A year after its collapse, Carillion's insolvency continues to haunt both its supply chain and the wider UK construction industry. Many of those left unpaid had spent months chasing Carillion for payment, all the while staving off payment demands from others. Overnight, their debts became unsecured. The flow of cash from Carillion that would have paid its supply chain dried up. A cascade of consequential insolvencies was inevitable.
It must be galling for those affected to know that mechanisms to avoid late or non-payment already exist. Their frustration has reached politicians' ears, as can be seen from recent parliamentary activity. For example:
the industry's misuse of retentions is widely recognised and under scrutiny (you can read more about the Aldous Bill here);
the Department for Business, Energy and industrial Strategy (BEIS) ran a consultation in 2018 on "Creating a responsible payment culture: a call for evidence on tackling late payment" (on which government feedback is awaited); and, more recently,
Debbie Abrahams, Labour MP for Oldham East and Saddleworth, introduced a bill into Parliament championing the use of project bank accounts (PBAs). PBAs require clients to pay money due under the project into a trust account, which protects parties from the insolvency of those further up the supply chain.
PBAs were traditionally opposed by tier 1 contractors, who would lose the financial benefit of cash flow, and by parties generally because they were fiddly and expensive to set up. However, the English government has, for a number of years now, required PBAs to be used on central government construction projects unless there are compelling reasons not to do so. PBAs are also required to be included by relevant public bodies in Northern Ireland (on public projects over £2 million), in Scotland (on projects over £4,104,394 for building projects and £10 million for civil engineering projects) and in Wales (on projects over £2 million).
Had PBAs been set up on Carillion's various major projects, the prospects of recovery for many of its creditors might have been very different. Of course, it is easy to say in hindsight that PBAs should have been used more widely – but why are they not used more frequently? Set-up and administration costs are often cited as a key reason but maybe the industry should be giving more weight to the longer-term benefits of PBAs, such as increased collaboration.
How do PBAs work?
A PBA is a tool designed to implement fair payment practices on a project. It protects payment money against upstream insolvency risks and enables project money to flow down from the client through the supply chain at a rate quicker than the industry's average (lengthy) payment cycle. Here's a broad outline of how they operate:
Clients (usually, currently, in the public sector) trigger the use of PBAs on a specified project and require the main contractor to sign up to their use.
A ring-fenced bank account with trust status is then set up. The trustees and account holders will be either the main contractor and the client acting together as trustees (sometimes referred to as the "Dual Authority") or the client acting as sole trustee (the "Single Authority"). Occasionally, the main contractor may act as sole trustee (the Single Authority). It is also possible, although fairly unusual, for key sub-contractors to also be trustees. The Single Authority and Dual Authority approaches operate in different ways. For example, under the Single Authority approach, only the client can deposit funds in the PBA and authorise the bank to pay out whereas, under a Dual Authority approach, both parties can do so.
To set up a trust, the parties need to enter into a trust deed linked to the PBA, which requires careful negotiation and drafting of the terms. This trust deed is an agreement which contains the provisions for administration of the PBA. Shorter additional trust deeds (often described as joining deeds and under which a party joins the trust deed) will later be required from the sub-contractors and suppliers if they are to benefit from direct payments through the PBA arrangement.
PBAs are most often set up for use on a single, large project. However, some government/local authorities create one PBA for use on several, smaller, contracts, a mechanism which saves costs and administration time.
Once the project starts, the parties operate the contract payment mechanisms in the normal way. The client may pay the entire project funds into the PBA in a lump sum at the outset of the project or may pay amounts due under a contract into the PBA once such payments become due. Upon issue of an authorisation, moneys due are released direct from the PBA to the main contractor and sub-contractors. This authorisation is typically prepared by the main contractor (setting out sums it assesses as due to itself and to its sub-contractors and suppliers) but approved by the project manager. It is then signed by the client and submitted to the project bank for payment.
The terms of some PBAs allow the client to withhold payment if contractually entitled, say if the main contractor is in breach of its contractual duties. In this event, in some cases, the main contractor may be obliged to top up the PBA to ensure that the due payments are available to be made to the sub-contractors. Provisions such as these require negotiation and careful drafting in the contract documents at the outset (and, consequently, are more expensive to set up).
A specific example: JCT "PBA 2016" supplement
The Joint Contracts Tribunal (JCT), 2016 edition offers its "PBA 2016" supplement (for public or private works) for projects on which a PBA is to be used. The supplement includes various enabling provisions to be incorporated into the JCT contract and a form of PBA, to be signed as a deed by the contractor and the employer. The PBA is set up as a trust with named beneficiaries (such as the main and sub-contractors) with provision that the moneys are held in trust for and payable only to the beneficiaries. The effect of the trust is that the money is protected in the event of insolvency: it ceases to be the client's money on payment into the PBA and the money intended for the sub-contractors does not go through the main contractor's own accounts. Additional trust deeds are signed and appended to the contract later when (additional) sub-contractors are appointed (although lower-value sub-contractors may not be added as beneficiaries).
In terms of the trigger for payment, the contractor provides a declaration to the employer of what is due to the supply chain along with its application for payment. The payment certificate sets out the split of what is due between the contractor and the sub-contractors and the employer pays the due money into the PBA. The bank then pays out the due sums simultaneously to all the parties.
The gradual rise in use of PBAs
Support for the use of PBAs stretches back to Sir Michael Latham's 1994 report (Constructing the Team) and Sir John Egan's 1998 report (Rethinking Construction), both of which recommended PBAs particularly for public sector clients.
