Local Democracy, Economic Development and Construction Bill [Lords]

In speaking to new clause 3, I must acknowledge the huge assistance that I have received from Professor Rudi Klein, who is chief executive of the Specialist Engineering Contractors Group. I should also mention that the Unite union is fully in favour of the contents of the new clause. The point of the provision is to address the gross inequality, to which reference has been made in several speeches, between the main contractor and a small or medium-sized enterprise further down the line. The hon. Member for Falmouth and Camborne (Julia Goldsworthy) referred to the fact that those building firms typically have five or six employees, and having to lose out on several hundred thousand pounds without any redress is often a death knell to them. As has been made clear, the building industry has probably been the worst hit industry in this recession. That is no surprise, because it is always the first to be hit, but it has been particularly badly hit. The Governments in this place and in Cardiff—I am sure the same is happening in Scotland—are bringing forward Government contracts to try to perk things up, and that is all to the good. New clause 3 seeks to make a slight variation on the whole issue of insolvency protection. It states:""A party to a construction contract may at any time request the other party to provide adequate security including bank guarantees and bonds in respect of payments of the contract price, including the price of any varied or additional works…Where a party fails to provide the adequate security as requested…the party making the request has the right to suspend any or all of his obligations under the construction contract with the party in default…The right may not be exercised without first giving to the party in default at least seven days' notice of intention to suspend performance, stating that performance will be suspended unless, in the meantime, the security requested…is provided…The right to suspend performance ceases when the party in the default makes available the security requested under subsection (1)"—" and so on. We all know of various tales of woe of smaller small and medium-sized enterprises in the building industry hitting the wall not because of anything that they have done but because of the inequality between themselves and the main contractor, which I would describe as the inequality of arms par excellence. Let me cite one example. Two sister companies—Pierse Contracting and Pierse Contracting Southern Ltd—recently went into insolvency. Both continued to commission construction work and engage subcontractors over the past 12 months, when they were clearly insolvent. Just over a year ago, the net worth of each company was between minus £400,000 and minus £500,000. In the past year, the former company had 29 unsatisfied county court judgments against it and the latter had 43. Companies in Pierse Group—the holding company—regularly moved whatever assets they had between themselves and businesses in Ireland. Both Pierse Contracting and Pierse Contracting Southern Ltd were engaged by public sector bodies as main contractors. Such bodies included authorities in Wales and in England, and one was the Cheshire police authority. Pierse Contracting was the main contractor for the tactical training centre at Winsford in Cheshire—a project to the value of £10.7 million. As a result of Pierse Contracting's insolvency, a number of subcontractors have been put in peril, including one that has lost more than £600,000. This situation, I regret to say, is not unusual within the industry—nor is it new. Firms are engaging supply chains to carry out work when their liabilities exceed their assets—in other words, when they are insolvent. Often work is commissioned by developers that are £100 companies with no assets to speak of. Of course, another issue is important. Why are public sector bodies engaging insolvent main contractors and therefore putting them in a position to inflict substantial financial damage on the rest of the industry? In a letter dated 17 May 2004, the then Chief Secretary to the Treasury said that""the primary problem facing suppliers is the uncertainty over when and indeed if payments are made"." He went on to say that""the difficulties caused to suppliers"—" in the construction industry—""in the event of insolvency higher up the supply chain requires analysis. Regardless of the payment or contractual arrangements in place, it is important that suppliers receive fair treatment."" Given the fact that insolvencies up the supply chain are now causing severe distress to many small and medium-sized enterprises, which do not have the ability to protect themselves against insolvency risk or even to manage the risk through credit insurance or bank borrowing, it is now time for the House to legislate on the matter. Construction SMEs are now losing almost £1.16 million a year because of non-payment, according to the recent Barclays local business annual late payments report. The incidence of insolvencies in the construction industry is four times greater than in other industries. During the Bill's passage through the other place, no less an expert than Lord Borrie QC introduced an amendment to help firms faced with the Pierse Contracting scenario. In effect, my new clause 3 reintroduces those amendments, and I believe that it is straightforward and self-evident. Firms in the construction industry already have a statutory right to suspend contracts for non-payment, and the proposal is that that right should be extended to cover circumstances in which a procurer of construction works is unable, on request, to provide security such as a bank guarantee or payment bond. Where such security cannot be provided, and there is evidence of the payer's inability to pay, the payee would be able to suspend the contract. Let me dispose of some of the arguments against the new clause. First, if the payer were to fail, fewer assets would be available to satisfy other creditors. As I have said, the sub-contractor already has a statutory right to suspend a contract for non-payment. If that happened and then the payer subsequently discharged the payment, there would still be fewer assets left for creditors in the event of the payer becoming insolvent. Failure by the payer to provide a bank guarantee or payment bond indicates that