This is a quote from a 2015 report by the Senate Economics References Committee into insolvency in the Australian construction industry (chapter 11.4).

I believe the Queensland contractor licensing regime is effective in ensuring as much as possible that only financially viable licensees are able to operate. In this respect the Minimum Financial Requirements (MFR’s) play a vital role and I strongly support their retention and ongoing quest to improve them.

However the MFR’s have certain limitations that I will address in this article.

I have also had cause recently to reflect on the above quote because of criticism I have noted of a financial investigation undertaken by the QBCC into the Cullen Group prior to its collapsing in late 2016 and the publishing of information relating to proposed changes to the MFR’s for licensing to take effect during 2019.

In an ABC news online article entitled ‘Building regulator allowed Cullen Group to keep trading after it defaulted on debt’ it is stated that:

The Queensland Building and Construction Commission (QBCC) was advised of a magistrates court default judgment against the Cullen Group in March 2016, but decided to make no changes to the company’s licence.”

Further on in this article the comment is made:

The QBCC ordered an independent audit of the Cullen Group in early 2016 and decided its financials were secure enough for it to retain its licence to deal with projects of up to $60 million a year.”

In this article the liquidator of the Cullen Group, Michael Caspaney, was also quoted as saying in relation to the March 2016 default judgment against the Cullen Group:

That’s a very obvious indicator that the company can’t pay its bills.”

However the Commissioner for the QBCC, Brett Bassett was quoted as saying:

“One debt does not necessarily mean a company is trading while insolvent.”

Significantly, elsewhere in the article it is stated:

“The liquidator of the Cullen Group, Michael Caspaney, has found the company was trading while insolvent for almost all of 2016.”

Understandably subcontractors are wondering if the QBCC failed in its regulatory responsibilities in this matter.

I believe that subcontractors are certainly entitled to seek answers. In this regard I have noted a post on the Subbies United website which I am of the view fairly addresses the concerns of subcontractors. However, I also believe that in considering this matter it is very important for subcontractors to understand the limitations of the MFR’s.

I believe that I am uniquely placed to provide readers with valuable insight into actions the QBCC takes with regard to contractors identified at risk of failing to satisfy the MFR’s. As the inaugural Compliance Manager of the QBSA (predecessor of the QBCC), I undertook thousands of investigations of this nature.

The Cole Royal Commission into the Building and Construction Industry (2001-2003), in reviewing SOP issues, acknowledged my experience in this regard in its Final Report, reform issues, part 2, volume 8, SOP, page 235:

“Mr Michael Chesterman, the Compliance Manager of the Queensland Building Services Authority (QBSA), has supervised several thousand investigations into the financial viability of building contractors”.

Background

With the exception of the removal in 2014 of the requirement for licensees to have to demonstrate on renewing their licence that they continue to satisfy the current MFR’s, the relevant legislation and policy settings have not changed a great extent since 1999.

I note that this requirement is to be reintroduced on 1 January 2019.

The following sections of the QBCC Act are the most relevant financial legislative provisions, namely:

  • Section 31 – entitlement to contractor’s licence where the applicant satisfies the relevant financial requirements;
  • Section 35 – imposition of a condition on the granting of licence in that the licensee’s financial circumstances must at all times satisfy the relevant financial requirements;
  • Section 36 – subsequent imposition of conditions if the commission has reason to believe that a licensee may have insufficient financial resources to meet possible liabilities in relation to building work;
  • Section 48 – cancellation or suspension of a licence if the licensee contravenes a condition to which the licence is subject to under sections 35 or 36;
  • Section 49 – procedure for cancellation or suspension. The Commission must, before cancelling or suspending a licence, give the licensee notice of its reasons for the proposed cancellation or suspension.
  • Section 49A – immediate suspension of licence.The Commission may suspend a licensee’s licence without allowing the licensee time to make written representations before the suspension takes effect if the commission reasonably believes there is a real likelihood that seriousfinancial loss or other serious harm will happen to other licensees, the employees of other licensees, consumers and suppliers of building materials or services.
  • Section 50C – supply of financial records and other documents under approved audit program or for other reason if the Commission is satisfied there are reasonable grounds for concern that a licensee does not satisfy the relevant financial requirements.

Central to everything the QBCC does concerning the financial position of licensed contractors is the MFR’s.

What are the current MFR’s?

The objectives of the current MFR‘s are “to promote financially viable businesses and foster professional business practices in the Queensland building industry.”