In 2011, the government recommended PBAs for public sector projects in its Construction Strategy, which set targets for the value of contracts to be put through PBAs. In May 2012, the Cabinet Office released its "Guide to the implementation of Project Bank Accounts in construction for government clients", which envisages payments from the PBA out to the contractor and sub-contractors within five days or less from the due date.
The Scottish government released "Guidance for the public sector on setting up PBAs for construction projects" following a procurement review in 2013. (This guidance gives links to PBA: Q&As and a 55-page guide on implementing PBAs. There is also a useful diagram of how the PBA works as compared with the traditional waterfall payment system – see Annex A on page 28.)
The EU Commission has also recommended the use of PBAs to member states, as has, most recently, the UK Public Accounts Committee.
Advantages of using a PBA
The English government promotes the use of PBAs on public projects as a way of meeting the aims of its Construction Strategy including addressing unfair payment practices and ensuring transparency and certainty of payment. Aside from enabling sub-contractor beneficiaries of the trust account to receive money due to them swiftly, the key benefits are as follows:
PBAs promote compliance with the principles set out under the Prompt Payment Code: the payment process is more transparent and it is easier to measure payment timescales;
prompt payment promotes good cash flow, which underpins successful businesses and encourages investment. It avoids payment disputes and the costs associated with late payment such as interest payments on credit, time lost chasing payment and, ultimately, the financial and emotional cost of insolvency;
simply knowing a PBA scheme will be used on a project can encourage sub-contractors to submit lower bids – in the knowledge that prompt payment will reduce their costs;
a PBA scheme works alongside the contract payment terms;
PBAs help parties focus on the project and more efficient, better-value service delivery, which has long-term benefits for the wider industry including increased collaboration and innovation. Not surprisingly, PBAs are widely supported by groups representing sub-contractors such as the Specialist Engineering Contractors' Group and the National Specialist Contractors' Council;
PBAs do not affect VAT, general tax and accounting obligations; and
various of the standard forms provide supplements to facilitate the setting up of PBAs. The JCT, 2016 edition has its "PBA 2016" supplement (for public or private works), as mentioned above, and NEC3 and NEC4 have "Secondary Option Y(UK)1". PPC2000 and SPC2000 also make allowance for a PBA.
Disadvantages of using a PBA
PBAs are not a mechanism for resolving payment disputes. They deal only with how moneys are paid, when and to whom. They do not affect the payment functions of the various parties under their contracts.
The set-up and administration costs (in time and money) can be prohibitive for those involved in smaller projects. Setting up a PBA might also require some time to encourage positive engagement in the process. Tier 1 contractors might increase their price accordingly.
Potential beneficiaries of PBA tend to stop at tier 3 sub-contractors. Smaller sub-contractors therefore might not benefit.
The PBA process is not always a watertight method of protecting against insolvency. In the case of the JCT PBA 2016, for example, the contractor does not have to specify how the moneys in the PBA are allocated. If the contractor were to become insolvent before making this specification, technical arguments could arise about whether the sub-contractors are owed the money at the time of the main contractor's insolvency.
PBAs do not offer protection from an insolvency at the top end of the supply chain in every case. A sub-contractor who wants to extract due money from the PBA must show that there is a trust in its favour. This can be a complex exercise. Failure to establish a trust will mean that the party will simply rank as one of the unpaid creditors in the insolvency – and might recover very little, if anything.
The right approach is essential to run a successful PBA scheme
The Scottish government's review of PBAs reported on key themes that emerged from its trial PBA programme. To be successful, PBA schemes require a systematic means to implement PBA policy, leadership teams committed to that implementation, good project management of the PBA infrastructure, good channels of communication about the process, and central oversight of the PBA policy to integrate all involved no matter what their discipline.
PBAs in the spotlight after Carillion
Most recently, the stark effects of Carillion's insolvency on the supply chain have underlined the potential of PBAs to ensure fair payment processes. The cause for the use of PBAs on public projects has been taken up by Labour MP for Oldham East and Saddleworth, Debbie Abrahams. Spurred on by the experiences of some of her constituents after Carillion's insolvency, she introduced the Public Sector Supply Chains (Project Bank Accounts) Bill 2017-19 into the House of Commons on 15 January 2019. (You can read her speech here.)
In launching the bill, Ms Abrahams argued that existing measures to tackle late payment have had limited effect and legislation is needed. Further, recently-introduced statutory requirements for listed companies to publish payment practices are not improving payment times.
Notably, her bill sets the threshold value for public sector projects at £500,000 as the trigger for using PBAs. This is a relatively low threshold compared to the projects on which PBAs are currently used due to the set-up costs involved.
Use of PBAs in the private sector?
Note also that Ms Abrahams' bill focuses on public sector projects: there is no such planned requirement for PBAs to be used on private contracts. Parties contracting privately are left free to agree their own terms and generally steer clear of PBAs. Private contracts tend to be of smaller value than public projects and the costs can be prohibitive. However, with contracts bodies such as the JCT simplifying the set-up process by supplying standard forms for setting up PBAs, those negotiating contracts on larger private projects should perhaps consider the wider benefits of PBAs early on in the process. In particular, reducing the scope for payment disputes and protecting the supply chain from insolvency risks might make PBAs attractive in these uncertain times overshadowed as we are by Brexit uncertainty.
The Public Sector Supply Chains (Project Bank Accounts) Bill is scheduled for its second reading in Parliament in early March. There is plenty of support for it but its greatest enemy as we write is the government's preoccupation with Brexit: the bill could well be edged out of the Parliamentary schedule, just like the Aldous Bill. One thing is for certain, however: PBAs are here to stay, at least on public contracts. Whether parties on private contracts will consider them is another matter.