Fintan Wolohan on Managing Partner at Womble Bond Dickinson (Inputs by Michelle Essen, Simon Rowland and Jonathan Dunkley)
Many organizations in the construction industry are facing financial difficulties and they can no longer be ignored. As the sector buckles under the strain, it is important to recognize that there is no single reason why construction has found itself in this situation.
As the quarterly statistics of the Insolvency Service show, the sector is the most affected by the increase in financial pressures. The latest figures, for the first quarter of 2023show:
- the total number of business insolvencies in England and Wales was 5,747, up 18% compared to the first quarter of 2022;
- of these, construction experienced the largest number of insolvencies, with 1,049, around 18 percent of all cases;
- this was also the case for the 12 months ending in the first quarter of 2023, where construction accounted for 19 percent of all cases.
In fact, when you look at the insolvency statistics by sector over the last 10 years, construction consistently comes out on top (or bottom, really), except during the peak of the lockdown in the mid-to-late 2020s, when The accommodation and food service industry, not surprisingly, took the lead.
The general upward trend in business insolvencies has also been reflected in the latest monthly statistics from the Insolvency Service (May 2023), with a total increase of 40% compared to the same month in 2022.
Why is construction so affected?
The past few years have been incredibly tough for construction. Looking back, you can see a trail of obstacles that the sector has had to overcome, among which stand out:
- Brexit: Leaving the EU in 2020 led to a significant reduction in the number of EU workers in the construction sector, which previously relied heavily on this workforce.
- Pandemic: Covid blindsided the UK, but construction was particularly affected by material shortages, due to products not being manufactured, imported or delivered; reduction in the number of workers due to Covid and changes in working practices; and discontinued projects.
- Ukraine: The war, which began in February 2022, has had an impact on Ukraine’s supply of construction materials (such as metals, raw materials and chemicals), and fuel and energy costs have increased significantly exponential
- Shortages: Compounded by the perfect storm of Brexit, the pandemic and the war in Ukraine, construction has suffered from ongoing material and labor supply issues, as well as high material costs and wage inflation.
- Extreme weather: The UK’s climate is changing with heatwaves, floods and snow affecting work on site and the health and safety of workers.
The combined effect of the above is that developments and projects have been disrupted, either by stoppages or shortages. Profit margins have been hit hard by rising material and labor costs, which in turn have led to delays and disputes. In times of supply chain distress, cash flow can quickly become a problem.
Will the trend continue?
If the last decade is anything to go by, then yes. In addition to the current pressure points mentioned above, current and future challenges for construction are also significant, with issues including the review of the building safety regime, biodiversity planning changes for net benefit, net zero goals, the housing shortage, the role of modern construction methods and innovation, energy security and renewables, and much more.
“The upward trend in construction insolvencies is unlikely to abate”
We are still seeing contractors having to navigate fixed-price contracts that were entered into before the stratospheric increase in material and labor costs. These increases are often cited as among the main causes of the current wave of contractor insolvencies.
Until financiers, clients and employers take a more holistic view of risk sharing and appropriate risk transfer, the high rate of construction insolvencies is likely to continue. A more alliance-based approach to pipeline margins and profits would also have a significant positive impact.
What we are seeing is a perfect storm of economic factors that, although they affect many other sectors, are most acutely felt in construction. With high levels of inflation, supply chain issues, labor shortages and the looming threat of recession, the upward trend in construction insolvencies is unlikely to abate. Now more than ever, therefore, it is increasingly important for employers and contractors to monitor cash flows and contingency plan accordingly.
