House of Commons - Business and Enterprise

Select Committee on Business and Enterprise Written Evidence

Supplementary memorandum submitted by Specialist Engineering Contractors' Group

INTRODUCTION

The Specialist Engineering Contractors' (SEC) Group forwarded its submission to the Trade & Industry Committee's inquiry into the UK construction industry on 16 May 2007. This paper provides additional explanation for the issues raised in that submission and is updated to include matters which have arisen since.

At the end of each section we have distilled the issues to provide some focus for the Committee's deliberations and, to help the evidence-gathering process, we have also listed questions that could be asked of witnesses. Against the suggested questions we have identified the government departments to whom the questions could be put.

As in our submission the overriding theme of this paper is that the industry remains bedevilled by poor and outdated practices that hold it back from becoming a modern and efficient industry, having more in common with the 20th century than the 21st century. As a consequence many investors still give the industry a wide berth. It continues to struggle to attract high calibre professionals within the fields of engineering and project management. Above all else traditional procurement and delivery processes are wasteful and inefficient. This, in turn, has an adverse impact upon capacity and productivity.

The key issues which need to be addressed are:

1. We should now put in place "drivers" to achieve greater integration of the delivery process especially the early involvement of the supply chain as part of the design team.

2. Action is now needed in the areas of payment, insurance and contracts to remove barriers to integrated teamworking as well as to facilitate it.

3. The Construction Act requires amendment to strengthen its payment and adjudication provisions to reflect the intention of Parliament when passing the Act. Such amendment, therefore, should enhance payment certainty and ensure that adjudication continues to be inexpensive and accessible.

4. In order to promote a sustainable industry that delivers value for money, public sector procurers should insist that only competent firms are engaged on public sector works (whether as contractors or sub-contractors). However, we need to have in place a means for recognising competence (which are acceptable to procurers) whilst, at the same time, rationalising competence schemes and reducing the burden on SMEs of myriad third party vetting processes.

5. Public sector procurers should be more proactive in improving the treatment of SMEs engaged on public sector works contracts.

In each section we have listed recommendations which we believe, if taken up by the Select Committee, will help create a sustainable industry in which the potential of all firms in the industry—especially SMEs—is exclusively engaged in delivering improved value to customers. As a result the industry will be better placed to improve upon its current low levels of profitability.

We wish to commend the (now re-named) Business, Enterprise & Regulatory Reform (BERR) Committee for its decision to launch this inquiry and look forward to assisting the Committee in its work.

1. CREATING A MODERN AND EFFICIENT INDUSTRY

Background

1.1 Construction works are traditionally procured by engaging architects and engineers to carry out the design which is then put out to competitive tender to main contractors. Tendering main contractors will, in turn, invite bids from sub-contractors who may also invite bids from sub-sub-contractors and suppliers. Main contractors will, then, submit lump sum bids.

1.2 Sub-contractors and suppliers will be specialist contractors such as foundations specialists, cladding and structural steelwork contractors, engineering services contractors and fit-out specialists. Over 85% of the value of the industry's output is delivered by such specialists together with their suppliers and manufacturers. This includes a significant amount of design work as well as construction or installation works. They are also responsible for the repair and maintenance of the delivered product.

1.3 But, as the supply chain, they have little or no influence over the procurement process especially the initial decisions affecting the planning of the project, the design, the management of the risks involved and the costs. It is these decisions which will determine whether the completed building or structure will represent value for money. This factor alone represents the major fault line in the delivery of construction works in the UK.

1.4 The traditional delivery process is fragmented and disintegrated. There is very little (if any) dialogue on design solutions between architects, consulting engineers and key specialist contractors such as engineering contractors, the latter often carrying out a substantial amount of design work.

1.5 Specialist contractors and suppliers are frequently having to convert design concepts into practical and coordinated design solutions whilst at the same time absorbing most of the risks associated with the delivery process (including any shortcomings in the design they have inherited). As a result out-turn costs are usually much higher than the initial lump sum bid.

1.6 The diagram below shows the traditional procurement process:

Customer: with help of consultants/lawyers develops project/design brief for tendering on lump sum – but design usually incomplete.

Main Contractor: Manages construction delivery; usually under-capitalised and needs cash from customer to pay sub-contractors

Sub-Contractors: Specialist contractors that deliver the bulk of the detailed design and construction and absorb most risk (eg. original design not working)

Traditional Procurement: Key Features

— Poor communication
— All risk transferred along supply chain
— Adversarial relationships and disputes
— Lowest price
— Retentions — No integrated working—everybody operates within “silos”
— Hierarchical & sequential appointments
— Many interfaces
— IneYcient delivery (eg re-design and re-work)
— Out-turn cost exceeds original budget (sometimes many times over)

TRADITIONAL PROCUREMENT - THE COST OF FRAGMENTED DELIVERY

The bulk of Wembley (in terms of value) was designed and built by specialist contractors; eg. foundations, steel structured, engineering services and fitting out. They had no say in the early design decisions and cost plan

* Not including the cost of myriad disputes, adjudications and court cases!

1.7 There are other consequences of having a fragmented delivery process:

(a) Planning and design decisions often overlook health and safety issues arising in the construction (or production) process.

"Of all fatal accidents on construction sites, as many as 60% can probably be attributed to choices made before the work on site began."

Published by DTI, August 2000

(b) Sustainable construction becomes impossible; there is much waste:

— a delivery process based upon hierarchical and sequential appointments generates needless transaction costs.

— a focus on lump sum, lowest price tendering ignores whole-life costs, eg. maintenance and energy consumption over the lifetime of the building or structure.

— there is a large amount of waste arising from duplication at all the different levels of delivery.

— waste also arises through much re-design and re-work.

i. the initial design solutions not being "bought into" or "owned" by those delivering the product;

ii. a combination of the lowest price culture and ease of entry into the industry which deter reputable and established firms from investing in training and technology;

iii. too many interfaces;

iv. firms (particularly SMEs) absorbing a disproportionate amount of risk.

"Many construction problems are caused by poor design because designers often have insufficient information about the performance of the product in use. Design-based defects are a major cause of customer dissatisfaction . . . because of the complexity of modern buildings, rising expectations of building performance are exposing the inadequacy of traditional design approaches."

on behalf of The Built Environment & Transport Foresight Panel.

1.8 In 1998 the [then] Deputy Prime Minister appointed Sir John Egan to chair a Construction Task Force to consider the scope for improving construction efficiency. Sir John's key recommendation was that the industry must integrate its delivery processes to remove waste and, thus, provide added value to customers. Sir John further recommended that the public sector should take a lead in bringing about the necessary change.

Traditional procurement—the cost of fragmented delivery

Construction Defects and their Causes

1. Unclear / missing project information—poor communication

2. Design not working

3. Low quality design

4. No co-ordination of design

5. Difficult to build

6. Designer not understanding materials

"Quality Control on Building Sites": 1981 Building Research Establishment Study of

27 building sites involving public sector projects valued between £100k and £12m

Integrated Delivery

1.9 What is integration? It is the bringing together of all the processes involved in construction delivery—especially design and construction—into a seamless whole. This involves a flatter delivery structure with greater collaboration between the delivery team—consultants, project managers, specialist contractors, facilities managers and suppliers. The focus is on identifying the customer's requirements or value criteria (relating to matters such as functionality and usage) and the appointment of the team best suited to deliver against such criteria. Needless to say, the team should be appointed and actively involved at the outset of the procurement process to agree the design solutions, cost plan and risk allocation before construction begins.

"The most successful enterprises do not fragment their operations—they work back from the customers' needs and focus on the product and the value it delivers to the customer."

Rethinking Construction: Sir John Egan, 1998

1.10 The public sector responded to Egan's challenge with the launch of the Achieving Excellence programme in March 1999. This became a five year programme to overhaul construction procurement by government clients. The Office of Government Commerce (OGC) was given responsibility for implementing the programme. In it's Procurement Guide 6, the OGC stated: "An integrated project team should be appointed to carry out the project."

