Lessons learned from major project construction insolvencies in Australia

Hamilton Locke recently presented the following paper at the Society of Construction Law, revealing insightful lessons for the construction industry in the wake of ongoing major contractor insolvencies.

‘Compulsive Gambling and the Audacity of Hope’ – Lessons learned from Major Project Construction Insolvencies in Australia;

The Australian construction industry has a gambling problem.

Industry stakeholders, starting with government and international head contractors, know from bitter experience the consistent causes of mega-project failures. This is self-evident in case studies of major project failures going back decades (if not longer).

Despite this, like compulsive gamblers, those same parties too often turn a blind eye to what should be obviously broken models in terms of risk allocation, structuring, and project delivery, and expect outcomes other than contractor insolvency. The audacity of hope (if not insanity) is seeking a different outcome despite repeating the same patterns of behaviour.

Government and financiers alike enable the compulsive gambling of major head contractors. The results are inevitable.

Through case studies examining recent major contractor failures, including on ‘giga projects’, it will be seen that:

• we know the fundamental problems that have led to major project failures and insolvency in the construction industry;
• risk allocation in major projects in Australia is broken – with a culture of risk taking and recidivism if the price is right; and
• the result has been that in this financial year alone, approximately one in four companies in Australia entering insolvency has been in the construction sector¹. This problem has plagued the industry for years².

Australia has an unprecedented project pipeline across civil infrastructure, renewable energy and other nation building mega-projects. So how do we avoid another ‘profitless boom’³ for the construction industry? What lessons can be learned from recent major construction insolvencies? And how do we improve the financial stability of the construction industry?

The industry does not need more regulatory intervention or red tape to improve financial stability. Rather, accepting we have a problem as an industry is the first step in addressing this gambling problem. Increasing awareness as to this systemic problem will resolve many of the risk allocation and behavioural issues which have plagued our industry.

We know what the problems are

These problems are not new. Research in respect of insolvency in the late 1800s in Melbourne, yielded many of the same systemic problems in the construction industry:

‘The boom jeopardised builders in many ways. Contractor(s)… found that the more work… accepted, the less capably he could supervise…

Like many builders, he did not know how to keep accounts and could not ascertain his position until too late…

Contractors… realised (they)… would lose money… but needed visibility to persist… (and were) … taking contracts at a price which was not remunerative.

Under-capitalization weakened many businesses, forcing them to borrow at high interest rates.

… a rational response to a precarious future was to continue to seek work and ride out the crisis. To gain survival work, they bid lower still.’⁴

More recent studies as to the causes of insolvency in the construction industry have identified causes including ‘procurement methods, underbidding… pyramidal contracting chains …and undercapitalised project participants’⁵. Of all those causes, research found underbidding to be the ‘biggest contributory factor towards construction insolvency’⁶. Whilst harder to quantify, it is respectfully submitted that it is underbidding in conjunction with major project risk allocation based on the ability to push risk downstream that is the combined root cause of contractor failure.

Analysis of major contractor insolvency in recent giga-projects highlights many of these same issues.

The consequences of how we structure and deliver mega-projects are inevitable. Let’s look at some recent examples.

Lloyd Group

Lloyd Group went into administration, and subsequently liquidation, over the course of 2023. An Australian company which had a focus on local and state government projects as well as commercial and community sector projects across the Eastern seaboard.

Revenue for the Lloyd Group increased substantially between FY19 and FY22, increasing from $92.8m in FY19 to $276m in FY22⁷. The substantial increase in revenue generated was primarily due to an increase in the number, size and scale of projects in Victoria and New South Wales. This included a number of projects which were part of COVID and post-COVID stimulus packages by various levels of government.

Lloyd Group, in the same vein as our contractors in the late 1800s, suffered from:

• a high volume of work under fixed price contracts with very low margins;
• contractual assumption of risks associated with COVID lockdowns, material and labour cost increases (and shortages) and weather delays;
• the insolvency of subcontractors downstream suffering those same issues;
• unawareness of their true financial position until it was too late – or wilful blindness in the hope that they would be ‘too large to fail’ if they kept taking on larger projects; and
• limited working capital and poor cashflow management generally.

Despite this contractor largely working on government projects which were under $20,000,000, the cumulative impact of the assumption of almost all possible risks on small margins drove their ultimate collapse. Even on smaller public projects, risk allocation is broken.

RCR Tomlinson Group

It is not just government procurement and delivery structures. Let’s examine the collapse of RCR Tomlinson Group (RCR Group) which suffered from the consequences of poor risk allocation in the energy sector.

