Late government payments threaten survival of SA’s construction sector

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JEREMY MAGGS: South Africa’s construction sector says late payments are choking the life out of the industry, contractors warning that projects are increasingly being financed out of their own pockets as payment cycles stretch well beyond the legally required 30 days, in some cases reaching 75 or more.

Now, with razor thin margins, a shrinking pool of major contractors, rising legal complexity in project contracts, and growing competition from international firms, industry leaders say the sector is under intense strain just as government is pushing a massive infrastructure drive. Let’s discuss this in a little more detail. I’m in conversation now with Euan Massey, director at construction law specialists, MDA Attorneys. Euan, welcome to you. Let’s start with the core issue, how serious have payment delays become in the sector right now?

EUAN MASSEY: Thanks, Jeremy. Our business, obviously, we represent a number of major contractors in this sector, and we’re at the coalface of a number of these particular payment issues. It’s a real problem, Jeremy.

There’s legislation in place. But unfortunately, particularly in the public sector, there’s large non-compliance with the legislation, and contractors are really left to their own devices to collect money and to be innovative in doing that.

So it’s a real issue, and one which is having a profound impact, particularly on what I would call the smaller-sized contractors, where they are unable to finance these larger projects for a prolonged period of time.

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JEREMY MAGGS: Euan, I want to talk about consequence in just a moment. But those payment cycles, as I referenced, 60, maybe even 75 days or more. Do you have a specific reason as to why this is happening?

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EUAN MASSEY: I just think it’s largely incompetence, Jeremy, to be honest with you.

It’s the administration of payments in a number of government departments that just doesn’t take place within these periods of time.

JEREMY MAGGS: So for contractors and particularly smaller ones, as you referenced, and operating on very thin margins, maybe just explain to me what a delay like this actually means in practical terms.

EUAN MASSEY: What it means is that whilst you’re busy with the project that you’re executing, you can’t buy materials, you can’t pay your subcontractors, you can’t pay your labour in some instances. That brings these projects to a grinding halt. You only need to take a look around in most of our major cities, Jeremy, to see projects which have been running, never mind years, but decades.

I don’t know if you’re based in Johannesburg, Jeremy, I presume you are.

But we only need to look at the BRT (Bus Rapid Transit) here in Johannesburg. It’s been built for well over a decade. It still isn’t finished.

JEREMY MAGGS: If that’s the case, do you think that the delays could impact on safety and quality?

EUAN MASSEY: Yes. I think that most contractors would not compromise safety. There are safety issues, as we’ve seen recently. But most certainly on quality, when people aren’t paid, the quality does drop off. That could be a real consequence of late payment.

JEREMY MAGGS: Some from the industry say that contractors are effectively financing public infrastructure projects themselves. That’s probably a fair description, but unacceptable, you would suggest.

EUAN MASSEY: Yes, completely unacceptable. Most contracting businesses tender in very competitive markets. As you said in the introduction, they have very low margins. It’s certainly not a reward at those margins to finance these projects the way they have to and they’re being required to.

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JEREMY MAGGS: Euan, if payments are this unreliable and patently nothing is getting better here, why are contractors still bidding for these projects?

EUAN MASSEY: Many of the contractors, obviously their business is contracting, and they contract both in the public and private sector. So it’s not all projects which are subject to these extensive delays, and there are still good margins to be made on certain projects. So if you are a contracting business and you have several projects, you’re making money on some and losing on others, and hopefully in the balance, everything is going to be okay.

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EPC contracts

JEREMY MAGGS: You mentioned the rise of something called an EPC contract, which as I understand it, shifts more risk onto the contractors themselves. What is that? Why and how is it changing the industry?

EUAN MASSEY: Jeremy, EPC stands for engineering, procurement and construction. Essentially what that means is that a contracting organisation is appointed to do everything. So there’s a concept which the employer needs – I require a water treatment plant, or I require a power station, and I want you to build it for me. Please go away, design it, engineer it, procure the entire thing, construct it, and essentially give me the keys to the front door when you’re done, and it must work.

It’s an own risk contracting strategy, but one which is very effective and one which I think has found favour for a number of reasons.

Firstly, it’s bankable. So for private investors, particularly in the renewable energy space, for example, where money is being lent by banks to build wind farms and solar farms, it’s a very good contracting strategy. But it’s also finding favour in government circles because it transfers much of the risk onto the contractors.

Now, it’s not a matter of that risk being transferred unfairly, but more a learning curve for the local contractors to go through to adapt to this kind of contracting model, to ensure that they adequately price for the unforeseen risk that they are taking on. What we’ve seen is that a number of contractors, particularly in the renewable energy space, have underestimated that risk with fairly severe consequences.

JEREMY MAGGS: Let me move on to another issue, and that’s the growing presence, Euan, of international contractors winning major projects. Are local firms now being crowded out?

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EUAN MASSEY: To a degree, yes, Jeremy. There’s increased international competition, particularly from China, but also from other countries, from Europe, from India. Competition is good. But I think that some of the key projects which are being let at the moment, there is definitely a preference from government in particular to look abroad as opposed to investigating what’s available locally, and if we don’t have the expertise locally, to try and put in place plans to grow that expertise and make sure that we have it. There are several examples here.

Some of the key projects and contracts for the Sanral (South African National Roads Agency) N2 upgrades have gone to foreign firms.

Also, the new generation versus transmission projects where the transmission lines are being constructed by the new company that’s been formed by Eskom. A lot of that work is earmarked to go to international contractors.

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JEREMY MAGGS: Let me end with this. If government, Euan, is serious about its infrastructure pipeline, and one hopes that it is, is there a specific reform or reforms needed around payment and contracting that might just actually result in some kind of stabilisation?

EUAN MASSEY: Yes, I think the answer, Jeremy was actually put up a number of years ago by the Construction Industry Development Board, where they published a set of proposed regulations called the Prompt Payment Regulations, which provided for regulated payment terms. If payment was not made, there was a very quick dispute resolution mechanism which could be enforced by contractors to secure payment.

Something along those lines would need to be introduced. We’ve seen it in a number of other countries, and it works with great success. So in the UK, in Australia and many other countries around the world, they have similar regulations, and I think we need something like that here locally.

JEREMY MAGGS: Euan Massey, director of construction law specialists, MDA Attorneys, thank you very much.

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