1.11 Government clients responded enthusiastically to Achieving Excellence. Procuring staff were trained to become better informed about construction; new procurement strategies were introduced in an effort to engage the supply chain in key decisions affecting planning and design. There was a clear commitment to move from the lowest price syndrome to best value comprising whole life cost.

1.12 But, unfortunately, bad practice has become difficult to dislodge. In its 2005 report, Improving Public Services through better construction, the NAO concluded that government clients still had much more to do to involve the supply chain (ie. the delivery team) in the key decisions affecting project outcomes. Alongside other best practice measures such involvement would help contribute towards overall annual savings of £2.6 billion.

1.13 The NAO's view was echoed in our own survey in 2005. This was a survey of specialist engineering contractors—often delivering up to 50% of the value of the project—which had worked on government projects. The results were very disappointing. Very few firms had been involved on a regular basis in the early design decisions or had been part of partnering or collaborative working arrangements. Consequently, progress in achieving integrated delivery has been slow and patchy despite a growing accumulation of evidence of the benefits of integration.

1.14 In 2002 Sir John Egan launched Accelerating Change which identified measures to drive and facilitate integrated delivery. This report set a target of 50% of construction projects (by value) to be undertaken by integrated project teams by the end of 2007. We are nowhere near meeting this target!

The issue

We should now put in place "Drivers" to achieve greater integration of the delivery process especially the early involvement of the supply chain as part of the design team.

Our Recommendations

1.15 A very effective driver would be to make funding conditional on delivery by integrated project teams. This can be introduced progressively. This was supported in Accelerating Change (referred to at paragraph 1.14) which was endorsed by the [then] Department of Trade & Industry.

Consitionality of funding

"It is important that the public sector demonstrates that it is a best practice client which consistently secures the best whole life performance that the construction industry can offer. The public sector can be helped to achieve this by ... linking government funding of construction projects to the application of `Rethinking Construction' principles."

(Para.4.10 Accelerating Change: Sept 2002)

Further support for such conditionality of funding was implicit in the 2005 NAO report "Improving Public Services through better construction".

Conditionality of funding

"... despite all departments' formal committment to embedding the principles of Achieving Excellence as a matter of Government Policy, public funding for construction is not always conditional nor does it contain the right incentives to embed the principles of the Achieving Excellence methodology."

(para.2.29 Improving Public Service through better construction: NAO 2005)

1.16 The Housing Corporation is now making funding of housing association construction works conditional upon compliance with the 2012 Construction Commitments. The Commitments—launched last year by the Secretary of State for Culture, Media & Sport—are best practice requirements for Olympic construction but they are now regarded by the OGC as generally applicable to public sector works.

1.17 An alternative approach is to make funding conditional upon evidence of compliance with the OGC's Common Minimum Standards. They are a list of key minimum procurement standards that are mandatory across central government departments and executive agencies (including the non-departmental public bodies for which they are responsible). The first and "General Standard" refers to adherence to the OGC's "Achieving Excellence in Construction" initiative. This has as its overall theme the procurement of integrated project teams involving all the key suppliers at the outset.

1.18 Three further measures are suggested:

(a) A "champion" to promote integrated project teams on public sector construction

It is suggested that Treasury appoint a high profile individual from the private sector to champion project team integration. Such person could compliment the work of OGC in creating an understanding of the benefits of integration amongst public sector clients. The appointed person could also monitor progress, identify barriers to progress and help in providing solutions to overcome them.

(b) The best value review process for local authorities should assess their progress in procuring construction through the use of integrated project teams.

This should not be used as a "stick to beat" local authorities but rather as a means of encouraging local authorities to recognise that procuring construction works in this way is far more likely to achieve best value. This will also help to identify local authorities which are in need of support in making the necessary progress.

(c) In conjunction with the Regional Development Agencies (RDAs) and Constructing Excellence BERR should establish a network of independent construction advisers (or "integration facilitators") to assist customers on sourcing, assembling or appointing integrated project teams.

About 95% of the construction industry's customers are one-off or occasional clients. The RDAs (working with Constructing Excellence, a best practice body) are best placed to identify construction professionals who can help customers develop their strategic briefs (listing their user requirements) and put together the appropriate team. The adviser or facilitator would not have a direct participation in the delivery process and, in this sense, would be akin to an independent financial adviser.

Questions

1.19 (a) At the heart of the Achieving Excellence programme launched in March 1999 was a commitment to procuring construction projects through integrated project teams. What progress has been made? [Treasury/OGC]

(b) In view of the fact that Accelerating Change in 2002 and, more recently, the NAO have favoured making funding conditional on the use of integrated project teams, what steps have the Government taken (as the leading public sector client) to bring this about or what steps (if any) does it intend to take? [Treasury/OGC]

(c) Would the Government have any difficulties linking funding to compliance with the 2012 Commitments or the Common Minimum Standards? [Treasury/OGC]

(d) What, if any, lead-in time would be required before conditionality of funding can be put in place? [Treasury/OGC]

(e) What options are there for driving integrated procurement and delivery across government construction bearing in mind that progress, to date, has been very slow? [Treasury/OGC]

(f) Will the Treasury appoint a high profile "Champion" to drive integrated procurement and delivery in the public sector? [Treasury/OGC]

(g) As part of the best value review process, would you support district auditors progressively insisting on the use of integrated project teams to deliver local government construction? [BERR/DCLG]

(h) Would you agree to the Regional Development Agencies (working with Constructing Excellence) establishing a network of independent construction advisers to assist customers on sourcing or assembling and appointing integrated project teams? [BERR]

SUMMARY OF SEC GROUP'S RECOMMENDATIONS

1.A	The Treasury to progressively make funding of government projects conditional upon evidence of compliance with the OGC's Common Minimum Standards or with the 2012 Construction Commitments.
1.B	The Government to appoint a high profile "Champion" to drive the integration agenda.
1.C	The Audit Commission (and Audit Scotland, the Wales Audit Office, Audit Office Northern Ireland) to insist that evidence of integration and collaborative working be a major part of the best value review process.
1.D	BERR should invite the Regional Development Agencies (working with Constructing Excellence) to establish a network of independent construction advisers (or "integration facilitators") to guide and assist customers on sourcing, assembling and appointing integrated project teams.

2. PUTTING IN PLACE MEASURES TO FACILITATE TEAMWORKING ON PROJECTS

2.1 Since close collaboration within the delivery team is vital if we are to achieve value for money delivery, measures should be in place to facilitate such collaboration. We consider that the following measures are necessary for successful teamworking:

(a) project bank accounts;

(b) collaborative contracts;

(d) phasing out the practice of retentions on public sector projects.

Together these measures, if implemented, would provide the necessary degree of trust and align the behaviours of team members which are crucial for genuine and, therefore, successful collaboration.

Project Bank Accounts

2.2 Generally payment for the supply chain has to pass through many "pockets". Along the way its passage is often impeded; those that have the cash have an immediate incentive to produce excuses for holding on to it before releasing payments to the supply chain.

2.3 The majority of the major UK contractors are under-capitalised but, nonetheless, "farmout" most of their work to sub-contractors and suppliers. They do not have the means to pay their supply chains until they have been put in funds by the customer. In the meantime they depend upon their supply chains to finance the works. Moreover, many developer clients are "shell" companies without assets and, therefore, are simply conduits for transferring onwards the cash received from their funders or investors. Special Purpose Vehicles specifically set up for procuring construction works as part of PFI/PPP projects are in a similar position.

2.4 The UK construction industry, therefore, continues to be funded "bottom-upwards" which is inefficient. Furthermore the supply chain is at constant risk of insolvencies further along the chain without an effective means of accommodating this risk. Consequently, the costs of UK construction are substantially enhanced by poor payment practices which include:

(a) multi-layered payment systems;

(b) payment abuse and disputes;

(d) lengthy payment periods.

Poor payment practices are a major barrier to teamworking. [The subject of payment is also raised in the next section on the review of the Construction Act.]

2.5 The NAO recommended that public sector procurers should consider project bank accounts. This was supported in the 2012 Construction Commitments and recently endorsed by the Public Sector Construction Clients' Forum which (through the OGC) has published guidance and documentation for operating project bank accounts. The guidance advises that project bank accounts (together with a new Fair Payment Charter) will produce significant savings for the public sector purse. It recommends that public sector clients progressively introduce project bank accounts as from 2008.