Similar to major infrastructure projects, large energy projects, from oil and gas through to renewables, involve a concentration of dominant players that force market participants to lower their bid prices in tenders to gain market share. These lower profit margins necessitate ‘robust risk management and project management expertise for delivering the contract’⁸. These same lower profit margins preclude retaining such engineering expertise as cost prohibitive.

Again, it is evident that this contractor, relatively new in the renewables sector, with an aggressive growth and risk appetite:

• assumed almost every possible engineering, procurement and construction in large scale solar projects, including the notorious challenge of grid connection, AEMO compliance, access to properties and changes in law;
• was unaware of its true financial position, lacked adequate project controls, chasing exponentially larger projects in the hope of surviving major delays, particularly on those solar projects, including as to that gird connection risk; and
• was insolvent prior to its entry into administration, only months after a major capital raise⁹.

The list is endless – Probuild, Clough and Forge all faced similar issues leading to their insolvency.

Risk allocation is broken

We know that top-down risk allocation based on a ‘one size fits all’ delivery model does not work. The perceived certainty of a ‘lump sum’ as ‘bankable’ is inevitably illusory.

In circumstances where:

• we understand engineering risks (including known unknowns) on a project;
• we have the tools to model aspects of projects on an unprecedented scale;
• we can assess most project risks and weigh them as ones to assume, pass down, insure or refuse;
• we understand legal risks; and
• we have a spectrum of contract delivery models and forms of project structures from relational or collaborative models to harsher or simpler pass through.

For too long, on an increasing, if not unprecedented scale, it has become the norm for a head contractor on a major infrastructure project to accept super-normal risks and pass it downstream. It has become a part of the culture in construction to accept big, often unknown and/or unquantifiable risks if the value of the project is large enough.

As advisors, on some of the largest and most innovative projects in Australia, too often we simply accept:

• major projects involving entirely speculative bid costs;
• design risk, even when the ultimate project outcome is in a state of flux (e.g. the various stages of the NBN Project – largely delivered in lump sum tranches);
• allocation of site risk, sometimes even sites unseen without reliance documents, on major infrastructure projects (e.g. look at the Sydney Light Rail – no one knew precisely what lay under the City of Sydney); and
• margins as little as 2-3 percent with little scope for contingency.

It is not good enough as construction lawyers to hide behind the shield that accepting a risk is ‘market’. Saying ‘it’s market’ is saying another poorly advised contractor is likely to assume the same irrational, unquantified and poorly understood risk.

This phenomenon is similar to the plight of a recidivist criminal. A criminal that has been incarcerated lacks the tools to function back in society so reoffends, often a worse crime, in a downward spiral. In criminology, there is noticeable disparity between criminals and non-criminals. Firstly, education reduces crime. Secondly, education impacts the personality traits which are associated with crime. Indeed, a study in Western Australia highlighted that even education during incarceration tangibly reduced recidivism¹⁰. It is worse than recidivism. The risk appetite in the construction industry is deeply embedded across all project participants. It has become a behavioural norm over decades – if not longer – despite our knowledge of such risks resulting in project failures and contractor insolvencies.

We also know that management and delivery of projects adopting traditional adversarial approaches do not work.

‘Literature relating to the management of mega infrastructure projects suggests that traditional project management, which has been described as reductionist and mechanistic, is not suited to the management of mega infrastructure projects due to the size, scale, pace, levels of complexity and uncertainty that these mega infrastructure projects involve.’¹¹

The adoption of draconian one-sided contracts fosters an adversarial approach to project delivery which results in simple pass through and hard administration of contracts which result in downstream insolvency.

So, what can be done?

Don’t start with the end in mind

In major projects, government and the industry need to recalibrate what is a ‘good project outcome’.

Project sponsors should not be focussed on lump sum ‘on time, on budget’ models predicated on the fallacy that what a completed mega-project will be is known from commencement.

Where government is delivering a mega-project, there needs to be transparency and education to adopt contract delivery models which incentivise:

• upskilling our limited labour pool in Australia;
• fostering a culture of innovation and excellence;
• focussing on improving diversity in the industry; and
• supporting mental health initiatives for a more resilient industry.

Many of these are intangibles – but all contribute to better governance and drivers which the public purse can support. Far from altruism, taken on a broader projects perspective, the outcomes will be better for all stakeholders leading to a more sustainable industry.

