Memorandum submitted by the Specialist
Engineering Contractors' (SEC) Group
We wish to thank the Committee for calling an
urgent hearing into the difficulties faced by SMEs in the current
economic climate.
SEC Group represents the specialist engineering
sector in the UK construction industry which comprises over 60,000
companies and a workforce of more than 300,000. The overwhelming
majority of firms in the sector are SMEs. SEC Group is an umbrella
body representing the following trade associations:
— Association of Plumbing and Heating
Contractors;
— British Constructional Steelwork
Association;
— Electrical Contractors' Association;
— Heating and Ventilating Contractors'
Association;
— Lift and Escalator Industry Association;
and
— SELECT (Electrical Contractors' Association
of Scotland).
During the Committee's inquiry into the UK construction
industry last year SEC Group made two lengthy submissions in May
2007 and December 2007 and also provided oral evidence. In those
submissions and in our evidence to the Committee an overriding
concern was poor payment practices in the construction industry.
This was damaging the potential of SMEs to deliver to their full
potential as well as adding substantially to their costs. The
Committee's report "Construction matters" responded
to this concern by making a number of recommendations relating
to retentions, the implementation of the Fair Payment Charter
and project bank accounts.
Since last year's inquiry into the UK construction
industry the economic climate has dramatically changed. The Prime
Minister has confirmed that the UK economy is in recession. So
far as construction SMEs are concerned the recommendations of
the Committee in Construction Matters now have added urgency.
Consequently, we have developed a 5-point action plan to help
SMEs in the construction industry. After setting out the plan
we will give a brief explanation of the actions we have listed.
It is arguable that SMEs in the construction
industry have greater vulnerability compared to those in other
industries. For the most part the UK construction industry is
bottom-up funded with SMEs in the supply chain, having carried
out the work and/or delivered their services, being made to incur
a lengthy wait before payments are made. The current problems
experienced with bank lending are more acute in construction because
it is difficult for most SMEs to accurately predict the throughput
of cash flow on the projects they are involved in. They are also
exposed to the high risk of insolvencies up the supply chain without
the means to protect themselves against this risk. Once goods
and materials have been incorporated into the building or structure
all title to them is lost. Furthermore, this problem is now made
worse by the lack of availability of credit insurance.
EXECUTIVE SUMMARY
1. The problems faced by SMEs in construction,
particularly poor payment practices, have already been well rehearsed
in the inquiry held by the Committee into UK construction. However,
the Committee's recommendations in Construction matters have been
given added urgency as a result of the difficulties experienced
by construction SMEs in obtaining financing and credit insurance.
2. The economic crisis is having a greater
impact on construction than on other industries. Construction
activity has rapidly declined. Insolvencies in the industry are
rising at a higher rate than in other sectors. These are exceptional
times and require bold and progressive measures.
3. The Specialist Engineering Contractors'
Group—representing a sector comprising almost 60,000 SMEs—invites
the Committee to endorse a five-point action plan summarised below:
(i) Cash flow to SMEs to be addressed by the
following measures:
— Project bank accounts to become standard
on all public sector projects.
— Where project bank accounts are not
in place, public sector clients should oblige all lead contractors
to pay within 10 days; otherwise payments to sub-contractors will
be made directly.
— No retentions on public sector projects.
— Advance and mobilisation payments
to be made on public sector projects.
— Lead contractors on public sector
projects to provide bank guarantees or payment bonds to their
supply chains.
— The pay when paid exemption in section
113, Housing Grants, Construction & Regeneration Act to be
repealed.
(ii) All sub-contracts for public sector works
to be no less favourable than the main contracts.
(iii) One badge should now be instituted for
pre-qualification on public sector works.
(iv) An emergency task force to be established
to accelerate public sector construction activity.
(v) The Government to engage with private sector
clients to obtain their support in helping SMEs.
SUMMARY OF
THE CURRENT
PROBLEMS
1. "Construction and property companies
suffered more than a third of the UK's insolvencies in the autumn"
(Independent, 23 October 2008). Building and construction
was worst hit with 21% of all insolvencies compared to 8% in financial
services and 5% in the retail and wholesale sectors. Since the
beginning of the year the construction industry has seen the sharpest
fall in activity compared to other industries.
