Project bank accounts

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With the old adage “Cash is King” truer than ever before, the use of project bank accounts has in recent years been promoted by the Office of Government Commerce as one of the main solutions to the problem of poor payment practices within the construction industry.  However, take up of these has been slow and there are potential problems to be aware of before considering their use as financial security for a project. 

 

There have been many attempts in the past few years to solve the age-old problem of poor payment practices within the construction industry.  Legislation such as the “Construction Act” 1996 and the Late Payment of Commercial Debts (Interest) Act 1998 have both been implemented and had an impact, but have not been enough to solve the problem. 

 

In 2007, the Office of Government Commerce produced a guide to best fair payment practices for construction procurement, designed to help save the public sector up to £750million.  Amongst other measures, the chief recommendation was to try to introduce project bank accounts wherever “practical and cost effective”.  As with most public sector measures, the intention being that the Government’s use of project bank accounts would pave the way for their more widespread use in the private sector. 

 

However, despite some use on public sector initiatives, the results of a recent JCT industry-wide consultation (published on 22 January 2010) on the use of project bank accounts has found that only 5% of respondents have ever been involved in a project using a project bank account, plus respondents thought that only 30% of projects are likely to use them in the future.

 

How Project Bank Accounts Work

The ethos behind the use of a project bank account is to establish a fair payment system which ensures the contractor and key members of the supply chain receive prompt payment for monies that are rightfully due to them through the payment mechanism in their construction contracts.  The idea is that the bank account is set up jointly by the client and the contractor through an agreement similar to a trust deed, under which all payments are authorised to be made by the bank. 

 

With the money held independently in trust by the bank as a third party, there is increased transparency over cash flow.  The employer can see exactly when and where monies are being transferred to, and, with payments able to be made direct to members of the supply chain rather than through the main contractor, monies can no longer sit for months in the main contractor’s account without finding its way down the supply chain. 

 

This gives assurance to the contractor and the supply chain that payments will be made promptly, thereby improving trust and collaboration (leading to fewer disputes, better value for money and better productivity) and resulting in further savings over time in terms of the overheads associated with debt collection and administration.  In addition, their use should, in theory at least, avoid the need for parties to price for insolvency risk, thereby providing a cost benefit to the project and to the client. 

 

A further advantage of project bank accounts is that the supply chain is protected from insolvency of the main contractor, since the monies are ring-fenced from the main contractor’s third party creditors and payments to the supply chain can be made directly from the bank account.

 

Based on these general principles, a number of drafting bodies have produced standard form Project Bank Account Agreements, including the NEC, JCT and PPC 2000 bodies.  Indeed, part of the JCT consultation referenced above was designed to gain feedback on their recently published standard form agreement. 

 

Problems Still to Resolve

Whilst the principles behind the use of project bank accounts, particularly in the current economic climate, appear to offer many advantages, it seems as though there are still a few problems left to resolve before their use becomes widespread practice. 

 

The main criticism is that project bank accounts do not provide any solution to the problem of client insolvency, since the amount paid by the client into the project bank account at any one time is only the amount that is certified as due to the contractor and supply chain already.  As such, a project bank account only really constitutes a payment mechanism, not a full security package, meaning that members of the supply chain still need to consider more traditional forms of security (such as payment guarantees or vesting certificates) in addition to the use of a project bank account. 

 

To resolve this, many question why a client cannot simply place the whole contract sum within the bank account right from the beginning (which provides much better security), but the problem with this is that a client will often be reluctant to tie up so much cash for a long period of time.  If a client is agreeable to this, however, it is possible to agree a bespoke escrow arrangement between the parties.

 

The project bank account structure has also been criticised because the trust arrangements are only designed to protect key parties within the project (the parties who are signatories to the trust deed).  There is a wide belief that the project bank account should be more inclusive of other parties (for example, sub-contractors with small value work packages) as well as the main parties involved in the works. 

 

Other common problems include the additional costs of setting up and maintaining the bank account (which should be researched carefully), a fear over the financial solvency of the banks holding the money (a relatively new problem following the recent general economic anxieties) and a perception that clients and contractors simply do not want to relinquish control over the payment mechanism to be used (which will improve as the use of project bank accounts becomes more familiar within the industry). 

 

Conclusion

There is little doubt that the theory behind the use of project bank accounts is a good one in terms of trying to improve the payment problems within the industry.  The introduction of standard forms will make access to project bank accounts easier. 

 

James Lee

Cripps Harries Hall LLP

March 2010