More design

Too often, contracts on mega-projects are entered into as if the project outcome were certain from the outset. Rather than a pursuit of illusory ‘cost certainty’ – more, smaller design packages, including on a competitive and paid basis, will allow more local participation in addition to better project outcomes.

Progression of detailed design prior to major construction contracts being awarded will improve productivity and support a more sustainable industry. Indeed, longer design periods incentivise innovation and value engineering in a tangible way where project participants can afford to engage in more detailed and rigorous analysis of project concepts – rather than focussing on the cheapest lump sum to meet the minimum required of a contract.

Too often projects are let on a lump sum basis, where the concept or project outcome is so ill defined that the contractor faces, at best, an uncertain scope with open ended risks.

Balanced risk allocation

Rethinking traditional risk allocation in mega-projects is critical to preventing major project insolvency. The adoption of more balanced and collaborative project delivery models by government will lead to better project outcomes for all project stakeholders.

Further, why should government engage superintendents or principal’s representatives on the basis of striking out good faith or reasonable obligations in standard form contracts? How does this foster trust or collaboration between industry participants?

We need to go back to common sense – where a giga-project is being modelled, adopting as a starting point the Abrahamson Principles, such that a risk is only allocated to a party if:

• ‘the risk is within a party’s control;

• the party can transfer the risk, for example, through insurance, and it is most economically beneficial to deal with the risk in this fashion;

• the preponderant economic benefit of controlling the risk lies with the party in question;

• to place the risk upon the party in question is in the interests of efficiency, including planning, incentive and innovation; and/or

• the risk eventuates, the loss falls on that party in the first instance and if it is not practicable, or there is no reason under the above principles, to cause expense and uncertainty by and uncertainty by attempting to transfer the loss to another.’¹²

Exploring options to share risk and/or to incentivise contract strategies and models which facilitate joint management of risk by all project participants. The early success for Sydney Water in adopting the NEC4 suite of contracts and their Partnering for Success program is one example of more collaborative contracting models creating a more integrated project delivery framework for major infrastructure¹³.

This is not to say NEC4 is a panacea to all giga-project delivery models – rather, this example is used to highlight a model which is at the very least underutilised in public infrastructure. Similarly, in some instances, the adoption of each contractor involvement models can enable a contractor to be involved at an early stage of a project, without the confines of a lump sum fixed price as the project outcomes and concept are considered and developed.

Inflation

In the current market conditions, global uncertainty means there will be ongoing inflation and economic uncertainty.

If we accept that rise and fall was the norm until the early 2000s, in circumstances where we will have inflation for at least the medium term, there is no rational basis for not adopting sensible rise and fall provisions on major long term projects – particularly where a project sponsor is a public body. Such provisions can be applied to labour and materials in the current market.

Post COVID – how can it be acceptable for government or financiers to accept a head contractor accepting risk on long term projects for rise and fall in the face of known long term inflationary pressures? This was the norm until the early 2000s – we need to go back to some of those tried and true provisions.

Skills to pay the bills

Compounding the impact of inflation, it’s no secret that the Australian construction industry has faced an ongoing and acute skills shortage over the past few years.

Inflationary concerns have also been part of the rationale, however questionable, from omitting skilled labour from fast-track visa processes in Australia.

‘Infrastructure Australia …warned that demand for workers on projects was expected to be about 48 per cent higher than supply over the next three years and that one-third of jobs advertised could remain unfilled, highlighting the construction industry’s poor record on attracting women¹⁴.

The obvious solution is to improve the proportion of women in the industry – from trades to engineering and project management, the under-representation of women exacerbates what is already a gross undersupply of labour. This is a long term issue.

The success of companies like Roberts Co¹⁵ with five-day work weeks/programs, more flexible working arrangements, and support for mental health initiatives, has led to better retention of talent and a greater diversity of participation in the sector. There is a lot more to be done. In circumstances where everyone knows there is a serious shortage of skilled labour, it is a time to revisit simply having a principal putting labour risk solely on a head contractor. There are various risk sharing models available for project participants to share such risk.

Productivity

Productivity in construction projects has gone backwards over the past three decades in Australia¹⁶.

‘If we cannot fix construction’s productivity problem, we will soon be unable to deliver all the housing and infrastructure Australia needs to accommodate its growing population, not to mention the new energy assets required to meet our decarbonisation commitments’¹⁷.

