Jacob Austin 00:00:00 Hi there all Jacob Austin here and welcome to episode 157 of the Subcontractors Blueprint, the show where subcontractors learn how to ensure profitability, improve cash flow and grow their business. Today's episode is all about counterparty risk and how to check out whether the main contractor is handing you the order that they can actually pay for the work before you commit your money to it. So let's dig in. There's an imbalance in this industry that almost nobody really speaks about before a main contractor lets you on site. They'll put you through pre-qualification. They'll want three years of accounts, your insurance certificates, your health and safety record, your accreditations and quite often a credit reference. They'll assess whether you're financially capable of delivering the package. That's all very normal and sensible, but you do none of that to them. You check the drawings, you check the specification. You check the program, the access, the attendances, the retention percentage. And then you'll sign an order that commits you to buying materials, paying wages and funding an average of 60 to 90 days worth of work in progress, all on the assumption that the company on the other end is good for the money.
Jacob Austin 00:01:40 Now look at the numbers. In the 12 months up to March this year, 3827 construction firms entered into insolvency. In the UK. That was down about 7% on the year before. So maybe the direction is right, but it's still around 19% above where we were in 2019. Construction continues to account for the largest share of business failures of any sector in this country, and the commentary from BCS this summer has been that risk stays elevated specifically for small contractors and specialist subcontractors, with the added warning that soft demand could push firms into cutting prices to win work in the back half of this year. Now, that makes really important because price cutting to win work is how a main contractor buys its way into a cash flow problem. And because you're funding the work, you're the one funding that cash flow problem. It's worth understanding how a main contractor actually fails, because it's often slower and less visible than people picture. It rarely starts with one bad month. It starts with a job that's priced too keenly 18 months ago to keep the teams busy over a period when work is thin on the ground.
Jacob Austin 00:02:58 That job runs. The margin erodes and the losses get funded out of cash arriving on newer jobs. So from the outside, the business looks fine because cash continues to come in. But what's really happening is that that new work is paying for old mistakes. And the only way to keep that running is to win more work, which means pricing keenly again. By the time it shows up in filed accounts, those are accounts that describe a position that's over a year old. And that is exactly why the BCS is warning about price cutting in the back half of this year, and why you should pay attention to that. If you can see that a main contractor is winning something at a number that makes no commercial sense, that isn't clever buying. That's a business. Buying a project because it needs turnover. So where does the money actually go? When a main contractor fails, your exposure isn't just the last application. It's that last application, plus the work that you've done since that application that you haven't applied for yet, plus your attention on the job and then any retention on the previous ten jobs that you finished for them if you haven't claimed it yet.
Jacob Austin 00:04:09 And on top of that, you might have shelled out on materials that you've bought and you've stored and you can't get back on site. That number can be 2 to 3 times what people assume it is, because they think about the one outstanding invoice. So with all that in mind, let's have a look at the contractual framework. And what the contract actually gives you here is honestly not very much. Standard subcontract terms are written to manage performance risk not credit risk. So there's very little in a JCT or NEC subcontract that protects you against the other party simply running out of money. What you have got is this under section 112 of the Construction Act. You got a right to suspend performance for non-payment after giving seven days written notice. That's a statutory right and it can't be contracted out of. And it's the most underused tool in the industry. It matters here because suspension is how you stop exposure. You stop committing more money to a lost cause, or at least whilst you work out what's going on. People treat that as if it's a nuclear option, but it isn't.
Jacob Austin 00:05:19 It's just like a brake pedal. I will just mention the mechanics of that because people can get them wrong, and people don't use that right at all because they don't understand it. Firstly, the notice has to be in writing. It has to state that you intend to suspend and why, and you have to give it at least seven days. If the contractor pays you inside those seven days, that right falls away and you need to restart. You carry on as normal. You can suspend part of your obligations rather than all of them, which is a change that came a few years back and hardly anybody uses. And when you do resume, you're entitled to a reasonable extension of time for the delay the suspension caused and to your reasonable costs of suspending and re mobilizing. So the downside of doing this properly is a great deal smaller than the fear of doing it suggests. What you cannot do is just down towards without serving the notice. If you do that then you are a party in breach of contract.