Project bank accounts: NAO's view

"Departments need to provide specialist small and medium sized suppliers with greater certainty that they will be paid on time to reinforce the trust that should exist between all parties for collaborative working to operate effectively. If this trust does not exist in the supply chain then specialist suppliers, who can significantly influence the value for money obtained on a project, will have little incentive to innovate. Considerable losses can also be incurred over payment disputes which will ultimately feed their way back into the costs for the client. The use of a single project account is one way to provide greater certainty of payment to specialist contractors and suppliers further down the supply chain from the main contractor."

better construction", 2005)

"Over time, as confidence in the system increases, the use of `Fair Payment' Charters and Project Bank Accounts will become more widespread and further overhead and risk savings could be realised, increasing savings to over £750m." (emphasis added)

by the Office of Government Commerce

on 19 September 2007

2.6 Rider Levett Bucknall, a leading firm of construction consultants, has developed a training package to support client organisations and supply chains intending to use project bank accounts; it has experience of using such accounts. The Bank of Scotland and Barclays Bank have developed specific banking documentation to facilitate the setting up of the account. Contract producing bodies are also developing project bank account provisions for their contracts. The OGC has set up a monitoring process to gauge progress. Therefore, everything is in place to enable procuring organisations to set up and use project bank accounts from January 2008.

How a Project Bank Account works

2.7 Last year SEC Group carried out a survey of firms in its member associations to inquire into the extent to which their costs would be reduced by having project bank accounts. 65% of respondents thought that their costs would be reduced; the majority of respondents believed their costs would reduce by up to 5%. A significant number stated that their costs would be reduced by up to 10%. The survey results were audited by David Langdon.

"There is very good alignment between the mechanism of Project Bank Accounts and the principles of fair payment, and it is recommended that public sector clients should progressively specify use of Project Bank Accounts where practicable and cost effective. Where they are used, clients should give a written committment to a payment period linked to a PBA. Their use generates the confidence in both the supply chain and the lead contractor, reducing their risks and prices by providing real surety of cash flow for all parties."

(Para.18. Guide to Best `Fair Payment' Practices, OGC Report: August 2007)

Collaborative Contracts

2.8 Contractual arrangements should be transparent throughout if we are to achieve genuine teamworking. Government procurers should insist on the use of collaborative contacts throughout the supply chain; furthermore, lead contractors' bespoke sub-contracts should be outlawed on public sector works.

2.9 Our 2005 survey of engineering contractors working on Government projects (as sub-contractors) indicated that only 38% of firms were content with the contractual terms on offer on the majority of projects. The supply chain construction contracts for government projects are generally bespoke contracts generated by lead contractors. Our attention has often been drawn to the fact that at government client-lead contractor level the contracts are even-handed but, below the lead contractor, there is a disproportionate allocation of risk to the supply chain. This undermines the efforts of government procurers to encourage greater teamworking within the delivery team.

"Forms of contract should aim to improve the quality and cost-effective delivery of clients' projects through . . . [allocating] each risk to the party who is best able to manage it."

(Procurement Guide 6, Procurement and Contract Strategies, OGC)

2.10 This provides an opportunity to raise another issue relating to contracts on government construction projects. There are a vast array of construction contracts used by Government procurers for various procurement methods and building types. Often the contracts are unnecessarily complicated and lengthy. Whilst there has been progress in developing longer-term relationships with the industry through framework agreements, standardisation of contracts has not been achieved. Instead there is now a proliferation of contracts with a variety of payment and risk/reward mechanisms.

2.11 This, of course, adds substantially to the costs of bidding for government construction works and of administering the contracts. In principle, all contracts and sub-contracts for government works should be standardised or, at least, their core provisions should be standardised. The only attempt at standardisation has been the Treasury's standard project agreement for PFI arrangements (SPOC4). But the construction contracts and sub-contracts let under PFI arrangements are not standard. The easiest solution would be for Treasury/OGC to insist upon the use of the available collaborative contracts as recommended by the NAO in its 2005 report Improving Public Services through better construction.

"The use of standard forms of contract helps to reduce both tendering and contract administration costs. Bespoke or amended standard forms require clients and tenderers to seek additional and frequently costly legal advice and this increases the risk of disputes arising from unfamiliar terms."

(Procurement Guide 6, Procurement and Contract Strategies, OGC)

Use of collaborative contracts: view of NAO

"Modern forms of contract can support clients in developing closer, more collaborative, longer-term working relationships with suppliers. The Engineering and Construction Contract . . . is one example of a contract written in plain English that embeds the principles of good project management in its procedures and promotes role clarity. It encourages early issue resolution, and contains options onto the choice of procurement route. It is non-adversarial in its tone and spirit, and as such, many clients have adopted it for use in long-term collaborative working arrangements . . . More recently Collaborating for the Build Environment (Be) has developed a collaborative form of contract. This has widespread support from the industry and is now starting to be used on projects in the UK . . . Some contracts are still written in the traditional more adversarial approach and are not suitable for modern collaborative ways of working. The Office of Government Commerce is currently working to reduce the number of standard forms of contract being used in the public sector.."

NAO Report: 15 March 2005)

Project Insurance

2.12 Traditional insurance arrangements in the industry are aimed at protecting the individual rather than the team. This is a major barrier blocking the way to greater teamworking. There is an acute need to develop a policy of insurance that underwrites the whole team.

2.13 The Public Sector Construction Clients' Forum has agreed that government procurers should identify suitable projects for piloting "single project financial loss insurance". A number of brokers and insurance companies are interested in supporting pilot projects. It is now urgent that Government procurers come forward with projects for piloting. In the meantime, both SEC Group and the OGC have been funding work on developing a suitable policy. It is expected that the first projects for piloting project insurance will be underway in 2008.

"[Departments should] ... seek opportunities to pursue the case for project-wide insurance, not only to reduce costs through bulk buying, but also to align behaviours with the principles of integrated team working."

NAO Report, 15 March 2005)

Phasing Out the Practice of Retentions

Retentions: do they make a difference?

"Holding retention is intended to incentivise contractors to repair defects in the defects liability period on traditional contracts. In reality there is little evidence to show it actually encourages contractors to produce defect-free properties. If anything holding retentions encourages contractors and sub-contractors to increase their prices accordingly because they will not necessarily receive their retention."

February 2002: The Challenges Ahead

2.14 The Trade & Industry Committee has already carried out an inquiry into the practice of retentions: The Use of Retentions in the UK Construction Industry (Second Report of Session 2002-03). This was followed by a further report, Retaining Retentions? (Fifteenth Report of Session 2002-03) which was the Trade & Industry Committee's commentary on the government's response to the initial report.

2.15 The Committee concluded that the practice of retentions was out-dated in a modern, professional industry. The evidence presented to the Committee indicated that the practice had more to do with the provision of interest-free cash than providing security against defects. The deduction of cash retentions (usually 5% of due payments up to practical or substantial completion of the works) was "part and parcel" of the lowest price culture.

Some local authorities regard retentions as convenient interest-free loans

"Reduces borrowing and aids cash flow" (Aberdeenshire Council)

"Retentions are not put to any `use' as such. Budgets are allocated on the basis that retentions will be deducted so, indirectly, retentions are used to finance capital schemes". (Salford Council)

"Held in capital project accounts" (Strabane District Council, Northern Ireland)

"Invested" (Poole Borough Council)

"Held in capital programme." (Barrow Borough Council)

The Use of Retentions in Local Authority Construction Procurement published in 2004

(available at www.secgroup.org.uk)

2.16 Moreover retentions are the antithesis of teamworking and collaboration:

(a) they indicate a lack of trust: if a firm is considered incapable of carrying out defect-free work it should not be selected in the first place;

(b) the practice is divisive: retentions are not deducted from other members of the team such as consultants and manufacturers;

(c) there is never any mutuality in the practice: those deducting retentions do not offer concomitant security for performance such as payment bonds.