The MFR’s requirements apply to approximately 70,000 licensees, all of which must comply with the following:

  • have a certain level of Net Tangible Assets;
  • based on their NTA, not exceed a prescribed Maximum Revenue (MR) each financial year;
  • demonstrate a current ratio (current assets = current liabilities) of 1:1;
  • prepare and maintain internal management accounts at least on a quarterly basis;
  • pay all undisputed debts as and when they fall due within industry trading terms;
  • in a limited number of licence categories e.g Builder design, termite management, and passive fire protection, obtain Professional Indemnity Insurance;
  • if a licensee or any company within its group of companies is required to provide an auditor’s report or review report to ASIC or the ASX, they must also supply a copy of that report to the QBCC within 30 days of it being signed or submitted to ASIC or ASX. These reports include statements of financial position, statements of profit and loss, cashflows, changes in equity, and director’s and auditor’s reports.

What are the limitations of current MFR’s?

Number 1They are NOT a guarantee of contractor solvency.

In an earlier article entitled ‘Construction industry issues. The good, bad, ugly, missteps and unresolved‘, I stated:

“There is a belief that the Minimum Financial Requirements for licensing (MFR’s) are issued by the QBCC on the basis that contractors are solvent and will remain so.In this regard I have noted a recent media article entitled “Ostwalds to JM Kelly: Building game’s five-year trail of woe” the following statement was made:

“The state’s building regulator has as a basic requirement that those companies granted a Queensland Building and Construction Commission licence were solvent and remained so.

However there were numerous examples over the past half decade of failed building companies who were later found to have traded for a considerable time while insolvent”.

“There is not one mention of the word ‘solvent’ in the current MFR’s. The objectives of the MFR’s are stated as:

“The objectives of the Minimum Financial Requirements in this policy are to promote financially viable businesses and foster professional business practices in the Queensland building industry.”

The MFR’s serve a very important licensing purpose but in their current form they are not based on licensees having to be solvent at all times.”

Number 2They largely represent a ‘snapshot’ back in time of a contractors financial position.

I have raised this MFR’s limitation on many occasions over the years.

“While the Authority has in place the strongest licensing regime in Australia which is achieving its objective in eliminating from the industry those contractors who clearly fail to meet the relevant financial criteria, it nevertheless should be recognised that licensing in itself is not an appropriate vehicle to deliver further improved security of payment outcomes for subcontractors. The licensing financial criteria is a “snap shot” back in time that all contractors have to satisfy on licence application, renewal or on request by the Authority under a compliance audit. This process can never reflect an absolute current position. In the building and construction industry a lot can change in one week, let alone 3 months, which is the most “current” financial position contractors with a higher annual turnover have to satisfy.”

14 years later, at a Senate Economics References Committee Public Hearing into insolvency in the Australian Construction Industry I represented the QBCC and the following is an extract from chapter 11 of the committee’s report:

“In an industry characterised by low barriers to entry, small profit margins and inequitable allocation of risk, an effective licensing regime is necessary to protect participants from both unscrupulous and hapless operators. However, as important as an effective licensing regime is, its inherent limitations must be understood—an effective licensing regime is not a silver bullet for the problems of the industry.

Mr Michael Chesterman, Queensland Building and Construction Commission, made this point to the committee in explaining the operation of capital backing tests. Mr Chesterman noted that capital backing requirements may ‘operate in different ways at different times, but they are always reflective of a position, essentially back in time’.[3] That is, a contractor who satisfies a capital backing test and thus receives a licence to operate at a certain level, has only proven they have capital backing at that ‘snapshot in time’;[4] it ‘is not a guarantee that the company is solvent at every single point of time’.[5]

“11.14 The QBCC acknowledged that this licensing system did not prevent the collapse of Walton Constructions (Qld).[16]It should be remembered, however, that licensing systems are merely gateposts to the industry, not the primary detection or enforcement mechanism.”

In a recent article entitled ‘SOP will continue to be a vexed issue in 2019’, I again emphasised the limitations of the MFR’s in this respect:

“The new Minimum Financial Requirements for Licensing (MFR’s) scheduled to come into effect on 1 January 2019, will not prove to be an effective tool in reducing the incidence of non or late payment by builders to subcontractors. This is because whatever criteria the government eventually settles on in this regard (Discussion Paper), the financial position of licensee’s will always be a “look back” at an earlier point of time.

The current MFR’s allows financial information in a report to the QBCC to be up to four months old. There is no doubt the MFR’s are an important and effective legislative initiative to promote financially sustainable businesses and foster professional business practices, but this is an entirely different purpose to them being an effective SOP tool.”

Do the same limitations apply for the proposed new MFR’s?

Based on the information released by the Government to date, namely a Discussion Paper and an information bulletin, I am of the view that the limitations apparent in respect of the current MFR’s will continue to be features of the new proposed MFR’s.

Aside from the re-introdution of mandatory annual reporting, I believe that the most significant other change relates to licensees that fall within the high revenue (greater than $30 M) categories 4-7. These licensees will be required to provide more detailed financial information in the form of a ‘balanced scorecard’ that may involve addressing additional metrics such as (page 14, Discussion Paper):

  • minimum debt to equity ratio;
  • profitability ratio; and
  • cash flow ratios.

