From 31 October 2016 Project Bank Accounts (“PBAs”) will be a mandatory requirement for Scottish Government building contracts with a value of £4,104,394 and above and civil engineering contracts with a value of £10,000,000 and above.
Back in 2013 then Deputy First Minister Nicola Sturgeon announced that the Scottish Government would trial PBAs on public sector projects. This had been a key recommendation of the Review of Scottish Public Sector Procurement in Construction chaired by Robin Crawford, and something which the UK Government was already committed to.
How do they work?
The main objective of PBAs is to improve cash flow for contractors, consultants, sub-contractors and suppliers in the construction industry – an issue which our industry has arguably never really gotten to grips with. At its most basic, PBAs are ring-fenced bank accounts into which the client places funds for a construction project on a rolling basis.
Each month the contractor, consultants, sub-contractors and suppliers participating in the PBA arrangement submit their payment applications as usual. Agreement is then reached on what element of the total sum certified by the client is due to each of the participating parties. Those sums are then paid directly to the relevant member of the supply chain on the contractually agreed dates rather than cash cascading down the various steps in the supply chain.
- Insolvency Risk: The risk of non payment as a consequence of the insolvency of a supply chain member further up the supply chain is reduced as payments do not pass through a number of hands down the supply chain. PBAs have trust status and, in the event of insolvency of the contractor for example, the monies are ring-fenced from third party creditors and payments can still be made to the supply chain. This also protects clients from the risk of ‘double payment’ to parties further down the supply chain if the contractor fails to forward the first payment before becoming insolvent.
- Speed: Payments can be made simultaneously out of the PBA and straight to the relevant members of the supply chain rather than having to cascade down the supply chain over a period of time. This can be an enormous boon to suppliers at the bottom of the traditional supply chain in particular, where more than anywhere cash is king.
- Transparency: A PBA helps to increase the transparency of cash flow to the supply chain. The client can observe exactly when and where payments go.
- Efficiency/Certainty: Less time and effort is spent pursuing payment up the supply chain thus reducing administration costs. Shorter payment periods should also reduce the extent to which supply chain members need to include financing costs in their pricing. The number and cost of payment disputes should also be reduced. However, these cost savings have to balance against the costs associated with setting up and operating PBAs referred to below.
- Focus: PBAs can assist the supply chain in focusing on delivering the project, and lead to greater collaboration and innovation amongst all parties.
- Cost: The initial establishment and on-going operation of a PBA has an inherent cost to it. For most, this cost will be worthwhile on larger projects only – perhaps why the Scottish Government has now specified a relatively high threshold for their mandatory use in the public sector.
- Loss of Control: As monies are held independently of the client/contractor this reduces their control over what is retained in the PBA, which is potentially a disadvantage to their commercial position. Provision has to be made in the PBA arrangements to include well-established rights of set off and the like where appropriate.
- Insolvency Risk: An important point about PBAs it that protection from insolvency risk is limited solely to the monies held in the account at that time, which will not be the full cost of the project (monies are deposited into the account incrementally by the client/contractor). Additionally, a PBA only protects those signed up to the arrangement, so it cannot in itself eliminate all solvency risk in a project (nor is it designed to).
- Disputes: A PBA does not necessary preclude payment disputes. These can and will still arise if, for example, the client’s payments are not made into the PBA on schedule, or if rights of set off and the like are exercised. A PBA can certainly help the money flow, but it does not and should not prevent parties from exercising their right to dispute payments, for example, in relation to valuations.
Many believe that PBAs, when used in appropriate circumstances, are likely to benefit all parties involved. However, care must be taken that the PBA arrangements put in place are clearly set out, understood by all parties and implemented in accordance with their terms.
What happens now?
The reaction to the Scottish Government’s announcement has been mixed. Many of the larger contractors have some experience of using PBAs already, either in England and Wales or as part of the Scottish Government’s trial projects. However, many others who do not have the benefit of that experience are likely to find the introduction of PBAs challenging initially.
The main standard form building and engineering contracts have PBA options. However, they all take varying approaches. It is important that those signing up to and operating PBAs understand the terms of the particular PBA arrangement being used on their project. As a consequence some careful thought and expert advice is likely to be required by clients, contractors and sub-contractors at least initially.
It should be noted that there are some exemptions from the new requirements. For example, if a contractor bidding for an eligible project will be carrying out at least 75% of the work ‘in house’ or by using associated firms (perhaps within their own group of companies) then an opt out from PBAs is available.
It remains to be seen whether PBAs will be more widely and voluntarily embraced by public sector bodies outside the Scottish Government such as local authorities who are not bound by the Scottish Government’s recent announcement. There may also be a PR benefit that will encourage both clients and contractors to promote the use of PBAs.
Could we see the private sector adopt PBAs voluntarily? Perhaps a culture of keener pricing will evolve from suppliers, in exchange for the solvency protection and speed of payment which PBAs can offer.
The Scottish Government’s announcement on PBAs has probably not come as a surprise to the industry. The reception to them has been mixed. Inevitably it will take a period of time for the Scottish construction industry to become accustomed to their use and for business models to be adjusted to take account of their impact. We operate in a changed environment from the days pre-recession, where there is ever more focus on cash flow and solvency risk across the whole supply chain. PBAs are by no means a silver bullet, but their mandatory adoption on eligible Scottish Government contracts will hopefully provide more certainty and stability.