"The retention system developed as a means of ensuring that contractors delivered work to the standard expected by the client, and its continuation is an indication of the degree of distrust between clients and the industry. It is also a very considerable burden upon the industry, especially small and medium sized companies that make up the bulk of contractors in the construction sector. The Specialist Engineering Contractors' Group (SECG) has estimated that SMEs are funding £3.25 billion of cash retentions every year. Furthermore, it is a burden on the taxpayer . . .. the cost to the public purse of such a practice could be as much as £750 million a year".

Committee: Fifteenth Report of Session 2002-03)

2.17 The results of a recent survey published by the Building Services Research & Information Association (BSRIA), a private sector research body, demonstrate the adverse impact that retentions have on the industry. Outstanding retentions account for 3% of the turnover of the mechanical and electrical contracting sector. If this figure is projected across the industry's turnover, a total of £3 billion of retention monies is outstanding! It is difficult to conceive of any other industry in the UK that would be prepared to tolerate such a burden of outstanding debt; such burden weighs most heavily on small businesses.

2.18 In its survey BSRIA invited firms to indicate the uses to which they would put retention monies in the event that the retentions system ceased to exist. 160 firms responded to this question as follows (some gave more than one use):

Better cash flow/stability 37%

More investment in training 20%

Employ more operatives 14%

More IT investment 13%

More investment in new equipment and tools 10%

Fewer people in credit control 1%

Status quo would remain 5%

BSRIA 2007 Survey: impact of retentions on capacity

An interesting result in the BSRIA survey is that 14% of firms would employ more operatives. There are over 50,000 firms in the M&E sector. If each of these firms employed an additional operative, there would be available work for almost 7,500 people. If these statistics were projected across the industry (which comprises approximately 180,000 firms) there would be employment for an extra 27,000 people! This, in turn, would enable the industry to significantly increase its capacity.

2.19 We believe that significant progress still has to be made on the complete abolition of retentions on government works. Even where government procurers have outlawed retentions, the evidence is that they are still being deducted by lead contractors from their supply chains. We invite the Business, Enterprise & Regulatory Reform Committee to insist on compliance with its recommendation that retentions on government works should be phased out "as soon as possible". Since this recommendation was made four years ago it should by now be implemented without further delay—given that government procurers are committed to collaborative working.

Retentions: the trade & industry committee's recommendation

"Given the annual cost of retentions to the construction sector and to their public sector clients, it is obviously in the interest of all parties that they are phased out as soon as possible. The Government has insisted that this be done by the successful introduction of best procurement practice so that the retentions system is rendered obsolete, rather than by direct action to remove retentions provisions from government contracts. We do not accept that these actions are mutually exclusive, as the Government appears to believe, especially as some departments, such as the Highways Agency, have already indicated that removing retentions provisions would be feasible by 2007, as we had suggested".

Retaining Retentions?

Trade & Industry Committee: Fifteenth Report of Session 2002-03)

The issue

Action is now needed in the areas of payment, insurance and contracts to remove barriers to integrated teamworking as well as to facilitate it.

Our Recommendations

2.20 (a) Given the support and guidance that is now available for setting up project bank accounts, we invite the Committee to recommend that all government procurers introduce such accounts on new projects commencing in 2008, where practical and cost effective. Local authorities should be encouraged to consider them for new projects starting in 2009. Initially, we would suggest that they should be applied to projects over £3 million (although this should not prevent public sector clients applying them to lesser—value projects if they so wish).

(b) Given the support for integrated project insurance from the NAO and Public Sector Construction Clients' Forum, further encouragement should be given to government procurers to identify projects suitable for piloting this type of policy. The project value should be between £20 million and £30 million. We suggest that the Committee invites the OGC to contact all government procurers to establish whether they can offer at least one pilot project.

(c) We suggest the Committee invites the OGC to set targets for government procurers to standardise construction contracts for all procurement routes by insisting on the use of standard collaborative contracts for the whole delivery team. This should involve the outlawing of bespoke contracts throughout the supply chain.

(d) The Committee has already proposed the elimination of retentions on government projects to take effect "as soon as possible". It originally recommended 2007 as the target. We suggest that the end of 2008 should now be considered as the target for phasing out this practice.

Questions

12.21 (a) Given that project bank accounts are recommended by the Public Sector Construction Clients' Forum, the OGC and the National Audit Office (and are also recommended in the 2012 Construction Commitments), will the Treasury/OGC now insist that they are introduced on all government projects commencing in 2008 where practicable and cost effective? [Treasury/OGC]

(b) What would be the most effective way of encouraging local authorities to establish project bank accounts on local authority construction works? [DCLG]

(c) Can we work together to set an achievable target (say 2009) for local authorities to introduce project bank accounts for all new projects commencing in that year? [DCLG]

(d) What measures will be taken to ensure that there is standardisation of contracts across all government procurement routes? [Treasury/OGC]

(e) The easiest solution, presumably, would be to insist on the use of standard collaborative contracts for all government procurement routes allowing for a fair allocation of risk within the supply chain? [Treasury/OGC/Individual Government procurers]

(f) If Treasury/OGC and individual procurers were to insist on the use of standard collaborative contracts will bespoke contracts and sub-contracts be outlawed? [Treasury/OGC/ individual government procurers]

(g) Will OGC take responsibility for drawing up a list of future government project(s) valued between £20 million to 30 million that could be adopted as pilots to trial policies of project insurance? [OGC]

(h) To what extent has the practice of retentions on government works been outlawed:

i. between clients and lead contractors; and

ii. between lead contractor and sub-contractors? [Treasury/OGC/ individual

government procurers]

(i) In the case of those government departments and agencies which still require retentions, what are their reasons for doing so and when will they cease the practice? [Treasury/OGC/ individual Government procurers]

SUMMARY OF SEC GROUP RECOMMENDATIONS

2.A	All government procurers to introduce project bank accounts where practical and cost effective for all projects commencing in 2008. All local authorities should be encouraged to consider them for new projects commencing in 2009.
2.B	OGC to contact all government procurers to encourage them to offer at least one project (value between £20-30 million) for piloting project insurance.
2.C	Government procurers should insist upon the use of collaborative contracts for the whole delivery team and that bespoke contracts and sub-contracts are outlawed. OGC should set targets by which these actions should be completed.
2.D	The end of 2008 to be the target for outlawing the practice of retentions on all government projects (including retentions applied along the supply chain) following a recommendation of the Trade & Industry Committee in 2003 that "Government departments . . . eliminate the practice of retentions as soon as possible".

3. REMEDYING THE WEAKNESSES IN THE CONSTRUCTION ACT

Background to Review of the Act

3.1 The priority for the overwhelming majority of contracting firms in the UK construction industry—mainly SMEs—is payment security. Over the years studies have consistently shown that payment delays and abuse are far more widespread in construction than in other UK industries. Payment abuse embraces a variety of behaviours from failing to pay without providing reasons to delaying payments for spurious reasons connected with, for example, the value of works carried out or alleged payee defaults. Following a recommendation in Sir Michael Latham's report in 1994 "Constructing the Team", Part II of the Housing Grants, Construction & Regeneration Act (generally known as the "Construction Act" and called the "Act" in this document) was introduced. It came into force on 1 May 1998.

"Two words . . . the gatekeepers to any real progress . . . These words are `trust' and `money'. They are totally interlocked.

Too little trust—and not enough money. A mighty machine which requires oil in its engine to drive it, has grit instead."

Sir Michael Latham's interim report in 1993)

3.2 Most firms in the industry would acknowledge that the Act has helped to improve payment certainty. In particular, the provisions relating to the right of suspension for non-payment, the limited ban on pay when paid clauses and adjudication (for dealing quickly with payment disputes) have been of great assistance in helping to eradicate poor payment practices along the supply chain. But experience over the past nine years shows that:

(a) Weaknesses in the Act have become apparent and exploitation of these is rife;

(b) Most firms have difficulties in establishing whether their contracts are Act compliant;

(d) Adjudication has now become an expensive process which deters SMEs from using it. (An explanatory note in Schedule I at the end of this document summarises the Act's provisions and its major weaknesses.)

