In a tough economic climate, the construction industry faces numerous challenges including managing adequate cash flows to ensure timely payments to subcontractors and suppliers occur. Over the last 6 months, a number of mid-tier builders have encountered severe financial challenges with several going into some form of insolvent external administration.
These companies are often head contractors for major government projects and when they fail, there are significant knock-on effects – for the government owner, sub-contractors and suppliers. While a range of legislation exists giving sub-contractors and suppliers rights to ensure timely cash flow, the legal processes are slow and often drawn out. This has ramifications for smaller sub-contractors and suppliers which often need an expeditious solution to any payments issues to remain solvent.
In the United Kingdom, the Office of Government Commerce has pioneered the use of project bank accounts (PBA) where the government employer makes direct payments to the subcontractors to mitigate the insolvency risk to employers and subcontractors if the head contractor encounters an insolvency event. Direct payments also have the added benefit of saving public sector clients money. It is estimated that up to 2.5% of construction costs could be shaved by minimising prolonged payment cycles and introducing greater payment transparency down the supply chain.
To date, only Barclays Bank and the Bank of Scotland offer PBA arrangements and an increasing number of government agencies such as the Highway Agency, Crossrail, Defence Estates, Ministry of Justice have adopted or are planning to adopt PBAs for their projects. There are also plans to introduce them for facilities management contracts.
As expected, PBAs are not popular among the major construction companies as it impinges on their ability to manage their cash flows and the overall financial management of their business.
A PBA is a ring-fence bank account where the employer makes direct and simultaneous payments to various members (head contractors, subcontractors and suppliers) in the construction supply chain for its project. As part of the contractual arrangements, the employer, head contractor and the subcontractors sign a trust deed providing for the employer to pay the certified amounts under the head contracts into the PBA (subject to any amounts withheld). The PBA is a trust account opened with the mandated bank who, as the trustee, distributes the funds directly to the head contractor, the subcontractors and suppliers.
Importantly, as the PBA is held on trust, a liquidator or administrator may not have access to the money in the trust account. PBAs do not cut across the contractual or statutory rights that each party has under their respective contracts, and payments will be made in respect of certified amounts. The trust is not attached to the amounts due to the head contractor, but to the account held by the mandated bank.
By way of analogy, on PPPs or project financed projects, a SPV account is generally set up by the consortium/employer which provides for payments to the head contractor. That account generally can only be drawn down for specific purposes such as certified payments to the head contractor. However, the subcontractors and suppliers will not be paid from that account (and therefore are not protected).
There are also a number of complex legal considerations dealing with trust property (who are the beneficiaries of the trust account and proper setting up of the trust), insolvency (such as priority rights between the head contractors and subcontractors/suppliers, liability of the employer to the liquidator/administrator and preference issues), set-off and ownership of moneys in the PBA in the event of termination, and how will it sit with the various statutory and common law rights that a party currently has. The PBA concept being a recent innovation in the UK has not been challenged in the English courts. However, it is a significant development in ensuring that various parties in the construction supply chain are adequately protected.
It is an option open for the various State governments in Australia to consider. Ultimately, the success of any PBA-like system will hinge on contract documentation being properly drafted to address those complex legal issues.