The Australian Constructors Association has produced a 10-year National Construction Strategy with many pragmatic recommendations which address many of the same issues which have caused contractor insolvency – as well as addressing improved productivity, including:

• optimisation and harmonisation of procurement by government bodies;
• adoption of digital technologies;
• improving industry skills;
• increased governance; and
• improving reporting and monitoring.

The industry has made numerous submissions that such practical steps, including:

• a move back to standardised contracts;
• sensible risk allocation;
• reliance on principal supplied information;
• integrated project delivery;
• improved workplace practices; and
• incentivising innovation,

will all assist in improving productivity – which has been a contributing factor to much of the recent contractor insolvency.

Conclusion

‘If you can make one heap of all your winnings

And risk it on one turn of pitch-and-toss,

And lose, and start again at your beginnings

And never breathe a word about your loss’¹⁸

We romanticise the gambler – but Kipling’s words, whilst poetic, have no place in the structuring, contracts or delivery of major projects.

Analysis of mega-project failures highlights systemic long term industry norms which are deeply entrenched. As advisors and as an industry, we need to advocate more vocally for change – the alternative is more project failures and major contractor collapses.

It is heartening to see some government bodies adopting alternatives to hard lump sum project delivery structures – but this is not a solution in isolation, and this is a minority of project sponsors.

Pragmatic risk allocation and more opportunities for more design for longer periods will lead to innovation and better value for public infrastructure. Far from being altruistic, such mechanisms could improve productivity and ultimately give greater price certainty.

Breaking addiction is tough. As advisors, if a contract model is entirely unsuitable or a risk allocation framework is draconian, we need to highlight the benefits of different delivery structures¹⁹.

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¹ASIC Insolvency Data 1 July 2023 – 31 March 2024 (External Administrations) https://asic.gov.au/about-asic/news-centre/find-a-media-release/2024-releases/24-077mr-asic-insolvency-data-shows-increase-in-companies failing/#:~:text=Out%20of%20these%20external%20administrations,27.7%25%20and%2015.2%25%20respectively.

²Collins, B., 2012. Final Report of the Independent Inquiry into Construction Industry Insolvency in NSW Sydney: NSW Government.

³Australian Constructors Association ‘All Risk, No Reward – Fixing the Building Industry’s Profitless Boom’ (July 2023) https://www.constructors.com.au/wp-content/uploads/2023/07/All-risk-no-reward_July-2023.pdf.

⁴https://classic.austlii.edu.au/au/journals/AJLH/2004/5.html#fn1.

⁵Coggins J, Teng B and Rameezdeen R (2016) Construction insolvency in Australia: reining in the beast, 16(3) Construction Economics and Building 38-56.

⁶Above n5 at 38.

⁷Deloitte Report to Creditors pursuant to s75-225 of Insolvency Practice Rules (Corporations) Lloyd Group Pty Ltd and related entities (May 2023).

⁸https://bondadviser.com.au/news-and-insights/market-commentary/case-study/rcr-tomlinson-a-lesson-in-project-risk/.

⁹https://www.afr.com/companies/infrastructure/rcr-tomlinson-insolvent-weeks-before-administration-20200417-p54kqu#:~:text=RCR%20Tomlinson%2C%20the%20failed%20engineering,former%20directors%20breached%20their%20duties.

¹⁰Giles, M Study in prison reduces recidivism and welfare dependence: A case study from Western Australia 2005- 2010 Trends & Issues in Crime and Criminal Justice (2016) Issue 514 https://www.aic.gov.au/publications/tandi/tandi514.

¹¹Rollo, M Managing Mega Infrastructure Projects – Linking Theory with Practice (2020) USyd, Faculty of Engineering, School of Project Management.

¹²Abrahamson, M ‘Risk Management’ [1983] ICLR 241.

¹³https://www.sydneywater.com.au/about-us/our-suppliers/procurement-approach/partnering-for-success.html.

¹⁴Wiggins J, Migrants needed to plug infrastructure skills gap Australian Financial Review, 13 October 2021.

¹⁵https://au.roberts.co/news/project-5-a-weekend-for-every-worker-2/.

¹⁶Australian Constructors Association Nailing Construction Productivity (August 2023).

¹⁷Jon Davies, CEO, Australian Constructors Association, above n16.

¹⁸Kipling, R ‘Brother Square Toes’.

¹⁹An earlier version of this paper was previously presented at the Society of Construction Law’s National Conference ‘Trains, Cranes and Little Lanes’ in Melbourne on 13 – 15 June 2024. The earlier paper is published on the SOCLA Website’s Resources Section and is this revised paper is published with permission.