3.3 Consequently the (then) Chancellor announced a review of the Act in his 2004 Budget Statement. The DTI (now BERR) was given the task of carrying out the review. Sir Michael Latham was appointed Chairman of the Review Panel. Working groups on payment and adjudication were established to identify the issues on which the industry should be consulted. Sir Michael reported to the [then] Construction Minister on 17 September 2004.

Announcement of review of act

"Following concerns expressed by the construction industry on unreasonable delays in payment, the Government will review the operation of the adjudication and payment provisions in the Housing Grants, Construction and Regeneration Act 1996 to identify what improvements can be made."

(March 2004, Budget Statement)

3.4 In March 2005 the DTI initiated a three month consultation on issues arising from Sir Michael Latham's review. However, some issues had either been diluted or excluded from the consultation. (The issues raised in Sir Michael's review and progress to date are set out in Schedule 2.) A second three month consultation (Improving Payment Practices in the construction industry) was launched in June 2007 with proposals that bore little resemblance to the issues in Sir Michael Latham's 2004 report.

"Is there a need for improvement in payment practices? This was the million dollar question last March. The short answer from the consultation is `yes' we do need to improve payment practices."

—in his capacity as Construction Minister)

Amending the Payment Provisions

3.5 In summary BERR's proposals for amending the payment provisions were:

(a) The payer must issue a notice to the payee informing him of the payment which is due;

(b) The payer can revise that amount in a subsequent notice to the payee;

(c) If the payee wishes to challenge the original (or subsequent) notice he can do so by referring the matter to adjudication;

(d) If the payer does not issue a payment notice the payee can make a claim: the claim will, instead, be the amount due but it will be subject to a payer's notice withholding monies (the statutory fall-back provision);

(e) The statutory right of suspension of work for non-payment will be bolstered;

(f) Pay-when-certified clauses will be outlawed.

3.6 The fundamental issue in amending this legislation is to ensure that the payee is certain as to the date of payment and the amount to be received on that date; this, after all, was Parliament's intention in passing the Act. Furthermore, the statutory provisions for achieving this must be clear, simple and reflect commercial logic and practice. BERR's proposals [at 3.5 (a) to (d)] for amending the payment provisions do not achieve these aims:

"The legislation requires that payment should be defined in terms of amount and date" (emphasis added)

on 26 February 1996

(a) It is illogical for the payer to commence the payment process by, in effect, issuing the payee with his version of the payee's bill;

(b) The proposals are complicated and inhibit early communication to resolve differences since the payer can issue another notice—perhaps, some weeks later—making deductions from the amount in the first notice;

(c) The proposals prevent definition of what is to be paid at the payment date because any challenge to the amount in the payer's payment notice may have to be referred to an adjudicator; in the meantime nothing is paid and the payee cannot exercise his statutory right of suspension of his contract for non-payment (this position often forces firms into insolvency);

(d) It is not commercially practicable for the payee to go to adjudication every time he disagrees with the amount the payer states he intends to pay; adjudication has now become an expensive process.

3.7 The proposal to ban pay-when-certified clauses in contracts (enabling a main contractor to delay payments to sub-contractors until he has received an architect's or engineer's certificate) does not go far enough to prevent abuse:

(a) Clauses will be drafted to avoid the ban (for example, payments will not be made until the work has been valued—rather than certified—by an architect/engineer);

(b) The ban does not extend to the outlawing of those pay-when-paid provisions (currently sanctioned by the Act) which enable a main contractor to avoid paying subcontractors when a third party payer—such as the client—goes into insolvency.

An analysis of 100 sub-contracts revealed that 96% made payment conditional—as to time/entitlement—on the issue of a main contract certificate or some other event.

(Analysis carried out by SEC Group in 2000)

3.8 Furthermore, BERR has not addressed a number of issues raised in Sir Michael Latham's 2004 report:

(a) Outlawing cross-contract set-off (the practice whereby a payer will hold back monies because of alleged shortcomings by the payee on other—unrelated—contracts);

(b) Ensuring that payments commence from date of contract rather than from the date of work on site which could be many weeks later (after which a substantial amount of assembly or manufacturing may have taken place);

(c) Protection for SMEs against insolvencies up the supply chain (EU countries, the US and Australasia have statutory insolvency protection for SMEs engaged on construction works).

Early day motion 1941

"That this House believes that security of payment in the construction industry especially for small and medium sized businesses is a prerequisite to achieving trust and collaboration in the industry; therefore, urges the Secretary of State for Trade and Industry to use the opportunity presented by the current review of Part II of the Housing Grants, Construction and Regeneration Act 1996, initiated by the Chancellor of the Exchequer, to amend the Act to ensure that there is a statutory mechanism for defining the amount to be paid at the date for payment, that all conditional payment provisions and cross contract set-off are outlawed, that progress payments start from commencement of contract and that the Act provides effective protection for firms in the supply chain from `upstream' insolvencies. That this House believes that payment security will be a major factor in the successful delivery of the construction projects for the 2012 London Olympics."

(Signed by 185 MPs in 2005-06 Parliamentary Session)

Amending the Adjudication Provisions

3.9 Statutory adjudication was introduced as a "stop-gap" process to enable payment disputes to be dealt with quickly and cheaply. Disputes could be referred to an impartial third party who would have four weeks in which to reach a decision. In the House of Lords debate on the Act in 1996 the late Lord Ackner explained that it came under the rubric of "pay now argue later".

3.10 When the Act came into force SMEs could use adjudication to unlock their cash without having to go to arbitration or the courts. The dispute could be re-heard later in arbitration or litigation. This immediacy of adjudication coupled with the speed and relative cheapness of the process meant that—initially—it was highly successful. Small firms were given greater equality of bargaining power by not being at risk for the other side's costs if the decision went against them.

3.11 Unfortunately this picture has significantly changed. In its June 2007 consultation document BERR indicated that the average cost of an adjudication (including the adjudicator's fee and costs) was £20,000 per adjudication. It also revealed (in the same document) that almost half of all adjudications involve claims of £50,000 or less. Therefore 40% of the value of an adjudicated dispute is absorbed in its costs. On the basis that adjudication is only intended to provide a "stop-gap" decision, this hardly represents value for money.

3.12 A number of factors have contributed to the increasing costs of adjudication:

(a) There are a plethora of bespoke adjudication procedures which are primarily aimed at undermining the statutory adjudication provisions; this, in turn, provokes arguments about whether the procedures are compliant with the Act;

(b) There is a common bespoke arrangement that requires the weaker party to pay all the other side's legal costs in an adjudication irrespective of the outcome (such provision has been upheld by the courts);

(c) The jurisdiction of adjudicators is—invariably—challenged which increases legal costs because there are usually technical legal arguments involved.

Consequently there is a real risk that the use of adjudication will decline unless these issues are addressed.

3.13 BERR's proposals are summarised as follows:

(a) Two types of bespoke contract clauses will be outlawed:

(i) clauses making decisions on amounts of interim payments "final and conclusive" (such agreements could prevent parties disputing interim payments in adjudication), and

(ii) clauses requiring a party to re-imburse all the other party's costs irrespective of the outcome of the adjudication.

(b) the restriction in the Act that it only applies to contracts in writing will be removed (this requirement provided a fertile source of challenges to the adjudicator's jurisdiction).

3.14 BERR's proposals will not reduce the costs of adjudicating; on the contrary there is a likelihood that they will increase such costs:

(a) BERR is only outlawing two types of adjudication clauses but there remain myriad onerous provisions aimed at frustrating access to adjudication;

(b) The outlawing of final and conclusive decisions relating to interim payments will give rise to definitional arguments (and therefore, more costs) regarding the meaning of "interim". Moreover the Act makes clear that all disputes arising under the contract are referable to adjudication—these should, therefore, include disputes relating to the amount of the final payment. There are many more disputes relating to final payments than interim payments.

(c) The proposal for outlawing onerous cost provisions are undermined by the fact that the parties can agree—following referral of the dispute to adjudication—that one side pays all the other side's legal costs (or that the adjudicator can have power to require a party to pay the other's costs). Contractual provisions will be routinely drafted to secure such agreements.

