, restrictions on gang sizes and the need for bubbles, and the supply of materials has been hit by the availability of raw materials and fabrication slots due to similar labour availability reasons. This has led to some delays on construction projects, the need to replace labour/materials at short-notice, some premiums being charged, short-term borrowing and generally increased prices across many parts of the supply chain. While the construction industry has therefore managed to survive the Covid-19 pandemic well (albeit unfortunately still with some casualties), the true test is perhaps still to come as business gets back to normal and construction companies establish who is entitled to what. The combined effect of rectifying historic “at risk” payments and meeting increased labour/material costs is likely to therefore place significant pressure on cash flow within the construction industry in the coming years. This will also likely be coupled with an ever greater movement back to traditional practices and remedies such as “smash and grab” adjudications to enforce strict contractual rights. A look to the future While it is hoped that the challenges presented by Covid-19 and Brexit will continue to alleviate, now more than ever companies need to closely manage projects and supply chains to ensure that a steady flow of income remains. Given the removal of the restrictions it is natural that we will see an increase in parties trying to recover outstanding payments and reverting to winding up proceedings. It is further anticipated that interim agreements made between parties in the spirit of co-operation and under the pressure of the pandemic may not have been recorded in line with the requirements of the contract (or at all) and, as a result, it may not always be clear what has actually been agreed. However, a winding-up petition should not be used oppressively as a means of collecting debts faster or for putting undue pressure on a debtor (indeed, the costs of the petition will be payable by the creditor, most often on an indemnity basis, if it is substantively flawed), and the absence of a written agreement and/or failure to administer a contract correctly may leave parties with potentially significant evidential hurdles in any claim for breach of contract and/or debt recovery proceedings. Whatever the position, construction companies would be well placed to remember the spirit of collaboration which has taken precedence over the course of the past 20 months. Commercial relationships have been strengthened and it would be a shame to see cash flow pressures drive the industry back into a blame game. It may be the case that a simple without prejudice discussion, if the parties approach this sensibly, can resolve the issue. Secure cash flow funds new projects and finances day-to-day operations on existing projects. Where it is anticipated that parties will press hard for recovery of payments that remain due and owing – or indeed may seek to revisit contractual entitlement where agreements have been made to review unpaid invoices at a later date – controlling cash flow well, and fairly, is paramount to the success of all construction projects, and ultimately the government’s economic recovery plan. Suzanne Wood is an associate in the construction team and Adam Stanley is a trainee in the corporate team, specialising in insolvency, at Brabners In next month’s Back to Basics, the team at Brabners looks at property fraud and how owners can protect themselves from falling victim to it.