2. According to the leading credit insurer,
Aon, underwriters are likely to completely withdraw trade credit
facilities by the end of the year. The three largest credit insurers,
Atradius, Euler Hermes and Coface—which dominate the market—withdrew
cover from 12,000 policyholders last month alone.
3. Construction SMEs are now severely squeezed
between the sharp fall in demand and severe cost pressures. There
have been significant increases in materials costs and, more relevant
to the Select Committee's inquiry, a substantial increase in the
cost of borrowing. Where SMEs are able to borrow, the cost of
such borrowing has increased in many cases by approximately 25%
over a year ago. For many SMEs borrowing facilities have simply
dried up.
4. The consequence is that many firms are
laying off employees or reducing the working week. Existing apprenticeships
are being prematurely terminated. There is now increasing anecdotal
evidence that SMEs are under an enormous amount of pressure to
reduce prices. In some cases, especially in the house building
sector, SMEs have been pushed into reducing existing contractually-agreed
prices by, in some cases, up to 15%.
5. In fact there are now more subtle attempts
to delay payments. For example, the gap between completion of
the work (and/or provision of the services) and the due date for
the relevant progress payment is increasing. This is achieved,
for instance, by stipulating a certain period between the date
that monies are applied for and the due date for payment. Alternatively
it is achieved by other ploys such as claims that the application
for payment was deficient in some way or lacked supporting documentation.
Furthermore, many firms are finding that final account bills are
taking much longer to be settled with the bill often being reduced
on a "take it or leave it" basis. Needless to say, it
is becoming increasingly difficult for SMEs to secure the release
of retentions.
6. We welcome the following statement in
the Pre-Budget Report:
"There are currently significant delays
for many small businesses receiving payment of their bills from
the companies they supply. To help businesses manage their cash
flow, the Government has announced that it will aim to pay its
suppliers as soon as possible and within 10 days. This commitment
has since been adopted by the Scottish Government, Regional Development
Agencies (RDAs) and by a number of local authorities. The Government
is working with NHS Trusts and the Local Government Association
to extend this objective to the wider public sector". (para
4.17)
7. The major problem in the construction
industry is implementing this policy along the lengthy supply
chains which are characteristic of the industry. The largest construction
companies are poorly capitalised and are not in a position to
pay their supply chains until they receive payment from their
clients. Moreover, once such payment is received by them, their
profitability is dependent upon the extent to which they can generate
positive cash flow through maximising the length of time in which
to retain their supply chain's cash.
8. It would appear that it is a policy aim
of Government to address this. Speaking in a debate in the House
of Lords on 22 October 2008 Lord Mandelson, the Secretary of State
for Business and Enterprise said:
"Of the 10 Government departments we investigated,
88% of payments, totalling £58 billion, are now made within
10 days. I think that is a good record and a good performance.
However, we want to do better because we recognise how important
cash flow is to business survival. We want this performance to
be reflected not only right across the public sector but among
large firms as well, many of which have supply chains consisting
of thousands of small firms, all of whose payments are dependent
on the hub, the main company at the lead of that supply chain".
(emphasis added)
A FIVE-POINT
ACTION PLAN
FOR SME SURVIVAL
IN UK CONSTRUCTION
9. Our action plan is primarily directed
at the public sector which is responsible for almost 40% of construction
spend. But the Government should be give more proactive in encouraging
private sector client organisations to implement the listed actions
to the extent that they are relevant. The actions are as follows:
(i) The following measures to be implemented
to improve cash flow for SMEs:
— Project bank accounts should become
standard on all new projects unless a demonstrable case has been
made out that they would not be cost effective or practicable.
— Where a project bank account is not
in place public sector clients should oblige all their lead contractors
to pay within 10 days, failing which they will make direct payments
to sub-contractors.
— No retention should be deducted along
the supply chain on all new projects coming on stream; furthermore,
there should be a review of all public sector projects to establish
the extent of outstanding retentions along the supply chain with
the aim of securing the release of the retentions immediately
unless there is a current and genuine dispute over workmanship.
— Where a significant amount of work
(whether design, manufacture or assembly) is carried out off-site,
public sector clients should make advance payments in respect
of such work and, in any event, should provide mobilisation payments
to enable firms to gather together the resources needed for commencing
work on site. More importantly, they must ensure that such arrangements
are applied along the supply chain.