Jacob Austin 00:06:23 You've handed the contractor an instant set of argument and depending on the wording of your subcontract, you might have handed them grounds to terminate as well. The same issue can occur if you submit the notice in the wrong way. So if you are going to submit a seven day notice, you must read your subcontract and find out exactly where to send it and what communication method you use. It might need to be recorded delivery. It might need to go to a particular address addressed to a certain person, it might need to be an email to that certain person instead. Depending on the protocol that's outlined in your subcontract, you can use it. You can use it supremely effectively, but you have to do it the right way. Under section 113 of the same Construction Act, pay when paid clauses are prohibited. And there's an exception that can bite in exactly this scenario, where the third party up the chain is insolvent, a pay when paid clause can still operate. That was confirmed in a case between William Hare against Shepherd construction.
Jacob Austin 00:07:29 And the practical effect is that if the employer above your main contractor goes under a properly drafted clause, can leave you legally unpaid on retention. You firstly have to think what it actually is. It's your money that somebody else is holding, and in most subcontracts it's held just as a simple debt that the contractor owes to you, not on a specific trust or an escrow. If the main contractor becomes insolvent, that retention doesn't come back to you as your property. It joins the piles of unsecured debt behind any secured creditors, behind preferential creditors and behind the insolvency practitioners fees, which are usually a lot. Recovery against an unsecured debt is usually pence in a pound on materials. Retention of title clauses in your supply agreement are worth having, but that value disappears once goods are fixed into the building. So if you're a bricklayer, once you lay a brick, it's part of the building and it no longer belongs to you. Vesting certificates work the other way round where you hold materials, and you transfer the property to the main contractor so that they can pay you for them.
Jacob Austin 00:08:40 The trick here is to make sure the vesting certificate is conditional on receiving the money for the materials. Otherwise, you could be giving a certificate to show that the contractor owns materials that they haven't paid for. There is a protection that actually works, but mostly isn't used by main contractors, and it isn't part of the standard form, which is a project bank account. That bank account ring fences money so it isn't available to the main contractors administrator. Have a look at what your subcontractor gives you on termination. Most subcontracts give the main contractor generous rights if you become insolvent and much thinner rights running the other way. Some give you the right to terminate on insolvency and some are silent. Either way, the practical value of that right is limited because by the time it's triggered, the money's already gone. The right that carries a bit of value is the one that you can use early on. And that's the suspension, right? So your contract, your framework is actually thin, which means the protection has to come from what you do commercially, not from what the contract says.
Jacob Austin 00:09:47 There are a lot of false comforts that subcontractors can take. About main contractors, sometimes right up until the point that they get a phone call saying the liquidators are in. The first is the size. There are big company. They've been going 80 years. They're on all the framework lists. But size doesn't mean solvency. Some of the largest failures in this industry have been businesses with full order books and long, proud histories. Turnover might tell you how much work they're doing, but it tells you nothing about the margin that they're doing it and how full their bank account is. The second is the order book. They've got loads on a full order book on thin margins is a cash flow machine that only works whilst it's growing. It's the classic profile for a construction failure, and it can even look successful when you're looking in from the outside right up until the end. The third is that they've always paid you before payment. History is a lagging indicator. It tells you what was true last quarter. It doesn't tell you what happened to their tender margins 18 months ago on the massive job that they took on.
Jacob Austin 00:10:56 That's now going wrong. The force is thinking that the risk is just the current application. As I said earlier, it isn't. It's your total exposure across every open position that you have with that company. If you've got 3 or 5 jobs for them where you've got retention pots sitting that you've probably mentally written into last year's profit. Those are losses to the fifth is assuming somebody in your business is watching this. In a lot of SME subcontractors. A credit controller is chasing invoices. But nobody owns the question of whether your customer is deteriorating financially. Chasing an invoice and monitoring your counterparties are two completely different jobs. The sixth is the belief that you can't do anything about it anyway. Because if you turn down the work, then you've got no work. That's the one I'd push back on the hardest, because you're not choosing between the job and no job. There is always other work, and what you're choosing is how much of your money you're prepared to have out with one company at one time. And that's the decision you should be making very deliberately and not by accident.
