By Alisa Sainoski

Insolvency in any industry has impacts on businesses, employees, families and communities.  The collapse of a business places immediate pressure on the management and employees of that business, as well as its suppliers and contractors.

It is necessary for both head contractors and subcontractors relying on payments for work completed, to take cautionary steps at various stages during the contracting process.  Taking these steps is critical to avoid the threat of counterparty insolvency and protecting themselves from the threat of credit risks.  Various stages during the contracting process should have ongoing process which should be assessed.

A starting point would be limiting reliance on any individual party, as the loss of a key worker/provider may be fatal.  A key risk for a contractor/subcontractor will vary depending on the relative size and complexity of the counterparty.  As the risk associated will also be defined by the nature of your own business and its overhead and employment structure.

You should be checking the credit worthiness of the counterparty, like you are a detective.  Ideally a government body is considered to have a very low credit risk in comparison to a small business entity.

Lets’ say work ceased unexpectedly for a subcontractor that has large fixed costs and a portion of these costs are attributed to workflow from a key contractor.  How does the subcontractor deal with the gap in payment period and how do they find a replacement in a short period of time.  If it is a large scale project how would they consider the lead time.

Another issue which should be considered, is whether the contractor/subcontractor’s balance sheet sustains a large provision for debtors.  Do they have a provision for bad debts which are just never being paid?  If a significant debtor provision causes balance sheet insolvency, this may significantly limit their ability to secure new work.

Is it too good to be true!  In situations where contractors/subcontractors are experiencing financial difficulties, they will often underquote to win work, with the sole purpose of generating cash flow and high hope of variations during the contract therefore making the overall project profitable.  In a tight market, where margins on contracts are low, a tender that is substantially lower than that of competitors is an obvious warning sign.

It would be wise to perform forecast creditor assessments.  A forecast credit analysis can be performed by many specialised advisers who can conduct these types of reports.  They analyse the current financial position of the counterpart but also their position during and at the end of the contract.  Performing this assessment will test help you to determine whether they can meet their obligations and financial responsibilities during the contract term.  It should highlight the ability of the counterparty to deal with significant losses in the event they sustain a loss on a project.

This isn’t a “set and forget” exercise, continual assessment throughout the project is critical when identifying potential risks and implement strategies to mitigate them.  More often than not, a participants’ financial position can vary substantially in a short period of time based on timing of cash flows, outcomes of litigation and contractual issues as well as on going warranty liabilities post-completion.

These risks are not only evident in current contracts, but also completed projects which are within the warranty period.  One of the key signs to consider include loss of key staff, this is an indication of an underlying problem, within a business and something which needs to be investigated further.

Another underlying issue which is a good indicator of broader problems in the contractor/subcontractor is that of quality control.  Where management is struggling to control quality of work it highlights other potential issues within the business as well as possible warranty claims and potential problems with your own project.  The more obvious warning signs are contractors/subcontractors leaving or not attending site/union interventions, as contractors/subcontractors are the first to be paid on a regular payment cycle.  If a group of subcontractors are refusing to attend site an audit should be undertaken immediately and consideration should be given on whether to pay the contractors/subcontractors directly.

Measures should always been taken to investigate further but also plan for any likely outcomes.  The above signs should be watched out for as they are evidence of significant doubt as to the financial position of the counterpart and the likelihood of contract difficulties or even failure. Generally measures will vary on circumstances but should include securing documentation and certificates.  Any additional supervision of the quality of work, identifying possible replacements, identifying any key staff and minimising the ageing of the amounts owed should also be considered.

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