— Public sector clients should insist
that lead contractors provide bank guarantees or a form of payment
bond to their supply chains where the relevant sub-contracts are
for the sum of £50,000 or above.
— The pay when paid exemption in s.113
in the Housing, Construction Regeneration Act 1996 to be repealed
(this enables a payer (usually a main contractor) to operate a
pay when paid arrangement [against a subcontractor] in the event
that a third party payer [the client] has gone into insolvency).
(ii) All supply chain contracts in the private
sector should have a fair and proportionate allocation of risk
and, in any event, be no less favourable than the main contract
between the client and contractor;
(iii) It is now imperative that there should
be one badge for pre-qualification for all firms working on public
sector works based on compliance with core criteria relating to
health and safety, financial standing and technical proficiency;
(iv) The Government and industry should establish
an emergency task force for construction to help reduce lead-times
for commencement of projects by facilitating the use and deployment
of integrated project teams;
(v) The Government to be pro-active in persuading
private sector clients to adopt the above measures.
MEASURES TO
IMPROVE CASH
FLOW FOR
SMES [ACTION
POINT 1]
Project Bank Accounts
10. The Business and Enterprise Committee
has already recommended that central Government procurers now
make use of project bank accounts, where practical and cost-effective.
Working with Treasury and the DCLG, the Department for Business,
Enterprise and Regulatory Reform (BERR) should now apply pressure
on all public sector clients to establish project bank accounts
as standard on their projects (unless demonstrated not to be practical
or cost-effective). This is an effective way of ensuring that
the Government's 10-day payment period is implemented along the
supply chain.
Direct Payments
11. Where project bank accounts are not
in use, public sector clients should insist on a commitment from
lead contractors on all new projects that they will pay their
suppliers within 10 days. If that commitment can't be given, it
would not be appropriate to select that particular contractor
for the project. Where the commitment is given but, in the event
that payments to the supply chain are not made within this time
period, the client should make direct payments to the supply chain.
12. To the extent that some public sector
clients (such as NHS Trusts or local authorities) are not applying
the 10 day rule they should, at least, be making payments within
30 days as required by the Office of Government Commerce's Fair
Payment Charter which came into force at the beginning of this
year. Under this Charter lead contractors and their supply chains
are also bound to make payments within 30 days. Again clients
should advise lead contractors that, in the event of payments
not being made within 30 days, then payments will be made directly
to the supply chain.
Retentions
13. In Construction Matters, the Business
and Enterprise Committee advised that:
"The practice of holding a retention ...
damages the cash-flow of smaller subcontractors and reduces investment
in training and innovation. Government has other means by which
it can ensure the sector delivers good quality products, for example
where it has long-term framework arrangements in place. Given
that the practice is at odds with the Government's promotion of
integrated working through the Common Minimum Standards and the
Construction Commitments, we urge it to require all parts of the
public sector to end retentions as soon as possible". (para
143)
14. The Government's response to this recommendation
was, in substance, no different from that given by the Government
to the Trade and Industry Select Committee following that Committee's
inquiry into retentions nearly five years ago. At that time the
Trade and Industry Committee rejected the Government's response
and insisted that retentions be phased out as soon as possible
on public sector works with the Government leading the way. At
present SMEs are funding retentions amounting to well in excess
of £1 billion on public sector works. Given the amount of
time it takes SMEs to obtain the release of these monies, the
loss of interest and the overhead incurred in chasing retentions,
the abolition of this practice would provide SMEs with much-needed
support at this time.
15. Given that the time taken to obtain
release retentions can be as much as two years (and in many cases
in excess of that period) retention monies are always at substantial
risk from insolvencies of firms further up the supply chain. This
is no longer acceptable. In evidence to the Trade and Industry
Committee on 17 October 2002, Mr John Alty (Director of Business
Relations at the [then] Department of Trade and Industry) responded
to the following question from Sir Robert Smith:
"Can you see anything the Government can
do to improve protection of the retention monies"?
Mr Alty's response was as follows:
"This is something which Accelerating Change
has picked up and there is a program of work to look at construction
insolvencies".