3.15 There is a more fundamental objection to the proposal concerning costs. It shows a lack of understanding of the concept of adjudication. The process, unlike arbitration or litigation, is not concerned to establish which party is right. Parliament intended that it should be a "rough and ready" process for facilitating the flow of cash. Therefore the rule that "costs follow the event" (that the "losing" party pays the "winners" costs) is wholly inappropriate to adjudication.

The Melville Dundas v. Wimpey Case

3.16 Melville Dundas v. Wimpey is the first legal case on the Act to be considered by the House of Lords. In April 2007 the House of Lords held (by a majority of 3 to 2) that a contractual provision enabling a payer to withhold payment from an insolvent payee overrode the statutory requirement that a withholding notice be issued before the payment is withheld. BERR appears to support an amendment to the Act that a withholding notice need not be issued where the payee is insolvent. But, very often, the withholding of monies is the cause of insolvency! The statutory requirement that a withholding notice is required wherever monies are retained should be left intact. More importantly, the Act should be amended to make clear that its provisions cannot be overridden or modified by contrary contractual provisions.

The issue

The Construction Act requires amendment to strengthen its payment and adjudication provisions to reflect the intention of parliament when passing the Act. Such amendment, therefore, should enhance payment certainty and ensure that adjudication continues to be inexpensive and accessible.

Our Recommendations

3.17 (a) To ensure certainty of amount and timing of payment, the payee should be enabled to make a claim which, in the absence of a withholding notice (or fraud), must be paid on the payment date;

(b) All conditional payment provisions should be outlawed;

(c) BERR should re-consider its decision not to amend the Act to outlaw the practice of cross-contract set-off; to provide for the right to interim payments to start from commencement of the contract and to require adequate security for firms in the event of insolvencies upstream of the supply chain (eg direct payments from clients to sub-contractors or the provision of payment bonds or bank guarantees by the payer as security for payment);

(d) With the exception of the proposal to abolish the requirement for written contracts, BERR should replace its proposals on adjudication with the following amendments (which will obviate the need to continually outlaw specific onerous provisions):

(i) provide a single adjudication procedure to apply to all adjudications and,

(ii) increase the powers of the adjudicator so that he/she can decide whether there is a dispute (and, if so, its scope); whether there is a construction contract under the Act and whether he/she was validly appointed.

(e) The Act should be amended to ensure that its provisions cannot be overridden or modified by contrary contractual requirements.

3.18 Questions

(a) Would BERR accept that the lack of payment certainty continues to be a major concern for the majority of firms in the industry?

(b) Does BERR agree that there should be a statutory mechanism (excluding adjudication) that clearly defines the amount that is due on the date for payment?

(c) Why doesn't BERR, therefore, amend the Act to enable the payer to make a payment application which will become the due sum unless, in the meantime the payer has validity withheld monies (in which case the difference becomes due)?

(d) BERR wants to ban pay-when-certified clauses but won't this encourage pay-when-valued clauses as an avoidance mechanism?

(e) Why doesn't BERR simply outlaw all clauses making payment conditional upon an event under another contract?

(f) Why doesn't BERR amend the Act to make clear that the statutory right to interim payments takes effect on the making of the contact (rather than—as usually happens—from the date of work starting on site)?

(g) Does BERR accept that construction SMEs have little or no protection against the risk of insolvencies upstream of the supply chain?

(h) Why doesn't BERR address this issue in the Act, especially when other countries in Europe, USA and Australasia have already introduced construction specific legislation to provide insolvency protection?

(i) Why can't BERR, for example, require (as French legislation requires) that the payer provides a bank guarantee to the payee as security for payment in the event of insolvency?

(j) Does BERR agree that for most SMEs adjudication is becoming an inaccessible and expensive process?

(k) Wouldn't it be easier and cheaper for everybody to have one adjudication procedure (as they have in similar legislation in Australia and New Zealand)?

(l) Does BERR accept that a major component of costs in adjudication relates to challenges to the jurisdiction of the adjudicator?

(m) Why doesn't BERR increase the jurisdiction of the adjudicator to reduce these challenges?

(n) Why can't the adjudicator give a binding decision on whether there is a dispute or on whether he was validly appointed?

SUMMARY OF SEC GROUP RECOMMENDATIONS

3.A	There should be a simple statutory procedure to enable the payee to claim payment and such claim should be the due amount unless, before the payment date, a withholding notice has been issued (in which case the difference between the amount claimed and the amount withheld should be the due amount).
3.B	All conditional payment provisions should be outlawed.
3.C	It should be clarified that the statutory right to interim payments starts from commencement of the contract.
3.D	The Act should now include a measure of insolvency protection so that a payee can require a payer to provide adequate security for payment such as bank guarantees or payment bonds or, alternatively, the client may pay sub-contractors directly.
3.E	The statutory adjudication provisions require amendment to restore the original statutory intent which was to provide SMEs with a cheap and speedy process for dealing with payment disputes. Therefore:
(i)	the Act should have a mandatory adjudication procedure to apply to all adjudications, and
(ii)	the jurisdiction of the adjudicator should be increased so that he can decide whether a dispute exists and (if so) its scope, whether there is a construction contract under the Act and whether he was validly appointed.
3.F	Other than the proposal to abolish the requirement for written contracts (as a condition precedent to using the Act) BERR should abandon its other adjudication proposals.
3.G	The Act should make clear that the statutory provisions cannot be modified or overridden by contrary contractual provisions.

4. ACHIEVING A SUSTAINABLE CONSTRUCTION INDUSTRY

4.1 A sustainable construction industry is one that invests in training, regularly upgrades its skills, invests in new technologies and places health and safety at the top of its priorities. All these factors are crucial in delivering consistent quality and service.

"Effective procurement and contracting strategies require . . .. clients to use their considerable leverage and influence to only select suppliers who have a proven track record in, and commitment to, developing the skills of their workforce, collaborative working, health and safety and sustainable development."

construction, NAO, March 2005)

4.2 Public sector procurers have a critical role to play in promoting a sustainable industry by only selecting competent firms as contractors or sub-contractors on public sector works. At a minimum competence involves objective proof that a business:

(a) is technically proficient and sufficiently resourced to deliver the services it provides;

(b) is of sound financial standing; and

4.3 Confining selection to competent firms on public sector works would have the following consequences:

(a) It would create a "level playing field" since all firms would have been identified as competent prior to any competitive bidding process;

(b) Competent firms would be more likely to achieve stable and predictable margins which would enable them to invest in those resources necessary to improve quality;

Proliferation of Schemes

4.4 The absence of a widely-accepted means of identifying firms as competent has led to a plethora of vetting processes, pre-qualification requirements (relating to an assessment of fitness to tender) and approval processes—especially in the public sector. In addition, main contractors have their own vetting processes for sub-contractors. Public sector clients and main contractors (in respect of their sub-contractors) often rely upon third parties—usually private sector firms—to carry out the vetting or approval process. There is no evidence that such third party accreditation has helped bring about improved value for money for the public sector. Instead it has imposed a substantial burden upon the industry, especially SMEs.

4.5 This state of affairs was investigated by the OGC and Small Business Service (SBS) following a statement in the 2005 Budget Statement. The investigation was carried out by Merlin Consultancy which reported to OGC and SBS at the end of 2005.

Case study

An SME who provided services to a District Council and was an approved supplier received a letter from the Council to inform him that the Council was compiling a new directory of suppliers that would be managed by a third party. In order to be included in this directory there would be an annual charge. Failure to join the system would mean that a company would not be considered for any future Council contracts.

The SME in question was being asked to pay £225 per year when the Council had only spent £3,057 with them over an eighteen month period. Calculated over a year the sum charged was over 10% of the money he had received in payment for services, which significantly ate into profits thereby making it uneconomical for him to continue to trade with the Council.

Report presented to OGC and the Small Business Service, December 2005

The Merlin report made a number of points:

(a) The plethora of third party accreditation schemes is a major barrier to SME participation in public sector works;

(b) Such third party assessment is usually a desk-based process that checks availability of certain policies and procedures such as insurance and health and safety, and, also, references—the quality of the product or service is not assessed or inspected;

(c) On the other hand trade bodies have "quality mark" assessment involving the auditing of members' work through site visits and inspections.

