From inflation to insolvency

One issue has stalked the post-pandemic recovery of Canada’s construction industry more than any other – inflation.

With the inflationary warning lights burning bright, the more subtle danger of contractor insolvency has passed largely unnoticed.

Now as cost escalation eases, the threat landscape is changing. While the gravity of these two intertwined risks varies between sectors and provinces, insolvency may rise to become a significant barrier to project success.

By Q4 2023, the number of Canadian construction firms becoming insolvent had soared 228.6 percent compared to the pandemic-era low of Q3 2020. This happened after a combination of unprecedented fiscal stimulus, creditor forbearance and affordable finance suspended business closures for contractors prevented from working by COVID-19 restrictions.

Source: Office of the Superintendent of Bankruptcy

Construction firms accounted for 14.1 percent, more than any other industrial sector, of federal loans made under the Canada Emergency Business Account (CEBA) in April and May 2020. Though initially interest-free, any CEBA loans still outstanding in January 2024 became subject to 5.0 percent annual interest.

With other COVID-era support also gone, struggling construction firms no longer enjoy any of the protection that previously mitigated the threat of insolvency. The fall in construction output seen in every quarter of 2023, coupled with cooling demand, could push more teetering contractors into insolvency in 2024.

The risk this poses should not be underestimated. When a contractor goes bust, the impact on a construction project is always instant, sometimes severe and often long-lasting.

Failure to complete part of the works adversely affects later phases, and the sequential nature of most projects means there is often a whiplash effect. Often, this leads to both delays and cost increases that pushes the final cost well over the client’s original budget.

Putting prevention strategies in place

Contracts typically afford some protection from the fallout caused by a contractor becoming insolvent, and may include scope for financial redress, but their role is palliative rather than preventative. Clients should aim to identity and pre-empt insolvency risk throughout the project life cycle. Key areas to focus on are:

1.

Pre-contract and procurement

The procurement team should give equal weight to a bidding contractor’s financial stability as to their past project expertise and experience. Pre-qualification assessments should also consider:

The contractor’s current workload and exposure to project risk, and whether its business is disproportionately leveraged on one client or project.
Awarding bonus marks to firms which offer parent company guarantees or performance bonds.
The underlying reason for a very low bid. Indebted contractors bidding low to secure turnover seldom make reliable partners, and clients should beware that short-term savings can feed into higher long-term costs.

Intelligent delivery models which share the project risk between the client and lead contractor, mitigate the threat of insolvency and often deliver better project outcomes:

Progressive Design-Build has proved its worth in complex projects thanks to its combination of a target-price approach with an incentive mechanism which rewards contractors for high performance and penalizes them for failure.
Central to its success is the collaboration it fosters between client and supply chain. Rather than loading risk onto suppliers, it is distributed equitably. Both contractor and client will benefit from cost savings, and projects procured this way tend to attract more, and better quality, bidders.
With input costs alleviating in some sectors, the case for this model is especially strong right now.

2.

Projects already in flight

Project controls should be used as both an early warning, and correction, system.

Project managers must maintain real-time progress and defect reports, tracking all activities against the construction programme. Pro-active health checks should confirm that contracts are fully signed and adequate bonds are in place.
Clients need to be alert to contractor distress while also supporting them. In practical terms, this means re-running credit checks and challenging contractors on their ability to keep delivering, while also seeking to understand and allay their concerns.

Insolvency red flags to watch for in contractor behaviour include:

Unexplained difficulty in progressing the works.
Removal of materials or plant from the site.
Attempts to inflate interim payments.
Failure to pay suppliers or subcontractors on time.
High staff turnover or lack of staff on site.

If a contractor does become insolvent, speed is critical. The site must be secured immediately to prevent the removal of plant or materials, and a full valuation of the works should be undertaken, documented with photographs or videos.

Clients should pay only for completed work.
Records should be compiled of all additional costs incurred by the employer as a result of the insolvency, as these may later form the basis of a legal claim.
If a General Contractor (GC) becomes insolvent on a well-advanced project, paying subcontractors via a trust account may prove less disruptive than appointing a new GC.

Evolving risks, evolving solutions

Cost escalation, capacity constraints and intermittent material availability remain at the forefront of Canada’s construction industry concerns. However, the spike in contractor insolvencies should not be ignored. In some cases, insolvency is the product of the issues above. Especially when the risk burden is placed entirely on overstretched contractors.

A further increase in insolvency is not inevitable. It can be prevented by clients who adopt a proactive, pre-emptive approach to mitigate the threat during both the procurement and construction phases. Failure to manage insolvency risk may itself prove an unacceptable risk. It is far better for the client, project team and supply chain to work together to prepare for the worst and hope for the best.

Cookie Policy