The Construction Playbook underlines the importance of providing a fair return and reasonable payment terms for the construction industry, based on the fundamental principle 'that contracts should be profitable" for a market to be sustainable. It notes that unreasonable payment terms and unsustainable cost reductions 'can create a bias towards low quality and can increase the probability of contract failures'. An unreasonable approach to payment at any level of the supply chain undermines trust, collaboration and, ultimately, building safety.
As considered in Section 6.4, an open book ESI cost model protects supply chain profit and overheads by ringfencing them separate from other costs. These other costs are then open to analysis and agreement of the financial impact of improved safety and quality proposals while these are still being are built up into a fixed price or target price.
Dame Judith Hackitt's Independent Review: 'Payment terms within contracts (for example, retentions) can drive poor behaviours, by putting financial strain into the supply chain. For example, non-payment of invoices and consequent cash flow issues can cause subcontractors to substitute materials purely on price rather than value for money or suitability for purpose.' (Section 9.11, page 109) |
Team members need a clear understanding of what work attracts remuneration and what work is undertaken speculatively. The incentive of a pipeline of work is considered in Section 10 and may attract some speculative proposals for improved value. However, if a consultant or contractor can only expect to be paid if a project proceeds on site, then commercial logic dictates that its first priority will be to ensure that the project goes ahead rather than to provide objective advice on how to improve value.
CIRIA in 'Selecting Contractors by Value' recommended that payment provisions 'recognise all the contributions being made, and the related risks, responsibilities and rewards, particularly during project development'. Any pre-construction phase payment entitlements of a contractor or supply chain member should be clearly stated and not open to different interpretations. Collaborative relationships can quickly deteriorate into conflict if a team member considers it has been deprived of an agreed payment.
The Construction Playbook requires that 'Contracting authorities and suppliers should always pay their supply chain promptly'.
Payment security is essential to collaborative procurement, but manipulation of supply chain cashflow has often overridden other considerations. Payment abuse directly affects building safety because financial pressures can lead to shortcuts and compromises in quality. Poor payment practices are also a major barrier to collaborative working. Sir Michael Latham's 1993 report 'Trust and Money' made clear that a prerequisite to improving commercial relationships in the industry is trust, but that trust can only be achieved by providing greater security for payment.
Project bank accounts ('PBAs') enable supply chain members to be paid faster because monies do not have to cascade through different levels of contracting and because there is some protection of funds from upstream insolvencies. Since 2010, Government policy has been that PBAs must be used unless there are defined, compelling reasons not to use them, and this is reflected in the 2020 Construction Playbook.
The use of cash retentions can also interfere with cashflow and can undermine the principles on which collaborative relationships are based. Arguably, any collaborative relationship should exclude the use of cash retentions. If exceptional circumstances require a retention, then it should be held in an account ring-fenced by a trust arrangement. Alternatively, other forms of performance security such as a bank guarantee can ensure that funds are available for release to supply chain members or to rectify unattended, non-compliant work.