he does not have the funds to discharge payment when it falls due. Moreover, why should the payee continue to provide valuable work and materials when he knows that he is unlikely to be paid for them? New clause 3 would simply extend the use of the statutory right of suspension as a pre-emptive strike, as it were. Non-construction creditors are likely to have more effective ways—such as the retention of title clauses, for example—to deal with insolvency risk: why should construction firms be expected to continue working to benefit their creditors? If the new clause were to help 1,000 small and medium-sized enterprises in the construction supply chains from going into insolvency, thereby saving a substantial number of jobs, it would have served its purpose. Moreover, payment security would help small firms seeking funding from their banks. The new clause would help to address the problem posed by the banks' current reluctance to lend to SMEs. It has been said that compelling the payer to provide security would be expensive, and that ring-fencing any of the payer's funds could increase the risk of the payer's insolvency. However, if the payer cannot provide a form of security that shows his ability to pay, he should not commission the work. It is extremely expensive for the payee to finance the provision of plant, equipment, work and materials over the lengthy credit periods that are now common in the industry. A period of 60 to 90 days is becoming the norm, and the fact that the payee—usually an SME—is expected to finance such a long period increases the risk that he will become insolvent. That risk is further increased by the possibility that the payer could also become insolvent. In some sectors of the industry, such as lift installation and structural steel work, 80 per cent. of the value of a contract—that is, for lifts or steel—is supplied to a site without any payment being made. The payment process does not begin until the goods are on site, and there is no deposit on order. In addition, the payee is normally expected to provide security for performance, through instruments such as performance bonds and retentions—the practice by which 5 per cent. of payment is withheld until work is completed. The Government believe that, in contrast with other industries, construction firms should get preferential treatment over unsecured creditors, but that argument is relevant only if the payer becomes insolvent and the security mechanism kicks in. On the other hand, if the payee goes into insolvency, the payer is likely to have at least eight weeks of the payee's moneys in the amount withheld in retentions, the performance bond and a parent company guarantee. Therefore, other unsecured creditors currently get preferential treatment over construction creditors, as they can take advantage of the funds intended for the insolvent's supply chain. An administrator for the main contractor is usually called in when that contractor has been put in funds for onward transmission to the supply chain. It is widely accepted that payees in the construction industry do not have the ability to protect themselves against payer insolvency—for example, retention of title clauses are of little use. Once goods and materials have been used in a construction, title is lost. Furthermore, because of the current economic crisis, credit insurance has been withdrawn from thousands of firms. In the 1994 report, "Constructing the Team"—referred to by the right hon. Member for Greenwich and Woolwich (Mr. Raynsford)—which led to the Construction Act 1996, Sir Michael Latham fully acknowledged the problem of lack of protection against payer insolvency. He recommended statutory trust funds, but that proposal was not carried through in the Act. He repeated his recommendation in a report in September 2004 and the then Minister agreed to look at the problem. Throughout Europe, north America and Australia, the problem is acknowledged in construction-specific legislation, offering payee protection against payer insolvency. The Miller Acts in the United States, which apply at federal, state and local authority level, require main contractors to give payment bonds to their subcontractors. Canada and the States have a system of liens, or charges, that can be placed on the building by those who are owed money. France has legislation to require payers to provide bank guarantees and to pay subcontractors directly if a middleman goes into insolvency. German legislation requires all procurers of construction work to provide adequate security. Swiss legislation enables construction firms to place a charge on the property within three months of the date that payment became due. At present, millions of pounds-worth of construction works are being procured by firms with little or no assets—as I said, £100 development companies often procure multi-million pound projects. The majority of main contracting companies do not have the wherewithal to pay their supply chains unless or until they receive cash from their employers or clients. Once the cash is received they hold on to it for as long as they can, until they themselves go into insolvency and the cash is instead handed over to the secured creditors. It is, therefore, not surprising that the number of insolvencies in the construction industry is far greater than in other industries. There is concern that the new clause would mean that the construction industry was treated differently in respect of creditors, but as I have explained they are already treated differently, to their detriment. Section 159 of the Companies Act 1989 provides an exemption from the rules for distribution of an insolvent's assets. The exemption applies to schemes operated by investment exchanges and finance clearing houses in relation to the settlement of debts arising under market contracts. That appears to be an exception. Our new clause reinforces the provisions in part 8. There is little point in improving cash flow arrangements for the construction industry unless the cash is there in the first place. Over the long term, the proposal would bring about a better resourced and, therefore, a more efficient industry. The construction industry is key to efforts to recover from our current financial problems. I have some further notes, but time is pressing and I think I have made my case. I hope to press new clause 3 to a Division in due course.