At the time SEC Group invited the Department
to support the project Mr Alty was referring to but that support
was not forthcoming and the project did not take place.
16. In addition all public sector clients
should now review outstanding retentions on all their projects.
They should audit the extent to which retentions are outstanding
along the supply chain. On completion of this review they should
take steps to ensure that all outstanding retentions are released
to all members of the supply chain without further delay unless
there is a genuine dispute regarding a defect.
USE OF
STANDARD CONTRACTS
[ACTION POINT
2]
17. Under German law public sector procuring
authorities have to stipulate that the successful tenderer may
not impose less favourable conditions (especially as far as payment
arrangements are concerned) on its sub-contractors than the conditions
agreed between the authority and tenderer. In fact, the European
Union encourages contracting authorities to "include clauses
in contractual documents to ensure that their suppliers pay their
sub-contractors on time" (para 8, Commission Staff Working
Document: European Code of Best Practices Facilitating Access
by SMEs to Public Procurement Contracts, 25 June 2008).
18. In Construction Matters the Committee
recommended that, led by the OGC, departments should use collaborative
contracts (such as the NEC3 Engineering and Construction Contract)
and "ensure that they are adopted throughout their supply
chains" (para.132). In response the Government did not commit
to any specific action to implement this arrangement. We believe
that this recommendation should now be implemented without delay.
Furthermore, all public sector procurers should now audit the
contractual arrangements in place along their supply chains and
challenge the use of bespoke sub-contracts or amended standard
forms of subcontract. Bespoke contractual arrangements are simply
aimed at transferring all risks to SMEs in the supply chain.
19. In the Pre-Budget Report the Government
stated that: "It will ... help SMEs get a fair deal when
they are sub-contractors" (para 4.36). We suggest that this
is achieved, initially, by insisting that sub-contracts included
in the suite of contractual documentation used by the public sector
client are used along the supply chain (provided, of course, that
they represent a fair and proportionate allocation of risk). Furthermore,
there should not be any lead contractor-generated amendments to
the relevant sub-contract conditions.
ONE BADGE
FOR PRE-QUALIFICATION
[ACTION POINT
3]
20. In Construction Matters the Committee
recommended that: "The Government must reduce the burden
that multiple public sector prequalification schemes impose on
construction firms, particularly SMEs" (para 276). SEC Group
is currently surveying firms in the sector on the cost of pre-qualification.
The questionnaire is attached as an appendix. We will inform the
Committee of the results of the survey as soon as they become
available.
21. The Government must now produce a "badge"
that recognises compliance by firms with core criteria relating
to health and safety, financial standing and technical proficiency.
Such badge would promote mutual recognition between different
schemes; once a firm has obtained its "badge" it should
not have to pre-qualify under other schemes. Moreover, all public
sector clients must insist that only "badged" firms
are used at both lead contractor and sub-contractor levels.
EMERGENCY TASK
FORCE [ACTION
POINT 4]
22. The Pre-Budget Report announced that:
"£3 billion of capital spending from 2010-11 will be
brought forward into 2009-10 and 2008-09". There is also
the need to accelerate current programs in health and education
(especially the Building Schools for the Future program) which
have fallen behind their respective targets. Whilst the announcement
in the Pre-Budget Report is very welcome, the practical difficulty
is that the lead-in time for projects could be up to two years
especially where traditional procurement processes are used. In
the meantime many SMEs will have had to reduce overhead staffing
and labour costs.
23. As the Committee acknowledged in Construction
Matters the Government still has to make significant progress
on abandoning traditional procurement strategies in construction
and, instead, adopt delivery through project team integration—as
required by the Achieving Excellent program, the Construction
Commitments and the Common Minimum Standards. The lack of progress
is due to a variety of reasons including inertia, lack of confidence,
poor levels of training and insufficient resources.
24. The business case for integration—recently
published by the Strategic Forum for Construction—demonstrates
that a key benefit is that the average lead-in time for commencement
of construction activity can be reduced by many months. The business
case also includes a more reliable method of measuring the extent
of project team integration and its benefits for the project.
The Government's aim of accelerating construction activity can,
therefore, be achieved at a faster pace and more efficiently through
putting in place integrated project teams.
