Subcontractors are the human face of a building & construction industry in crisis

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ABC News Article 23 December 2018:

The construction industry is one of the backbones of the nation’s economy and, in recent years, residential building on the east coast has been a key driver of growth.

A booming housing industry and large infrastructure projects in Sydney and Melbourne have helped keep the economy ticking over as the west coast mining boom went bust.

But with prices now heading south and credit tightening, there are fears the pain felt in Western Australia is set to travel across the Nullarbor.

The construction industry in the west has been rocked by several large corporate collapses in recent years, causing a world of pain for smaller contractors further down the chain — who often do not get paid even if they have already completed the work.

Construction industry insolvencies on average cost subcontractors, employees and the tax office about $3 billion a year in unpaid debts, according to a 2015 Senate inquiry.

“Will we see more collapses? Yes, we will,” business commentator Tim Treadgold said.

“By mid-year, you’ll probably have a number of companies who thought they could survive wake up and realise they can’t.”

Major firms starting to fail

Across the country, almost 1,700 construction businesses went broke last financial year, with most in New South Wales and Victoria.

But it was the collapse of West Australian firm RCR Tomlinson, an engineering business of 120 years, which caught everyone’s attention.

What made this failure different to others was that most considered the company too big to fail, while the wide-ranging implications for 4,000 subcontractors and suppliers really hit home, suggesting broader systemic problems within the industry.

The collapse followed that of York Civil, an Adelaide-based firm which had several large projects across four states.

When the rainy day arrives

York Civil was one of six companies to have collapsed on Perth subcontractor Joe Tropiano over the past 18 months, costing him a total of $1.7 million.

“It’s like a minefield out there. You’re not sure who you’re working for,” Mr Tropiano said.

“You might have known these guys for 20 years and next thing you know they owe you all this money, and next thing you know they’ve closed their doors.

Mr Tropiano said his seven-figure debts had come from a range of contractors, ranging in size from a small operator to a big national company.

“Probably the last four months has been the hardest. Three of them have gone in the last three months and that has put strain on us, very much so,” he said.

Mr Tropiano is four years into a property downturn in Western Australia, a result of the mining bust, when population growth plummeted.

“I’ve never laid anyone off in 35 years … [but] my workforce has probably halved in the last 18 months,” he said.

“You always put a bit away for a rainy day and the last six or seven months it’s been bloody pouring.”

The buck stops here

The main causes of insolvency in the construction industry last financial year were a lack of cash flow and poor management, according to corporate watchdog the Australian Securities and Investments Commission (ASIC).

The problem, many in the industry said, was a highly competitive industry with a toxic culture of underbidding on jobs just to win the work.

Then, when the project could not be delivered on budget, the subcontractor got squeezed, or even worse, sent to the wall.

Pitcher Partners Perth chairman Bryan Hughes works closely with subcontractors, helping struggling companies restructure when they are close to failure.

“There is a culture from large clients, large contractors of dictating terms and that flows through the industry to some extent, and that is a bit of a toxic culture,” he said.

“I have often reviewed subcontracts and they are so one-sided, it’s unconscionable. It’s wrong but they have been agreed to because that was it, those were the terms dictated.

“Ultimately, if it’s been too lean at the head contract level to the point they can’t make money and they go bust, then it flows to the poor subcontractor who ends up copping it.”

Next year is not predicted to be any smoother.

Banks are under pressure for poor lending practices; house prices are plunging on the east coast; and businesses face an increasingly rocky economic environment abroad, with ongoing Brexit tensions and a trade war brewing between the United States and Australia’s largest trading partner, China.

“We’ve seen one big fall in RCR and you’d have to assume other companies are under similar pressures, caused by mismanagement basically — not getting their costs right, not getting their skill mix right and messing up contracts,” Mr Treadgold said.

“So next year could be a bad year for corporate failures.

“Those contracts were bought at a price which was too low and then they reach a point where they can’t complete the projects, and that causes a hell of problem for everyone involved.

“The company itself goes belly up and the subcontractors are the meat in the sandwich, they don’t get paid.

“I think you’re going to see developers struggle to sell the units or the property they’ve developed; you’re going to see heavy duty discounts just to shift assets off their books; you may well see companies selling things for less than they cost to build and that’s a one-way ticket to the poor house.”

