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Banks increase bankruptcy risk in building industry

13 December 2018

Recent changes by banks to their lending practices have increased builders’ risks of bankruptcy by in effect, forcing them to become de facto financiers for medium term debt.

Accordingly, customers’ worries have also been increased by the likelihood of being left with an unfinished project.

The problem stems from banks’ decision to change the way payments are being made to builders.

Traditional system changed

Traditionally people using an architect to administer a contract would ask a builder to prepare a detailed monthly claim for work done.

The architect would visit the building site to check that the claim was justified by satisfactory work and on the basis of that assessment, would authorise a progress payment.

At no stage was control of a project’s progress in the hands of either the financier or the supplier of material and labour.

Traditionally an architect’s role as an honest broker in getting the job done was seen as protecting the interests of client, financier and builder.

However, it’s Macks Advisory’s understanding that without consulting building industry representatives, some banks have decided to abandon this system by eliminating monthly claims and implementing one of staged payments.

These are being made at the banks’ discretion whether architects administer contracts for housing projects or not.

Effects of the change

By treating all projects similarly, the effect of this change would appear to make them riskier for both builder and client.

The client sees the builder getting paid without an expert’s assessment of the quality of work done, and there can be circumstances where builders find themselves in a dangerous situation by having to finance medium term debt.

In projects involving construction of a large number of houses, or in complicated individual projects extending over a year or more, builders can outlay hundreds of thousands of dollars, then have to wait three months or so for a staged payment.

In such circumstances it can be very difficult for many a construction company carrying such debt to remain profitable.

There’s further risk for a client whose builder goes bankrupt. 

Can another builder be found to complete the project?  What effect will delay have on the client’s finances?  How much more than the original cost will the new builder charge to complete the project, given possible damage caused as a result of the delay?

The short straw again

The Royal Commission has highlighted banks’ penchant for ensuring far too often that customers are left holding the short straw, so it’s hardly surprising, because it costs more for banks to process builders’ monthly payments, that they’ve decided to implement a system of fewer staged payments.

This of course takes no account of the consequent increased risk to customers arising from builders’ insolvency – risk that in most instances could be averted or at least minimised if architects were monitoring monthly payments.

If the cost of processing monthly payments is an issue for banks, why couldn’t banks factor this into loan arrangements?  It’s likely many people would be happy to accept into the cost of their building loans as an optional extra, an amount to cover monthly payments approved by architects.

It will be interesting to see the extent to which this will affect builders as a result of banks moving to staged payments for all building projects.

Possible effects to the building industry

Architects have no financial axe to grind in this issue.  They will be paid whatever payment arrangement is made for a building project.

It’s our belief architects are concerned the newly introduced payment system demonstrates a fundamental lack of understanding of their importance in maintaining a proper balance of the financial commitments of parties involved in building projects.

We suspect the introduction of staged payments, by forcing builders to act at times as de facto medium-term financiers, means many of them may have to reconsider the size and structure of their businesses, their pricing and how many projects they can undertake at any one time.

It seems this would be so particularly where builders are specialising in architect-designed projects.

For people who have borrowed money from banks to renovate homes or build new ones, it also seems banks have just ensured their projects become a whole lot riskier.

Disclaimer: The information contained in this webpage is general information and does not constitute legal advice. Nothing in this webpage is or purports to be advice. If you do need advice, then you ought to seek and obtain appropriate personal professional advice based on your personal circumstance.

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