Unfortunately there has been no follow-up work to this report and (to our knowledge), no further action has been taken.

Case study

An SME with up to 100 employees which provides mechanical and electrical services to local government, housing associations, utilities and police/fire services paid £3,190 in direct fees to be accredited on five separate lists. The SME declined to join two further lists, one for the local authority sector where the fee was £520 pa plus £100 for each additional council, and one for the utility sector where the annual fee was £605. The SME had over a period of time been on over one hundred council/housing association approved lists. There was no mutual recognition between lists and the SME considered that, "this has got completely out of hand", because in addition to the direct fees there was an associated overhead burden in terms of responding to the differing questionnaires and in particular where some of the questions "have no bearing on our line of business".

Report presented to OGC and the Small Business Service, December 2005

4.6 In addition to the plethora of accreditation schemes there are also various statutory requirements relating to competence. Many of these are to be found in the Building Regulations and other related regulations (such as the Gas Regulations, Fire Regulations and Water Regulations) which are often illogical and contradictory. There is a need to harmonise and rationalise these requirements.

4.7 In recent years SEC Group's member associations have made a substantial investment in developing qualification and registration schemes comprising stringent requirements relating to firms' technical proficiency and financial standing (as well as health and safety performance). Compliance with these requirements is regularly audited and monitored. Nonetheless, firms belonging to these schemes are frequently required to belong to other schemes or be accredited by other organisations. There should be a means of recognising membership of a registration or qualification scheme as a reliable indicator of a firm's competence. This should also allow for mutual recognition of schemes so that membership of one scheme would also satisfy the requirements of others.

4.8 As far as health and safety is concerned there are now core criteria in the Approved Code of Practice issued alongside the 2007 Construction, Design & Management (CDM) Regulations for determining the competence of a firm (either individually or through membership of a registration or licensing scheme). Where a firm is compliant with the core criteria it should not have to be accredited under any other scheme that is similarly compliant.

4.9 In recent years there has been the introduction of competent persons schemes. These schemes—quite rightly—acknowledge the fact that the industry possesses the necessary expertise and experience to determine whether standards are being adhered to. They allow for greater self-regulation by allowing firms to self-certify compliance with the Regulations. The industry has developed schemes to provide firms with the facility to self-certify but, again, there is a need to rationalise or harmonise these schemes to reduce the burden on industry. Furthermore, it should be considered whether these schemes could embrace other competence requirements in the Building Regulations and related regulations.

The issue

In order to promote a sustainable industry that delivers value for money, public sector procurers should insist that only competent firms are engaged on public sector works (whether as contractors or subcontractors). However, we need to have in place a means for recognising competence (which are acceptable to procurers) whilst, at the same time, rationalising competence schemes and reducing the burden on SMEs of myriad third party vettng processes.

Questions

4.10 (a) Is there any objection to the principle that only firms—whether contractors or subcontractors—which have demonstrated their competence (perhaps, through membership of reputable qualification/registration schemes) should be engaged on public sector works? [Treasury/OGC/DCLG]

(b) Is it accepted that there are too many vetting procedures on public sector works contracts which are time consuming, repetitive and exceptionally costly for SMEs? [Treasury/OGC/BERR/DCLG]

(c) Do you accept that the majority of vetting procedures simply involve a "desk-top" assessment of whether a firm has the relevant paperwork in place rather than an assessment of technical proficiency and resourcing involving visits to the firm and inspection of standards of work? [Treasury/OGC/BERR/DCLG]

(d) How should we assess whether a firm is competent? [Treasury/OGC/BERR/DCLG]

(e) Is it accepted that only firms that have complied with the core criteria in the Approved Code of Practice issued under the 2007 CDM Regulations—indicating that they are competent in relation to health and safety—should be engaged on public sector works? [Treasury/OGC/DCLG]

(f) Is it accepted that core criteria for technical proficiency and financial standing could be developed as a means of "badging" competent firms (either individually or as members of a registration scheme) and also to facilitate mutual recognition of schemes that comply with the criteria? [Treasury/OGC/DCLG]

(g) Would you accept a single badge for "competent person" schemes under the Building Regulations so that membership of one scheme may suffice without the need to join other schemes or similar schemes under other regulations? [DCLG]

(h) Could membership of a "competent person" scheme also help in demonstrating compliance with other requirements relating to competence in the Building Regulations and related regulations? [DCLG]

Our Recommendations

4.11 Public sector clients should take a lead in ensuring that only firms complying with the core criteria in the Approved Code of Practice to the Construction, Design & Management Regulations are appointed on public sector works. This requirement should extend to all members of the supply chain. It is suggested that a lead-in time is provided to enable firms to become compliant with the core criteris. Ideally such lead-in time should be, at least, one year.

4.12 In collaboration with the industry the OGC should be invited to develop core criteria relating to technical proficiency and financial standing for recognising—as competent—firms in membership of registration or qualification schemes (and also for similarly recognising firms not in membership of such schemes). The DCLG may wish to be involved because of its responsibilities for local authorities. Once the core criteria are in place all procurers of public sector works—including supply chain members—should only select firms in membership of schemes that have been badged as compliant with the core criteria (or, alternatively, individual firms that have demonstrated compliance with the core criteria). Again, a suitable lead-in time for the industry to become compliant would be required.

4.13 Our proposal is that the DCLG should develop a single identifiable badge for competent persons schemes together with common standards of accreditation for such schemes. Having a single identifiable badge will mean that a firm which is a competent person under a badged scheme will also qualify as a competent person under other schemes and, possibly, also comply with other requirements relating to competence under the Building Regulations and/or other related regulations.

4.14 The vision is that at some point in the future we will simply have one badge of competence showing that a firm is compliant with core and essential criteria relating to technical proficiency, financial standing and health and safety.

SUMMARY OF SEC GROUP RECOMMENDATIONS

4.A	It is suggested that the Committee recommend that all procurers (including supply chain members) of all new public sector works commencing in 2009 will only select firms that have (either individually or as a member of a qualification scheme) complied with the core criteria in the Approved Code of Practice issued under the 2007 Construction Design & Management Regulations. It is necessary that the Government makes an announcement to this effect as soon as possible to enable the industry to have sufficient time in which to become compliant.
4.B	In collaboration with the industry the OGC should be invited to develop core criteria in relation to technical proficiency and financial standing for recognising membership of registration/licensing/qualification schemes as a reliable indicator of competence (or for recognising individual firms as competent).
4.C	Once the core criteria (at 4.B) have been developed it is suggested that the Committee recommends that the OGC and DCLG (following a suitable lead-in time for the industry to become compliant with the criteria) advise all procurers of public sector works—including supply chain members—only to select firms in membership of schemes of qualification that are badged as complying with the core criteria (or individual firms that have demonstrated such compliance).
4.D	We suggest that the Committee invites the DCLG (and other interested parties) to work with the industry in developing a single identifiable badge for "competent persons" schemes so that membership of one scheme may suffice for membership of other schemes and, possibly, also satisfy other requirements relating to competence under the Building Regulations and other related regulations.

5. RELEASING THE POTENTIAL OF SMES

5.1 The burden of poor procurement and contractual practices is generally borne by SMEs. They comprise the overwhelming majority of firms in the construction industry; most are sub-contractors. They are responsible for delivering most of the industry's output.

5.2 A high proportion of the overheads of SMEs is wasted in dealing with adversarial tendering and contractual practices that are primarily aimed at transferring all risks to the SME. This burden upon SMEs is significantly enhanced by poor payment practices which we have already discussed at some length. All this has a detrimental impact on investment in training, technology and, ultimately, on capacity and productivity.

SME productivity

"Evidence suggests that small firm productivity is a key contributor to the overall productivity gap. This is especially important to the UK given the long and often in-efficient supply chains in construction: many smaller firms contribute to key elements of major projects."

