You Can’t Insure Against Builder Insolvency, BUT There is Another Way to Protect Your Project
You can insure yourself against many risks when it comes to property development, but builder insolvency is not one of them. Recent, high-profile insolvencies have made many developers & lenders nervous, leading to ever-increasing scrutiny on builder finances. Whilst no developer would appoint a builder they believe is at risk of going under, many have sustained losses despite them reaching a position of ‘comfort’ through extensive due diligence checks. This process is far from perfect.
NO MATTER HOW THOROUGH YOUR BUILDER DUE DILIGENCE PROCESS, THERE WILL ALWAYS BE GAPS
The primary limitation of these checks is that they are all historical, representative of a ‘point in time’ only and rarely provide any real insight into any looming cash shortfalls. Even if available resources appear sufficient at the time of contract award, no audit can predict the terms of any future contracts your builder may sign or cashflow issues they may encounter on another project during your build. As recent events have shown, even builders with great reputations are not immune to external market forces, particularly when operating under onerous contract terms.
What’s worse, due diligence in its current form places the onus on the developer and lender; it’s your responsibility to review all available data and satisfy yourself of a builders’ financial capacity to fulfil existing contractual obligations. If the information you are basing this decision on is out of date, incorrect, incomplete or worse still, fraudulent, you bear the consequences.
IT CAN BE DIFFICULT FOR BUILDERS TO ‘PROVE’ THAT THEY ARE TROUBLE-FREE
‘Good’ builders are also dealing with the fallout of insolvency; the issues of some causing all to be tarred with the same brush. Even those in a great financial position are in a constant battle to ‘prove it’. But without transparency over how client funds are being managed, developers can never be sure. As tricky as it is, the cost of getting it wrong can be immense. It’s not just having to pay subcontractors and suppliers again; reconciling transactions and substantiating creditor claims is a painstaking task and with every month that passes, holding costs compound and developer equity diminishes.
ONLY THE BUILDER KNOWS THEIR TRUE FINANCIAL POSITION; WHY SHOULD DEVELOPERS & LENDERS BE FORCED TO GUESS?
So, you can (and should) keep auditing balance sheets, work in progress/cost to complete and builder track records before awarding a contract but you should also make one fundamental change to your due diligence process – you need to shift the onus for any due diligence ‘gaps’ onto the builder – make them ‘prove’ their solvency by ensuring that your project is only viable for those that are as financially secure as they claim. How? By mandating that your projects be run under IPEX.
REDUCING RISK MEANS APPOINTING A SOLVENT BUILDER AND PROTECTING PROJECT FUNDS DURING YOUR BUILD
IPEX is an online payment platform that secures funds intended for a specific project, ensuring that progress payments can be used only to pay approved subcontractors and suppliers linked to that project. IPEX provides developers and lenders with visibility over who has been paid & when, without sharing a builders’ commercially sensitive information*.
IPEX impact pre-contract award: reduce the risk of appointing a builder that is already in financial distress.
IPEX offers a ‘real world’ test of builder due diligence. It doesn’t matter what their bank statements say or how creative they’ve been with their accounting, by offering the contract under the condition that all progress payments are ‘ring fenced’ to your project, you get to the truth: which of your prospective builders are financially sound & which are intending to use your funds to cover cash shortfalls on other developers’ projects.
IPEX impact during your build: protect against cash flow issues on any other project linked to your builder.
Even if your builder did experience cashflow issues once appointed, your funds remain secure as an IPEX account can’t be ‘borrowed’ from. And should a ‘payment default’ event occur before practical completion, the impact is minimised as:
- Any progress payment made via the IPEX platform has either been distributed to approved parties or remains in the account; and
- The developer may replace the builder as trustee of the project funds, gaining full visibility of all previous transactions and the ability to make payments directly to subcontractors and suppliers, reducing construction delays (and those holding costs).
IPEX SOLVES A HUGE PROBLEM FOR DEVELOPERS, BUT WHAT DO BUILDERS THINK?
Although IPEX is largely an extension of existing risk mitigation processes (in principle, IPEX asks nothing more than that builders pass on the entitlements of those they claimed funds on behalf of – something they already say they do via their monthly ‘stat dec’), it does restrict what a builder can do with project funds – initial reluctance is not unusual.
Having said that, our experience is that much of this hesitation stems from builders assuming ‘worst case scenario’; that agreeing means giving the developer full transparency and control – this is rarely the case. Practically, the level of transparency provided by IPEX standard portal view should not be of concern to any builder. Once this is understood, most builders are quite accepting of the concept, with discussions quickly shifting to how it’s to be implemented & what they can get in return.
There have however been a small handful of builders that met the request for IPEX with immediate threats to withdraw from the project; we can only imagine each had ‘grand’ plans for the initial progress payments and whilst it may be a coincidence, each has since entered administration.
To find out if IPEX can be implemented on your next project, get in touch.
*There are 2 IPEX developer portal configuration options with multiple additional variables impacting level of security & transparency; final implementation model to be agreed between lender, developer & builder