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

- 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 s.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 1bn 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