The Government hopes that this more holistic reporting approach will better equip the QBCC to detect potential insolvencies however it should also be noted that ‘balanced scorecard’ information will only apply to:

“of the approximately 70,000 QBCC licensees that are subject to the MFR, as at 4 July 2018, 844 of these licensees fell within categories 4–7.” (MFR Discussion Paper, page 11).

How does the QBCC undertake financial investigations into licensees?

While I cannot comment on the specific Cullen Group investigation, I can provide readers with some insight into the processes the QBCC will most likely adopt in matters of this nature based on my regulatory experience and a comprehensive understanding of the relevant legislation and published policy considerations.

A judgment debt against a licensee will result in the QBCC taking action in respect of their failure to comply with this aspect of the MFR’s.

In circumstance where the licensee has hundreds of subcontractors and suppliers and dozens of clients reliant on them, the QBCC will also undertake a comprehensive investigation of their financial position under the most relevant sections of the QBCC Act that I previously outlined.

What happens after this will be entirely dependant on how the QBCC assess the information received from the licensee and whether or not the judgment debt is satisfied. However in my experience there are only 4 scenarios that may eventuate, namely:

  1. The judgment debt is satisfied and the audit of the company’s financial position as at an earlier point of time reveals they are compliant with all other aspects of the MFR’s. Case closed.
  2. The judgment debt is satisfied but the audit of the companies financial position as at an earlier point of time reveals some concerns requiring further information to be provided to the QBCC. Case ongoing.
  3. The judgment debt is not satisfied but the audit of the companies financial position at an earlier point of time reveals they are satisfying all other aspects of the MFR’s. Action will commence to suspend or cancel the companies licence because of the outstanding judgment debt.
  4. The judgment debt is not satisfied and the audit of the companies financial position as at an earlier point of time reveals they are also not satisfying other aspects of the MFR’s. Action will commence to suspend or cancel the companies licence for both failures.

Final thoughts

The MFR’s are a crucial regulatory initiative and I strongly support their retention and the need for them to be improved for the purpose of promoting ‘financially viable businesses and foster professional business practices‘ in the industry.

However aside from one requirement, the current and proposed new MFR’s represent a ‘snapshot’ back in time financial position of a licensee. The exception in this regard is a requirement that all undisputed debts have to be paid.

The NTA and current ratio criteria contained in the current and proposed new MFR’s can only be accurately determined through the production of financial statements which comprises of:

  • statement of Financial Performance (Profit and Loss Statement);
  • statement of Financial Position (Balance Sheet);
  • notes to the financial statements which at least comprise a summary of significant accounting policies; and
  • signed proprietors/directors declaration.

However information of this nature will never represent a current financial position of a licensee because of the necessary time taken by accountants or auditors to produce them.

This is the reason the QBCC allows for financial information to be up to four months old under the current MFR’s. ASIC allows the same period of time for large companies under its legislative reporting requirements for the production of financial information.

Perhaps this maximum period could be reduced. However for reliable information to be provided to the QBCC on the financial position of a licensee under audit, it is vital that a suitably qualified external accountant or auditor does everything they are required to do under all relevant accounting standards.

For example one of the current and proposed new MFR’s criteria is that licensees must at all times satisfy a current ratio of current assets to current liabilities of 1:1. Any outcome that does not satisfy this criteria will result in the licensee being in breach of the MFR’s.

Furthermore there is no discretion under the MFR’s for an accountant or auditor to sign off ‘near enough is good enough’. The QBCC also cannot ignore such an outcome. Whether they take any licensing action is entirely a separate matter.

The reality is that it may take an external accountant or auditor a considerable period of time to undertake a detailed and accurate analysis of the financial position of a licensee.

As someone who managed several thousand investigations into the financial affairs of contractors, the decision to suspend or cancel a contractors licence always weighed heavily on me, not only because of the impact on them but also the consequential effect on creditors such as subcontractors.I only took such action after I was satisfied that I had for my consideration, accurate and reliable financial information that clearly showed the licensee was in breach of their financial obligations under the QBCC Act or Board approved financial requirements and all other options had been explored.

The MFR’s are necessary and I support the changes being introduced but if they are relied upon by industry as the silver bullet to cure insolvency in the industry – there will only be widespread disappointment. We should also recognise that the MFR’s play a very important role in ensuring as much as possible, only financially viable contractors are operating in the Industry in Queensland. While it is not the silver bullet it is better than what exists in most other States and Territories throughout Australia.

“Notwithstanding the failure of the then QBSA (now QBCC) to prevent the collapse of Walton Constructions, the committee believes that a graduated licensing scheme, similar to that currently operating in Queensland and recommended by the Collins Inquiry, which requires all builders to demonstrate they hold adequate financial backing for the scale of intended project is a necessary first step.”