The earthquakes in Canterbury created a disaster on a scale not previously seen in New Zealand during our lifetime. Christchurch will be rebuilt and when it gets into full swing it will be the biggest building project in New Zealand history. Treasury has forecast that the cost of the rebuild will be circa NZ$40 billion. Fortunes will be made out of the rebuild, but like any boom, history tells us there will be some spectacular failures along the way.
In this article we will explore the issues facing construction companies waiting for the Christchurch rebuild, the chances of another large construction company collapse and some advice on how you as a professional advisor or construction industry contractor can help protect your clients or yourself from another construction company failure.
Issues facing the rebuild
The rebuild of the CBD hasn't started. The government announced the Christchurch CBD will be reconstructed around 10 major anchor projects. The city centre shows little evidence of activity or rebuild projects having been commenced. Private developers are waiting for the anchor projects to get started before they erect their buildings because of concerns of not being able to attract tenants to a building surrounded by empty sites.
Increased competition. A number of large offshore companies have indicated they will tender for some of Christchurch's anchor projects. For example a MOU has been signed between Arrow International, one of New Zealand's largest construction companies and global construction giant China State Construction Engineering Corporation Ltd targeting the anchor projects in Christchurch.
Labour shortage and small supply chain. Christchurch still needs to find another 17,000 workers, including carpenters, joiners, electricians and plasterers, before the rebuild reaches its peak. It is estimated the rebuild will need a total of 35,000 construction related workers. The shortage of skilled labour could result in poorly constructed buildings that could leak or fail.
Rising costs. Escalation in construction costs is already exceeding 10% per annum in the residential market, as a direct result of material shortages. This is likely to spill over into the commercial sector.
High compliance costs. The cost of constructing commercial property in the Christchurch CBD will be very high as the new buildings will require deep and expensive foundations. The draft plan wants to restrict CBD buildings to a maximum height of 7 storeys. The end result is that landlords will have to charge very high rents to get the same yield they had before the earthquake. Tenants may not accept these high rents and elect to keep their business in the suburbs.
Cashflow constraints while waiting for rebuild. Construction firms are desperate to hold on to their good workers and supply chains in anticipation of the rebuild. They have huge overheads to absorb while they wait for the profitable work to start. Initially, it looked as though the rebuild would peak in 2015/16 but it now looks as though it will be in 2016/2017. The flow on effect is that construction firms may have to accept a lower margin for another 12 months to keep their employees busy.
Insurance fraud. The vast sums of money involved in the rebuild and recovery create an unprecedented opportunity for fraud and corruption and we are now seeing large scale frauds being uncovered. International experience shows that, regardless of the country in which it occurs, fraud and corruption activity increases significantly following natural disasters.
What is the likelihood of another Mainzeal?
To answer this question we need to consider the common causes of construction firm failures. From our experience these usually involve:
- Tight margins
- Insufficient capital
- Lack of skills and experience
- Leaky buildings and non-compliant construction
- Over-investment in fixed assets
- Inability to manage growth
- Lack of understanding for procuring products/supply chain
- Inaccurate estimates and tendering
- Poor pricing decisions
- Poor quality control
- Unsafe construction sites
How can you or your clients better protect themselves?
- Be familiar with the remedies under the Construction Contracts Act
- Keep good records and contract files
- Register on the PPSR a specific security over material supplies (a great defence if charged for a voidable transaction)
- Suspend work if not paid, or consider the adjudication regime
- Perform due diligence on developers or head contractors before commencing work
- Research/credit check developer or head contractors before starting/signing contract
- Get personal guarantees
- Moneys held in Trust accounts
- Set credit limits - enforce them!
- Search the directors on the companies office to see the number of liquidated companies (history)
- Be aware of phoenix companies and obligations of successor companies to give proper notice
- Get sign off from a quantity surveyor, architect or engineer before paying invoices/completing variations
- Review trading terms
- Get advice if you suspect the head contractor is insolvent. Any suspicion of insolvency can be detrimental when facing a voidable transaction claim from a liquidator
When you compare the list of the most common causes of construction company failures to the issues facing construction companies in Christchurch, it appears that there is a high chance of another significant construction company collapse.
As a first precaution we would advise you to look at the list we have provided to help protect yourself or your clients.
McDonald Vague has considerable experience advising clients in the construction industry. If you or one of your clients is facing financial difficulties in the construction industry please contact Tony Maginness or one of our other Partners.
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.