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Cut-throat combo: Killer clauses and bad debt

As the market picks up, new opportunities for SMEs are becoming more apparent - but these come with risks. In particular, bad debt and killer contractual clauses could cause SMEs to come unstuck.

The summer is always a busy period for construction, as reflected by the latest Markit/CIPS Construction purchasing managers’ index, which hit a seven-month high of 57.3 in August.

As we move further into the final quarter of 2015, many SMEs will continue to pick up work from large construction firms on the hunt for subcontractors.

Almost a million SMEs play a vital role in shoring up the construction supply chain, but figures from the Office for National Statistics show that the sector suffers from more liquidations than any other.

Whilst the market is buoyant there are likely to be a lot more opportunities, but these come with risks of their own. For SMEs there are two enduing chronic problems: bad debt and killer clauses.

Debt is bad enough

Bad debt is a debt that will never be repaid.

It is a serious issue for many construction businesses, who are often more exposed to the threat of overtrading or over-exposure to single debtors.

The issue here is that if one of these customers – for whatever reason – closes or is unable to pay, it puts the subcontractor at risk also.

“For SMEs there are two enduing chronic problems: bad debt and killer clauses”

However, subcontractors are unique in that they often work on projects where completion dates are one, two or even three years down the line.

Non-payment can occur due to customer insolvency, payment default or dispute and the issue is severely problematic for smaller firms who have often already footed the bill for labour and material costs.

This places a massive strain on these businesses, often causing viable firms to fold.

The problem is particularly acute for those who do not have sufficient working capital or bad debt protection in place to cover against this situation.

It’s in the name

It’s hard to think of a more menacing name than killer clauses.

These contractual agreements are potentially deadly to SMEs who remain unaware of them.

Without due care, SMEs risk sleepwalking into contractual nightmares.

Killer clauses are contractual agreements whereby a subcontractor agrees to enter a contract with an unfair or onerous contract clause.

These types of clauses can appear in many forms, none of which are beneficial to smaller construction firms.

The system places SMEs in a vulnerable position, which exacerbates existing cashflow problems or exposes them to unfair treatment from larger contractors.

“The government’s commitment to a Small Business Conciliation Service will go some way to ensure that construction SMEs have a voice”

One such clause is ‘termination at will’.

This enables contractors to terminate the engagement of the subcontractor at any time and for any reason upon written notice.

Another deadly clause is ‘no payment on insolvency’, which opens up SMEs to the possibility of being forced into insolvency by contractors looking to avoid payment for work completed.

These clauses can often result in subcontractors having to forfeit payment for any completed work at a moment’s notice.

This is particularly risky for SMEs who don’t have the legal resources to pursue litigation and to prove their contractor has deliberately withheld payment or unfairly terminated their contract.

Protecting your business

Without action to raise awareness of these issues, SMEs will continue to face significant risks that could see them become just another sad statistic.

But there are some steps subcontractors can take to mitigate risks associated with killer clauses and bad debt:

  • Check all contracts thoroughly to ensure you understand each clause and their potential impacts. If you’re unsure of how a particular clause will affect your business, seek advice from construction sector experts.
  • Agree additional work with written instructions and agree additional costs upfront.
  • Manage your customers’ expectations, including notifying them of any possible or likely delays.
  • Get your cashflow in order. Firms with a ready supply of working capital are less likely to come unstuck due to the impact of killer clauses or bad debt.
  • Secure bad debt protection for peace of mind. Many firms opt for construction finance, which enables them to continue to trade, pay wages and win new contracts, while they wait for payment. With bad debt protection, businesses still receive the money owed, even if their customers fail to pay for any reason.

Remedying the situation in the long term requires action from policymakers.

The government’s commitment to a Small Business Conciliation Service will go some way to ensure that construction SMEs have a voice.

But, for now, the onus is on SMEs to avoid becoming a victim of small print and bad debt by protecting themselves against highly hazardous contracts and cashflow shortages.

Helen Wheeler is managing director of construction finance at Bibby Financial Services

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