25. Our proposal is that, to help the Government
accelerate existing (or delayed) construction programs and future
programs within the £3 billion spend, there should be a joint
industry/Government Emergency Task Force. A key role for the Task
Force would be to bring together "integration facilitators"
who would support public sector clients wishing to accelerate
construction works by facilitating the successful procurement
of integrated teams. They would help clients develop their success
factors for projects and help them to measure outcomes to check
that these factors have been realised.
PRIVATE SECTOR
CLIENTS' SUPPORT
FOR SMES
[ACTION POINT
5]
26. "In addition to its engagement
with public bodies, the Government will continue to work with
the private sector to encourage businesses to pay their bills
promptly ..." (para 4.18: Pre-Budget Report). We propose
that the Government meets, as soon as possible, representatives
of the top 100 of the UK's highest spending private sector construction
clients. All the actions in our action plan can be adopted by
private sector clients with the exception of those relating to
amending section 113 Housing Grants, Construction & Regeneration
Act 1996 and the Emergency Task Force. Client representatives
should be invited to commit to any of these actions in a major
effort to help SMEs in their supply chains.
SUMMARY
27. We invite the Committee to endorse our
action plan to support SMEs in the construction industry. Time
is of the essence and, therefore, the Government will need to
act promptly to put in place our proposed measures. Together with
other representative organisations in the industry we remain willing
to work closely with the Government to ensure that any measures
adopted will be effective in supporting SMEs which are now facing
unprecedented challenges in order to remain viable.
28. Whilst these challenges have been exacerbated
by the actions of the banking and insurance institutions, their
provenance lie in deep-seated poor practices in the construction
industry. The Committee is now fully aware of the state of affairs
in the industry but the solutions require immediate implementation.
Our action plan is directed at achieving this by highlighting
a series of practical measures that can be applied now.
APPENDIX
SURVEY ON THE COST OF PRE-QUALIFICATION
The Government is inquiring into the burden
on firms of pre-qualification. We along with others aim to make
representations to Government to reduce the burden of multiple
pre-qualification schemes. The purpose of this survey is to assess
the costs to firms, in terms of time and money, of having to pre-qualify
under the different schemes.
Please would you take a few minutes to complete
the questionnaire below so that together with our umbrella body,
the Specialist Engineering Contractors' Group, we can actively
represent the results to the Government. (Please insert a tick
in the relevant boxes)
1. Size of firm (by annual turnover)
Under £200k £200k to £m
£m to £1m £1m to £2m
£2m to £5m £5m to £20m
£20m to £50m £50m +
2. How many pre-qualification schemes or lists
have you found it necessary to subscribe to?
(eg Constructionline, CHAS, Achilles, Exor, Sinclair
etc)?
1 2-4 5-9 10-19 20-29
Over 30 None
(If you tick none, please go to question 8)
3. For each of your main client sectors, what
proportion of their projects require you to subscribe to pre-qualification
schemes or lists? Please tick one box in each line below.
None A little Some Most All Do
not work
(0%) (1%-19%) (20%-49%) (50%-99%) (100%) in this
sector
Central government clients
Local authorities
Private sector clients
Main contractors
Other
If "Other" is responsible for all or most
of your scheme requirements specify..........................................................................................................................................................
.....................................................................................................................................................................
4. Please indicate the total amount per annum
of the fees paid to all the pre-qualification schemes you need
to subscribe to.
Under £200 £200 to £500
£500 to £1k £1k to £2k £2k
to £5k Over £5k
5. Please estimate the total other costs (in
addition to fees per annum) to your firm of meeting the administrative
and audit/inspection requirements for these schemes.
Under £2k £2k to £5k
£5 to £10k £10k to £20k £20k
to £30k Over £30k
6. How much time (ie. person days) per annum
is spent in completing the paperwork for all schemes?
Up to 1 day 2-5 days 2-4 weeks
Over 4 weeks
7. Please write below any comments or observations
you have on the issues raised in this survey. For example are
any of the pre-qualification schemes particularly burdensome in
terms of time or cost?
Please continue overleaf if necessary.
8. If you wish to receive a short report of the
results, please insert your email address below. Please fax or
email this completed form to: [Trade Association to insert details]
by [date].
Thank you very much for completing the questionnaire.
December 2008
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