When a commercial builder enters administration, headlines naturally gravitate towards what they might owe, before attention turns to why they failed.
And while the specific circumstances may vary, each collapse is inevitably chalked up to a version of “difficult market conditions beyond the builder’s control.”
But there’s a third element that’s rarely discussed.
Even if we accept that the ultimate outcome was unavoidable, we may need to start questioning the timing of these decisions. When should these builders have entered administration? Were the impacted developers (and subcontractors) all truly just ‘unlucky’ or did some engage builders who were already in significant financial distress?
You’d assume that an inability to meet existing financial obligations would rule out any possibility of a builder winning a new contract but a review of various builders that have entered administration since early 2023 suggests that’s not always the case.
Public records reveal that it is ‘typical’ for commercial builders that have entered administration to:
Have been ‘trading insolvent’ for about six months*
Have won the majority of projects that were in progress at the time they entered administration in:
the six months prior to the administrator-indicated ‘insolvent trading’ period or,
during the ‘insolvent trading’ period.
Several were deemed to have been trading insolvent for more than 12 months and, while it’s disturbing enough to think that a builder could satisfy financial due-diligence requirements just months prior to becoming insolvent, it gets worse; it seems that most were able to secure at least one new contract during the ‘insolvent trading’ period.
It’s clear why a builder might be tempted to push the boundaries in trying to save their business but the fact that such dire cashflow troubles were not able to be identified will be keeping developers and lenders up at night.
Can an external party ever hope to reliably distinguish between realistic and overly ‘optimistic’ cost to complete/cashflow forecasts or identify when critical financial information is incomplete, out of date or otherwise misleading?
And as much as we’d like to think that the worst is behind us, builder insolvency is a perennial risk (up a further 21 per cent on FY24, according to the latest ASIC data including multiple, high-profile casualties); it’s not going away.
Many lenders have reportedly tightened due-diligence requirements in response but few appear to have addressed the underlying limitations of this process—more of the same is unlikely to change the outcome.
Although builder insolvencies are still relatively rare within the commercial construction sector, the administrator’s findings confirm that cashflow trouble often begins long before signs of distress become outwardly apparent.
It follows that the main source of nervousness for developers we speak with is the ‘contagion effect’; the considerably more likely risk that progress payments might be used to cashflow their builder’s troubled projects. They end up (involuntarily) paying another developer’s bills, while their project inherits the cash shortfall.
Of course, the ever-widening gap between the on paper and actual cost-to-complete will eventually need to be filled.
For every insolvency that makes the news, there are countless other instances in which the developer is quietly strong-armed into paying significant sums of money outside of the contract to get their project to completion.
Developers and lenders are continually asking their builders to ‘prove’ that they’re financially sound and, of course, ‘prove’ that they pay their subbies.
The problem is, the industry-standard checks and balances don’t actually prove anything. It’s become clear to many that reducing their exposure will require going beyond what has long been considered ‘best practice’.
Legally and practically isolating each development from all others is fast becoming the preferred approach.
But as more developers and lenders put a ring-fence around progress payments, the pool of projects that a distressed builder can ‘borrow’ from gets smaller.
No matter how thorough your builder-betting process, if you’re still paying into your builder’s operating account and pinning your hopes on that monthly ‘stat dec’ being true, the chances of your project being impacted are only going up.
Want to prevent builder cashflow issues from impacting your project?
Get in touch: info@ipex.com.au or go to ipex.com/contact. Prefer a phone call? You can reach us on (03) 8456 8032.
*Insolvent trading period based on the administrator-indicated trading insolvent date (not provided for all builders).
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