Jacob Austin 00:12:06 Then there's a seventh, which is really an objection rather than a comfort blanket. But I want to give this proper airtime because it's the actual reason people don't act. It goes something like, if I suspend, then I'll never work for them again. That is not a stupid position. Relationships in this industry are very real and they are worth money. But work this all the way through. If the company is a healthy working business, then a properly served suspension notice gets your money paid and gets you as a reputation of being a company that works. A tight ship of a company that protects itself. It might be uncomfortable for a fortnight, but it's not fatal. You are going to go back to the job if you get paid, and if you do it in the right way, you brief your contracts manager or the project manager and explain your position as you're doing it. Then they'll understand and they'll probably be on your right side as well when it comes to getting your hands on that money. But in neither case does staying quiet come out ahead.
Jacob Austin 00:13:06 The only version where silence wins is the one where they were going to pay you anyway. And in that version of the event, the notice you served costs you nothing at all, because they pay inside the seven days you never suspend at all. Let's consider a scenario. Let's take a groundworks subcontractor. Their turnover is around 4 million, and they're doing a 500 grand package for a regional main contractor. They've got a good relationship. It's their third job for them, and they've always paid within the payment terms in the past. But this time by month four of a nine month job they've got an application in for 80 grand. That's due, but it's unpaid. In the time since that payment fell due. They've done another 40 grand and they haven't applied for that yet. The valuation is not due. They've got £25,000 worth of retention on this job. And they've got another 48 grand sat between the two previous jobs that they finished for that same contractor the previous year. One of those is past its release date.
Jacob Austin 00:14:04 They've chased three times and there's no answer. They've then got 15g worth of materials on site. It's been delivered. It's been paid for. And it was ordered specifically for this scheme. So the position on the last payment looks like around about 80 grand, but the actual exposure is actually over 200 grand, 280 even on a £4 million turnover business. That's not just a bad debt. It's your whole profit for a year. Now here's the part that matters most. All the signals are there. The retention on the old job going quiet is signal one. Payments creeping from day 30 to day 42 to day 50 is signal to the main contractors. QRS being replaced twice in six months is signal three, a supplier mentioning in the merchant's yard that they'd put the contractor on pro forma payments is signal for every one of those is visible from where you're standing. None of them requires a credit agency or forensic accounting, and the response to any one of them is the same, which is to stop the exposure growing whilst you find out more.
Jacob Austin 00:15:12 Because look at what suspension would have done here. Seven days notice under section 112 served at the point payments started stretching. That stops the extra 40g worth of an applied work. You don't fix the 80 grand, but you're capping the damage, keeping it to as little as you can. And that is the whole game. Now, what would happen next? The aftermath can be confusing. You get a letter from an insolvency practitioner. It asks you to submit a claim and it explains that you are an unsecured creditor, as it be politely worded, and it will tell you almost nothing useful about timing or amount, because at that stage nobody knows. Meanwhile, you got a set of practical problems that all arrive in the same week. Your plant is on a site that you might not be allowed onto. You've got materials there too, assuming they've not already been fixed, because once they're incorporated into the works, they're almost certainly not yours anymore. Whatever your supply terms might say, on top of that, your operatives are allocated to a job that's stopped and you're still paying them on Friday.
Jacob Austin 00:16:16 And the employer above might be looking to narrate the subcontracts across to a replacement contractor so that the job can finish. That last one might sound like good news, and it could well be, but only after you've asked one question. Does the new arrangement pick up the historic debt, or does it start from zero? More than likely, it starts from zero, in which case you're being invited to fund the completion of a job that's already cost you £208,000. That might still be the right commercial call, because you can pick up that job with the men that are available and start finishing it off on the coming Monday. What are the chances of doing that in the short term? So how do you protect yourself about this? There's three things that you can do to check up on your main contractors financial history. It'll probably take you about 40 minutes to sensibly do a bit of due diligence. First, you go to companies House. It's free to look at historic accounts. Firstly, ask whether the accounts are filed consistently or if they're left to the last possible moment, because chronic late filing is a management signal that points to a financial one.
