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Home / ... / Construction Industry...How to Survive the Slowdown

Jim Stafford and Tom Murray set out the issues facing the construction sector and offer advice on how companies in the sector can survive the inevitable building slow down.

It is generally accepted that housing starts in 2007 will be substantially down on 2006, and the forecast for 2008 is even worse. It is expected that a large number of jobs will be lost in the residential sector within the next two years. This presents severe challenges for construction companies involved in the residential sector. Experience has shown that when there is a significant over-capacity in the construction sector, contractors slash their tender prices in order to win work. The danger is that some may slash their prices too much and end up being loss making. While over capacity in the industry creates its own issues, another problem facing contractors is that developers may have paid too much for property sites at the height of the boom, and will now struggle to earn a profit. The developers’ only option may be to squeeze the contractor as much as possible. Given the issues facing contractors in the sector, it is more important than ever that they fully understand the terms of the contracts that they have entered into, and exploit them to the full.

RIAI Contracts The main contracts governing residential and commercial building in this country are the standard form contracts which are published by the Royal Institute of the Architects of Ireland (RIAI). The basic form has been issued in agreement with the Construction Industry Federation and the Society of Chartered Surveyors in the Republic of Ireland. There are a number of other standard forms of RIAI contract.

The Government Contracts Committee (GCC) has recently launched standard forms of contract to be used for Government work. As these forms are new, and are perceived to place more pressure on the contractor, there is considerable anxiety within the industry about their use. However, if the GCC forms are perceived by private sector developers to work, then the existing RIAI forms may cease to be used.

The RIAI standard forms of contract are well understood within the industry, and Case Law has developed to interpret many of the clauses, unlike the GCC forms of contract whose provisions may have to be clarified by the High Court. The RIAI contracts protect both the employer and the contractor. However, we consistently come across cases where a contractor has not exploited all of the terms and conditions to his advantage, whereas the employer has fully exploited the contract.

While this article assumes that contractors have signed an RIAI contract, many of the issues raised would apply to GCC contracts.

Contract Disputes It is common once a contract has commenced that an employer decides to vary the plans. The standard form of contract provides for procedures on how such ‘variations’ should be valued. Every time an architect issues an ‘instruction to vary the works’, it should be costed without ‘undue delay’ by the architect or the quantity surveyor. The practice of not valuing such instructions until the conclusion of the contract can be a mistake, as the employer may attempt to obtain a discount on the cumulative instructions given. In particular, the employer may attempt to exploit any cash flow difficulty facing a contractor at the end of the contract.

In some cases the employer may ask a contractor to do additional works, and may not ask the architect to issue an instruction. In these cases, the contractor should follow the procedures laid down and serve notice on the employer within the stipulated periods stating that a variation has been requested.

Some aspects of the contract may be ambiguous which may lead to disputes, e.g. a conflict between the drawings and the specifications. Contractors should be aware of the principle of Contra Proferentum which provides that any ambiguous clause will be construed against the party who prepared the document.

Delay and Disruption It is not unusual for a contractor to commence work on site, only to be delayed by other contractors employed by the same employer. In such cases some of the contractor’s work may be damaged by other contractors. If this happens, the contractor should maintain detailed records of the delay and disruption caused, and notify the employer, by letter, on a daily basis that these delays are occurring, and that the contractor will seek additional payment pursuant to the provisions of the contract. In cases of damage caused by other contractors, photographs should be taken as evidence. To facilitate the preparation of such claims, contractors should maintain a daily record of labour and machinery employed on the site.

Obtaining Payment In order to avoid a bad debt if the employer becomes insolvent, we would advise the contractor to carry out a detailed credit assessment on the employer, if it is not a Local Authority or Government Department. The credit assessment procedure should include discussion with other colleagues in the industry to obtain their views as to whether an employer is good at paying debts.

The standard form of contract sets out precise procedures as to how the contractor should be paid, and the contractor should ensure that these procedures are followed.

If the architect certifies that the work has been done, but the employer does not pay, what options are open to the contactor? Any non payment of sums certified by the architect is a serious matter and should be addressed immediately. Contact the employer to establish why they are not releasing payment. It is important that all of the vague delaying excuses, e.g. ‘our quantity surveyor is looking at it’, ‘I will sort it out next week’, etc., are drilled through to determine the real reason. In some cases the reason why the employer is unable to make further payments is because the funding bank may have declined further funding given the uncertainty in the housing market. In such cases, the contractor should seek legal advice as to whether they should ‘determine’ the contract and exit the site. We would suggest that the contractor does not do any further work unless there is a cast iron guarantee that they will obtain payment. In such cases, the contractor may obtain personal guarantee from the directors of the employer directly. We handled one case where the only way for the contractor to obtain payment was to arrange for some of the title deeds for some of the houses to be transferred into the contractor’s name, so that the contractor could sell the houses in due course. Obviously, such a ‘barter’ type transaction is expensive in terms of legal costs and stamp duty, but at least the payment is secured.

Dispute Resolution If agreement cannot be reached between the parties as to how a contract should proceed, the parties are obliged to refer the matter to dispute resolution procedures (conciliation/arbitration). In our experience, contractors are too slow to invoke conciliation/arbitration clauses, partially because they do not understand the process. If the employer has no proposals to settle the matter, then the only alternative is avail of the dispute resolution procedures. An unfortunate consequence of the compulsory dispute resolution procedures is that contractors are unable to refer claims in excess of €1 million to the commercial division of the High Court, with its expedited procedures.

Sub-Contractors It is generally accepted that sub¬contractors are at the bottom of the food chain in the construction sector. The best way to move up the food chain is to be appointed as a nominated sub-contractor. As a nominated sub-contractor, they are entitled to demand payment from the employer if the main contractor does not pay them.

Negligent Advice? Smaller contractors will usually rely on the services of an outside firm of quantity surveyors when submitting a tender. In some cases, the tender price calculated by the quantity surveyor may actually generate a loss, as a result of negligence on the part of the quantity surveyor. Sometimes, the negligence can be as simple as an arithmetical error. In such cases, the contractor should obtain legal advice as to whether to issue legal proceedings against the quantity surveyor. Contractors should be aware of a Code of Practice to the effect that the employer should notify the contractor of obvious errors in the contractor’s tender document before accepting such a tender.

Reckless Trading If a contractor is experiencing cash flow difficulties as a result of a contract, they should seek professional advice as to whether they are trading recklessly. In particular, the directors should assess whether the cash flow difficulties are caused by their own mismanagement of the contract leading to non-recoverable costs. Directors of a company that trade recklessly may be personally liable for the company’s debts.

Members Voluntary Liquidation Some contractors have built up substantial accumulated profits as a result of the Celtic Tiger. Given the inevitable building slow down in the residential sector, such contractors may consider whether they should stay in business, and risk incurring losses as a result of lower tenders, or, alternatively, place the company into a Members’ Voluntary Liquidation so share-holders receive the accumulated profits.

New Markets Responding to the slow down, some contractors are targeting the UK market, particularly in the south east of England which will benefit from a construction boom in preparation for the 2012 Olympics. Others will target the commercial building sector, which is still performing strongly.

I am doing a dissertation for my Masters in Smurfit Business school on contract forms and the associated risk relating to the construction Industry in ireland. This article would be very usefull.