Dialogue: Construction law has a price

Act commerce spokesman STEPHEN FRANKS discusses the likely impact of legislation to safeguard building industry contractors.

The collapse of large construction firms such as Hartner, Goodall ABL and, most recently, Project Works Construction has landed subcontractors - builders, plumbers, painters, electricians and others - in millions of dollars of debt. Some subcontractors - most recently Hornsby Earthmovers Auckland - have gone under themselves.

Given this history, the Construction Contracts Bill's intention to fast-track decisions on disputes is sensible. So are the resurrection of an ability to take liens (in effect, using the debtor's property as security), and the right to stop work if there has been a payment default.

Everyone in commerce would benefit from more prompt and effective remedies for contract breaches. If this legislation achieves that for the construction industry we should all welcome it.

But we should wait to consider select committee submissions before offering comprehensive judgment. There are always unintended consequences of well-intended law. Scrutinising the fine print will tell us some of these.

Subcontractors could find, for example, that they face an unexpected price for the change.

Under the bill, "pay when paid" clauses will be illegal. This attempts to prohibit the head contractor from agreeing with the subcontractors on sharing the risks of payment failure.

Until mechanisms are found to avoid the prohibition (and they inevitably will be found) the effect will be that head contractors must have more capital. We can expect fewer, bigger, contractors if they need more capital.

There may be a much greater market share taken by large international firms relying on multinational balance sheets. They will bring overseas attitudes to construction, for good or ill. With fewer and larger contractors, each could have greater bargaining power. Head contractors' profit margins will have to rise to reflect the larger risk, and the increased capital requirements.

As the head contractor's risks will be bigger, it could be harder for successful subcontractors to move through the business cycle to become head contractors.

Alternatively, the middle-sized firms may thin out. At one end could be large firms, fully capitalised. At the other end of the scale will be thinly capitalised companies.

The less scrupulous or those willing to back themselves unwisely into bigger risks could even deliberately use thinly capitalised companies designed to evaporate if the risks go sour.

If we see thinly capitalised companies going broke more often the concerns of the industry will simply transfer. The complaints will move from construction law to company and insolvency law.

We may chase the directors more often, but that only helps if they have not disposed of or lost their money. We stopped jailing for non-payment of debt many years ago. In practice there are now few effective remedies against most debt defaulters.

In any event, building contractors have an interest in the integrity of limited liability for decisions made in good faith. They will be exposed if building owners can come looking for deep pockets, perhaps many years after a job is completed.

Director liability could be cranked up to the point where every failure or collapse is followed by circling flocks of lawyers, shredding limited liability with sanctimonious hindsight judgments.

The proposal not in the bill, for compulsory performance bonding, would avoid many of the "thin capital" risks. Fees will be payable by those who would never go broke, as well as those who could. But there could be a cost greater than just the extra fees. That cost would be an effective veto power for the bankers and approved bond providers on who could move into head-contractor status. And of course there will be serious definition issues. When does a building owner have to get a bond just to have work done on his or her own building? Who will bear the cost of the credit appraisals the bond provider must do, even for solvent owners? Who will ensure the bond providers don't go broke?

I well remember Australian insurance industry outrage when we were designing the ACC reforms (repealed last year). NZ insisted that they be subject to our prudential regime. HIH protested. Now HIH's collapse may cost the Australian Government up to $1 billion.

The structure of the industry may change if the head contractor has to carry risks at present shared with subcontractors. Maybe they will do more work in-house. The subcontracting industry may shrink proportionately. People who are now self-employed may have to accept employee status if they want to stay in the industry.

None of this is to say that the subcontractors' concerns about their exposure to the costs of collapses are unjustified. It is simply that this Government has chosen to tell the industry there is now only one pattern for sharing that risk. There are always costs of abridging freedom. Some of those costs will fall back on subcontractors.

If the law works as hoped, it may reduce the risk of catastrophe for the minority who are caught by collapses. But the price could be some reduction in returns, and perhaps in opportunities for work, for all subcontractors.

Work on the fine print over the next few months may determine whether the price is worthwhile.