Jacob Austin 00:17:23 Look at the accounts themselves, and specifically at cash at Bank Against trade creditors, and how those have moved over the last 3 or 4 years. Look at net current assets and whether that number is heading in the right direction. Then look at the charges register if new large facilities are appearing on there, and there's no sensible reason why it tells you the business is trying to raise money. Watch out for invoice discounting facilities that mean they're looking to raise money against their receivables. Then check the directors, their other appointments and whether any previous companies they've operated have dissolved or gone into liquidation. Then check for county court judgments. There is a fee for this, but it's reasonably cheap if there's any recent ones. That's a big red flag. There's another free check and it's genuinely underused. And that is that large companies in the UK have to produce and publish their payment performance twice a year under the Payment Practices Reporting rules. That means average days to pay percentage paid within 60 days and percentage paid beyond terms. It's on a government website and it's searchable by company name.
Jacob Austin 00:18:34 It's self-reported by the company. So if a main contractor is reporting that a third of its invoices are paid late, that isn't a rumor. That's their own data pointing at a problem. The next thing you can do is decide a ceiling with that main contractor. Decide before you take the order the maximum amount of money you are prepared to have outstanding with one customer at one time. That means total exposure, not invoice value. So application plus an applied work plus retention and materials that probably wants to be a percentage of your net assets rather than a percentage of turnover because it's your balance sheet that has to absorb the loss. Then you have to manage that. If the ceiling is 100,000 and a job is going to take you to 160. You've got choices. Before you sign, you can ask for a payment schedule. With shorter cycles. You can ask for materials to be paid regularly as stock on site rather than when they get fixed. You can ask for a parent company guarantee you can negotiate a retention cap.
Jacob Austin 00:19:34 You could potentially stage delivery so that materials exposure doesn't get too high. Or you can take the job but know exactly what you're carrying, which is still better than not knowing and then have a planned exit strategy. This is a bit that takes some discipline. Confirm a trigger in advance so that the decision isn't being made emotionally in a tricky part of a difficult job. Something like if a payment goes ten days past the final date for payment, I'll serve a notice of intention to suspend. That's not a phone call, but a proper written notice. The reason that works is because it's mechanical. Everybody knows the risk of suspension potentially damaging a relationship, so therefore delays it. But the delay converts that from a recoverable problem into a big unrecoverable one. If the trigger is written down, then it applies to each customer equally. It stops being personal. It's just a procedure that your business follows. Now, one thing about frequency these checks aren't something that you should just do before you sign an order. One check that you did at order stage tells you about a company when its last accounts were filed, which could be, I don't know, 20 months ago.
Jacob Austin 00:20:47 That isn't the current picture as of today, so put some regularity into it. Run the free checks, maybe quarterly, on any customer that you've got meaningful exposure to. A final thing that you could do is have credit insurance. This, of course, is going to cost you an insurance premium and there will be an excess to pay. There's also a risk that cover on a construction company can be withdrawn at probably precisely the moment that you'll want it the most. And that in itself is a huge warning sign. That's probably the clearest, loudest signal that you'll ever receive that a business is about to go under. But you'll only get that signal if you're a policyholder. On some jobs, that early warning signal might be worth the premium on its own, regardless of whether you actually claim. Now, I hope all of that helps. My mission with the podcast is to help the million SME contractors working out there in our industry. If you've taken some value away from today's episode, then I really need your help to share the show and pass that value on to somebody else who'd benefit from hearing it so that I can help as many people as possible.
Jacob Austin 00:21:53 And thanks for tuning in. If you like what you've heard and you want to learn more, then please do find us at www.SubcontractorsBlueprint.UK. And we're also on all your favourite socials again at @SubcontractorsBlueprint. And remember, miss the contract detail and the commercial risk falls on you. Thanks all. I've been Jacob Austin and you've been awesome.