Financial contagion spreads east

While the industry in the west has been in the doldrums since the mining investment boom ended in 2014, the pain is now spreading east as developers and buyers deal with tumbling property prices and a credit squeeze at the bank.

“That will lead to a more competitive environment for contractors trying to compete for work … and that can lead to more corporate failures as a consequence,” Mr Hughes said.

“It’s a sector that’s remarkably tenacious at holding on, but at some point if the cycle does turn as it seems to have turned over, there’s just not enough trade to carry on and someone will collapse.”

Red flags are already emerging.

National building approvals are down about 14 per cent this year, with predictions of a further fall of up to 30 per cent over the next two years — the sharpest percentage downturn since 2000-01.

“The decline will be a bit more severe in Melbourne and Sydney, so the markets that went up the most, we expect them to fall the most in the downturn,” BIS Oxford Economics senior economist Timothy Hibbert said.

“When you look at a market like Perth, it’s already taken a fairly big hit over the last few years, so there’s not too much more to fall. So we expect it to be one of those markets which recovers earlier than the others.

“We expect more projects to be put on the sideline, or delayed, or developers basically re-sell their land.”

The construction industry directly employs about 10 per cent of the nation’s workforce, as well as providing work for a range of other sectors like manufacturing, engineering and professional services.

So keeping the country building is of critical importance to the broader economy.

“Basically, it’s going to mean fewer jobs. The construction industry has quite a high multiplier for the greater economy, so the greater economy will feel it,” Mr Hibbert said.

“It will mean fewer dwelling construction starts which will mean fewer materials — concrete and bricks and all your finishing inputs — so that will flow through to all the various manufacturing sectors.”

Financial regulator the Australian Prudential Regulation Authority (APRA) has reacted to the state of play.

This week APRA lifted restrictions on interest-only residential lending from January 1 next year, in an attempt to stabilise Australia’s ailing housing market.

It followed a move the regulator made in April to remove a “speed limit” it had imposed on lenders since 2014, requiring them to keep investor credit growth below 10 per cent each year.

Gloomy view not shared by all

Melbourne builder Ross Palazzesi has weathered financial storms before.

His business, Metricon Homes, still has work booked for another year and he did not expect the slowdown to be felt for some time.

“Right here and now, we’re not feeling anything. We’re as busy as we’ve ever been and, in fact, I don’t think the market in Victoria has peaked yet in terms of building on site,” Mr Palazzesi said.

“So this slump, if it’s going to happen, is probably 18 months away.”

While Mr Palazzesi said he was starting to see forward orders come off, he remained positive about the state of the market.

“If this keeps going, certainly it will flow right through,” he said.

“Apart from housing and trades and et cetera, there’s all the ancillaries — washing machines, everything that goes into a house — so it will have a marked effect.

“But I wouldn’t be that pessimistic, because I think at the moment we’re having the correction we had to have.”

Subcontractors left to pick up the bill

While several reviews into the industry have recommended cascading statutory trust accounts to make sure a subcontractor gets paid if the company above them goes insolvent, no government has yet introduced legislation.

Three recent reviews conducted by building disputes specialist John Murray, barrister John Fiocco and small business ombudsman Kate Carnell all make dozens of recommendations including the introduction of statutory trust accounts.

But there is still little protection to make sure subcontractors get paid if a company above them goes insolvent.

“We’d like to see something in the industry that’s implemented through the statute of law that says, as a contractor, if you are collecting money by work that’s done by your subcontractors, you absolutely have to keep that money in trust and you can’t just spend it however you might like,” Australian Subcontractors Association board member Louise Stewart said.

“The current laws in place on the east coast have dealt with prompt payment and fair payment — what they’re not dealing with [is] protecting payments in the event of insolvency.

“Subcontractors below the entity that’s had the insolvency event often don’t get paid at all, even though they have already paid their employees, their employee entitlements and their tax.”

New South Wales and Queensland have recently bolstered legislative protections, but there is little consistency across states and territories.

Western Australia and the Northern Territory are currently behind the national standard, but the WA Government is considering a raft of measures which, if implemented, would give subcontractors the best protections in the country.

NSW is considering statutory trust accounts but has delayed any action ahead of its upcoming state election.

“Obviously those at the top of the supply chain quite like the situation at the moment,” Ms Stewart said.

“There’s no transparency, there’s no oversight in terms of how those funds are spent that actually belong to the subcontractors who have done the work.

“This is the right thing to do. It’s necessary for the future of the industry.”