Demand/Capacity Study, Deloitte, 2007

(Report to the OGC)

5.3 In 2003 the Better Regulation Task Force and the Small Business Council recommended that public sector clients should become proactive in improving the commercial treatment of SMEs. In its 2005 report, Improving Public Services through better construction, the NAO made a similar recommendation. Although the Public Sector Construction Clients' Forum and OGC has published a Fair Payment Charter there is a need for a broader charter that addresses a number of barriers to SMEs becoming fully engaged in public sector works. At Schedule 3 we have included a draft best practice SME Charter for public sector construction procurement. This should be endorsed by the OGC (and its counterparts in Scotland, Wales and Northern Ireland) and applied to all public sector works contracts.

Treatment of SMEs

Extract from letter dated 29 March 2006 from Carillion to sub-contractors/suppliers following acquisition of Mowlem,

"I am writing to you to request your agreement to payment terms of net 65 days monthly account on all future subcontracts and orders. Please be aware that, whilst it is accepted that not everyone will be able to comply, preference must necessarily be given to Companies offering the most advantageous terms."

[NOTE: The Government's standard period for discharging payments is 30 days.]

The issue

Public sector procurers should be more proactive in improving the commercial treatment of SMEs engaged on public sector works contracts.

Question

Would there be any objection in principle to public sector clients adopting a best practice construction charter for SMEs and ensuring that such charter is adopted and implemented on public sector works? [Treasury, OGC, DCLG]

SEC GROUP RECOMMENDATION

We invite the Committee to recommend that the OGC (and its counterparts in Scotland, Wales, Northern Ireland) endorse the draft best practice SME Charter attached at Schedule 3. Following such endorsement they should be invited to take steps to ensure that the Charter is adopted and implemented by all procurers of public sector works. Further, its use should be monitored and it should be understood that non-compliance with the Charter could result in a failure to obtain public sector works contracts in the future.

SCHEDULE 1

EXPLANATORY NOTE ON PART II OF THE HOUSING GRANTS, CONSTRUCTION AND REGENERATION ACT 1996 ("the Act")

The Act introduces a number of statutory rights:

(a) A right to progress payments.

(b) A right to a withholding notice before deductions can be made from sums due for payment.

(d) A right to refer disputes to adjudication—intended to be a stop-gap process for dealing with disputes rapidly and inexpensively.

In addition the Act:

what

when

(f) Requires construction contracts to ensure payer notifies payee of the amount of interim/final payment [he] intends to pay.

pay when paid

(h) Requires construction contracts to contain certain provisions relating to adjudication.

Scheme for Construction Contracts

WEAKNESSES IN THE ACT

The weaknesses in the payment provisions can be summarised as follows:

(i) Contracts are required to have an adequate mechanism for payment. In practice, they are drafted to enable the payer to delay payment by spurious challenges to a payment claim or by simply ignoring the claim, thus forcing the payee to go to adjudication (and, thus incur significant costs).

(ii) Although the Act requires the payer (by virtue of an imposed contractual obligation) to notify the payee of the amount it intends to pay; such notice is rarely given because of the lack of sanction. This means that more often than not a payee will not know the amount it can expect from the payer.

(iii) It is unclear when the right to progress payments actually arises—as a result payment usually starts sometime after arrival on site. Many firms will have incurred vast expense (eg on design, manufacture and assembly) prior to such arrival and this is a significant drain on resources, particularly for SMEs.

when

what

(v) Deductions from monies due often consist of claims alleged to exist under other unrelated contracts (cross-contract set-off).

£1,000 is deducted for delay

(vii) By legitimising pay when/if paid provisions (enabling a payer to refuse payment where his payer has gone into insolvency); the Act has increased the exposure of SMEs to the risk of upstream insolvencies.

The weaknesses in the adjudication process:

(i) there are myriad bespoke adjudication procedures aimed at undermining the statutory provisions;

(ii) the cost of adjudication has been significantly increased by habitual challenges to the adjudicator's jurisdiction; and

(iii) many bespoke contractual adjudication procedures seek to impose upon a party an obligation to meet the other side's legal costs. This is inappropriate to a procedure which is only a stop-gap and not determinative of the parties' rights.

SCHEDULE 2

ISSUES RAISED IN SIR MICHAEL LATHAM'S REVIEW OF THE ACT AND PROGRESS TO DATE

Footnote:

* The working group examining the adjudication provisions provided Sir Michael Latham with a lengthy "shopping list" of issues; we have highlighted the key issues.

SCHEDULE 3

A BEST PRACTICE SME CHARTER FOR PUBLIC SECTOR CONSTRUCTION PROCUREMENT

THE AIMS OF THE CHARTER

— This Charter sets out best practice principles on procurement and contracts to encourage the involvement of SMEs on public sector works. It is intended to be applied along the supply chain from the public sector client to sub-contractors (unless the Charter indicates that a certain requirement(s) applies to a particular party).

— Lead contractors and their supply chains will be expected to sign the Charter prior to undertaking public sector works contracts. It is intended that compliance with the Charter will:

— help deliver best value in construction procurement to the public sector;

— improve the capacity of SMEs in the construction industry; and

— improve profit margins for SMEs engaged on public sector works.

PRE-QUALIFICATION

— Wherever possible and subject to the Public Sector Contracts Regulations 2006 procurers will seek to use local contractors.

— Procurers will seek to use contractors registered with reputable schemes of qualification that verify technical competence, health and safety performance and financial standing.

— Contractors who are registered with reputable schemes of qualification would automatically qualify for all public sector works contracts unless there are requirements that are highly specific to the nature or type of work involved.

— Procurers will use standard pre-qualification documentation developed by the Office of Government Commerce (OGC).

SELECTION AND APPOINTMENT

— Partnering or collaborative working arrangements will be inclusive of the supply chain.

— Contractors should be appointed as early as possible in the procurement process, preferably as part of the design team (in which case they should be paid a fee for their design input).

— Bids should always be assessed on best value (embracing whole life performance and sustainable solutions) rather than on lowest price; the best value criteria together with the respective weightings should be available to all tenderers.

— Lead contractors and sub-contractors should list members of their supply chains when tendering and such lists should be adhered to.

— When bidding all contractors should provide evidence of their payment performance in respect of their supply chains.

MONITORING QUALITY & PERFORMANCE

— Public sector clients will seek to institute mid-project and post-project reviews of performance to provide feedback to the whole supply chain that will include progress against Key Performance Indicators thereby promoting continuous improvement.

— Suppliers will work together as a team to manage out defects as work progresses.

CONTRACTS

— The suites of contracts used by the public sector client will be adopted (unamended) by the supply chain provided they achieve a fair and proportionate allocation of risk.

PAYMENT

— All payments will be discharged within a period not exceeding 30 days from the date on which payment becomes due.

— Public sector clients will announce targets for phasing out the practice of retentions and, where they do not use retentions, this policy will be followed through the supply chain.

— Where retentions are deducted they shall be ringfenced for the whole supply chain in a trust account.

— Where a contractor deducts retentions from members of his supply chain he must offer mutuality of security such as a payment bond.

— Public sector clients to put in place project bank accounts unless it is demonstrated that they would not be cost effective to set up.

— All final accounts will be agreed within a period of 30 days commencing from completion of the contract.

NON-COMPLIANCE WITH THIS CHARTER

— Complaints concerning non-compliance with this Charter may be made by clients or by individual firms or by a trade association acting on a firm's behalf.

— In the event that a complaint is not resolved between the relevant parties it may be submitted to the OGC to be considered in accordance with the suppliers' complaints procedure.

— The OGC will report to the relevant parties (and the public sector client if the client is not a relevant party) on whether there has been a failure to comply with the Charter.

— The OGC will produce an annual report on the extent of compliance with the Charter.

— Repeated non-compliance with this Charter by a client could affect future funding of projects instigated by that client.

— Repeated non-compliance by a contracting firm could affect its future selection for public sector works.

NOTE:

References to the OGC include its counterparts in the rest of the UK; the Scottish Executive, Welsh Assembly Government and the Northern Ireland Procurement Directorate. The provisions of this charter do not conflict with the OGC's Fair Payment Charter launched on 19 September 2007.



© Parliamentary copyright 2008	Prepared 16 July 2008