Can you rebuild a failing construction company?
Phil Deyes is an Intellectual Property and Real Estate Specialist at Leonard Curtis
Construction is a major sector of the UK economy and a good barometer of the country’s business prospects.
Construction is back in the spotlight as the government releases its insolvency statistics for England and Wales. The construction industry saw the highest number of insolvencies in the second quarter of 2022 with 19% (nearly one in five insolvencies) or 3,665 failures – the vast majority of which were liquidations and closures.
It also saw the number of insolvencies double from the previous 12 months at a time when the sector is experiencing a slowdown in its order book.
Why is it difficult to restructure a construction company?
A medium-sized master contracting business typically has assets available to meet business needs in the form of cash, work in progress, and accounts receivable. Debtors can be requests for payment of unpaid invoices, deductions, final statements or disputed items. WIP is essentially work done, which has not yet been invoiced and may be uncertified.
This snapshot of a construction company‘s balance sheet can be misleading in the event of an insolvency given the precarious nature of the composition of WIPs and debtors, where contracts in progress are terminated or become uncompleted due to an insolvency.
Construction contracts are complex. On the one hand, their compliance with industry standards provides a high degree of familiarity among all stakeholders. With a suite of standardized documents, each party knows when and how much to pay or be paid and what procedure should be followed in the event of a dispute.
Conversely, this somewhat prescriptive and legally formulated framework makes adaptation difficult, especially in times of financial crisis, and especially where the insolvency of one of the main parties to the contract is looming.
There is also a large and diverse group of stakeholders in any construction project. In addition to the parties specified in the contract, there are third-party stakeholders in the form of lenders and warranty providers as well as commercial protection insurers, employees and ultimate occupants of the program under construction. Each of these parties may have competing interests and financing arrangements in the event of insolvency.
The fallout can be significant
Without exception, all contracts in play (with lenders, sub-contractors, surety holders, guarantee providers, design and intellectual property rights holders and credit insurers) enter into automatic default in the event of of insolvency. A case of insolvency cannot prohibit the termination of these contracts.
In addition, in the event of insolvency, the contractor will be liable to pay liquidated damages (LAD) in the event of delay and/or termination of the contracts. These claims may in fact overshadow the claims of the contractor’s creditors immediately prior to insolvency and compound the difficulties of a restructuring.
These newly created claims take equal rank with previous creditors. Insolvency itself therefore crystallizes several additional claims that may put a turnaround beyond the reach of many entrepreneurs.
The impact of insolvency on stakeholders
An insolvent and failing construction company requires all stakeholders to bear part of the cost of restructuring and accept some degree of loss, whether or not there is a contractual obligation to do so. This is on the basis that the overall exposure would be considerably less with a collaborative settlement than the cost exposure in a formal insolvency. This is not to say that within the range of stakeholders, some may have to give up more than others.
It is the unequal sharing of the loss and the fact that, in some cases, an insolvency event can improve the position of one category of stakeholders and worsen that of another that sometimes makes collaboration impossible.
Can anything be done before an insolvency event occurs?
Early insolvency support and legal advice Is to help. This can facilitate a conversation with major working capital providers to negotiate additional margin in existing installations. It can remedy a temporary cash crunch but cannot fundamentally turn a loss-making business into a profitable one.
Many funders and bondholders require quarterly accounts. If they are not strong, a frank and open conversation can help rally these key stakeholders. Stakeholders don’t like surprises, but the struggling contractor’s reluctance to strike up a conversation is usually based on their fear that the situation could quickly slip away from them. This reluctance to lose an element of control can be crippling to a successful turnaround.
Attempts to reach settlements on legacy retentions and other disputed accounts can also help get cash quickly and be part of a liquidity plan. Early settlement of litigation procedures (which are costly and time-consuming) can be a useful step.
Trying to exit unprofitable contracts and focus on the most profitable ones seems reasonable, but the avalanche of LAD claims on abandoned contracts can quickly become unmanageable. If it is a question of abandoning certain contracts to focus on those that will ensure the survival of the company, then an insolvent rescue may be the only solution to separate the liabilities from the remaining assets. Specialist insolvency advice would be required.
The lifeblood is the balance between losses and gains for all stakeholders. If nothing happens, the business will fail, and it then becomes an element of education among all stakeholders to establish the best of the available alternatives. The fact is that the status quo is no longer an option and an alternative solution must be found if insolvency is to be avoided.
Opening conversations with employers to try to change the contract is sometimes the only solution, but can be hampered by the employer’s own funding arrangements or by the fear that the employer will suspend expected payments until the problems are solved, accelerating the entrepreneur’s already precarious cash position. It also means dialogue with sub-contractors to move the financial objectives of the initial contract, possibly by extending the credit terms, which may not be possible if the credit insurers on which the sub-contractors rely decide to cover themselves. .
In short, a financial restructuring is complex, but not impossible if advice is sought early and dialogue is initiated with all stakeholders. With its complex, contract-heavy and multi-party operating framework, the sector faces more challenges than most, but it can be navigated.
The key is to identify when a business is in trouble and act early to provide the greatest range of options, for all stakeholders, around a successful restructuring and business future, in or out. of an insolvency process.