Insolvencies Are on the Rise. How Can Contractors Protect Their Business?

Article featured in Builders and Contractors Issue No. 156 | Written by Steve O’Dea

Times Are Still Tough

Global economic activity is expected to remain subdued in the near term according to the Reserve Bank’s February 2025 Monetary Policy Statement. Activity remains below trend, and “[t]his reflects falling activity in interest rate sensitive sectors such as construction”. Growth is expected to recover during 2025, but the speed of that recovery is uncertain.

Construction Sector Leads Credit Defaults, and Insolvencies Are High

Inflation and interest rates have been a constraint for construction clients. With slow and uncertain work pipelines, aggressive pricing can lead to tighter profit margins and cashflow concerns. This puts a strain on businesses.

Credit defaults have hit the construction sector particularly hard, with construction defaults up 35% year-on-year, the largest increase of any sector (February 2024, Credit Indicator issued by Centrix). Company liquidations across all sectors are up 38% compared to the previous period. Centrix reports, “Notably, in January, 24% of these insolvencies were attributed to the construction sector”.

In this environment, contractors need to be alive to their risks. Proactively managing such risks can preserve cash flow and protect contractors in conditions where issues and disputes are more common.

Contracts That Work for You

Getting the contracts right saves a lot of trouble: Know who you’re dealing with. Does the client have enough contingency? How financially healthy and reliable is the supply chain?

Allocate the risks: Are the risks allocated to the person who can control each risk? Can that person afford those risks?

Align the contracts: Do the subcontracts align with the client contract? If not, the gaps can leave a contractor exposed.

Align the pricing: A fixed price client contract and uncertain subcontractor/supplier pricing can lead to losses.

Write up the contract: Even if the building work costs less than the $30,000 mandatory threshold for residential building work, have a written contract. This is vital for disputes relating to payment or scope.

Keep on Top of Admin and Payment Claims

Cash flow is the key to solvency. Good admin and getting payment claims right preserves cash flow and prevents expensive and time-consuming disputes.

Payment claims to the client: If payment claims/invoices are set out in the format required by the Construction Contracts Act 2002 (the Act), contractors can get the benefit of the ‘pay now argue later’ concept which is useful when dealing with difficult clients.

Payment schedules to subcontractors: Such enforceability under the Act also works for subcontractors against contractors. It’s important that contractors issue valid payment schedules. Otherwise, it will be the contractor who has to ‘pay now and argue later’.

An experienced quantity surveyor or project manager can prepare these documents and help contractors improve their cash flow and avoid expensive disputes.

Know Your Rights and Responsibilities on Retentions

There are many examples of clients and head contractors who went insolvent, and the retentions disappeared with them. However, the Construction Contracts (Retention Money) Amendments Act 2023 improved the protections for contractors and subcontractors.

There are now strict accounting practices (including reporting) for holding retentions. Non-compliance can lead to large fines and personal responsibility for directors.

Contractors should check their retention money is being held properly by clients. In turn, contractors need to ensure they’re looking after their subcontractor’s retention money to avoid personal exposure to fines and losses.

Know When to Notify Issues and Raise Disputes

Some contracts have strict notification requirements requiring contractors to raise any variations or issues in writing within a certain number of days or else lose the right to do so.

If an issue is raised but not resolved, contractors have access to adjudication under the Act, which is unique to the construction sector and provides a quick and cost-effective third-party decision without needing to go to court. Used right, this is a powerful tool that can secure cash flow when there are disputes.

It’s Easier Than It Sounds

Many of these steps are about good habits, templates, and processes. Spending a bit of time to get those right can help contractors maintain cash flow and weather the economic challenges until the boom times come again.

Author Information

Steve O’Dea is a construction law specialist at Anderson Lloyd. If these issues are relevant to you and you would like to find out more, you can find his contact details here.

Read the original article on Builders and Contractors here.