Vicious CIRCLE

The fact that the issue exists and is becoming more and more serious is confirmed by the statistics. "In January this year, over ?5,000 debtors from the construction sector were listed on the overdue payment monitoring programme of the Soliditet Polska credit information agency while their total debt amounted to PLN 228 mln - 54 pct higher than in the same month last year," says Tomasz Starzyk of Soliditet Polska (Bisnode Group). The numbers do not lie - the situation of firms in the construction industry is deteriorating. "It is clear to see in the growing number of bankruptcies filed in the commercial courts: 46 companies went bankrupt in Q1 this year, which is 44 pct than in Q1 2011," comments Tomasz Starzyk. Even though the situation mainly concerns small companies rendering services to bigger entities, we are faced with a general 'breathlessness' of the whole sector. According to Korporacja Ubezpieczeń Kredytów Eksportowych [the Export Credit Insurance [Corporation], the number of construction firms declaring bankruptcy is 2.68 pct of the total. A year earlier it was 2 pct. "Such situations tend to occur with public projects. There is an urgent need for deep, substantive and continuous control - throughout the whole duration of the project - to be carried out by a supervisory authority involved in the investment process. This could either be a project management company, its supervisory board or any other supervisory authority representing the public administration," insists Robert Nowak, spokesman of Imtech Polska.
Risky motorways
The case of Dolnośląskie Surowce Skalne (DDS), which has just filed for bankruptcy, is only one of many in the sector. DSS has informed us that the Chinese consortium Covec with whom it was building the A2 motorway owes it PLN 50 mln. This is only one of many examples of cashflow-related problems in the road construction industry. Urszula Nelken, spokeswoman of the General Directorate of National Roads and Motorways (GDDKiA), explains that payment gridlocks are arising between subcontractors and their service providers and suppliers. "GDDKiA pays its liabilities punctually, so general contractors receive their payments on time. According to article 647.1 of the civil code, we are also a payer to subcontractors fulfilling the conditions stipulated in the article, i.e. only to the construction companies which have been registered and approved as subcontractors. In the case where a general contractor fails to settle its liabilities, GDDKiA is obliged to do this instead," explains Urszula Nelken. Polimex-Mostostal sees this differently and considers delayed payments from GDDKiA to be the main issue. "We are struggling with the problem of the excessively long payment periods of GDDKiA with regard to completed or additional work, which is necessary in the case of road contracts. This concerns payments in the range of hundreds of millions of złoty, which impacts financial liquidity and makes it harder to pay suppliers and subcontractors on time. Payment gridlocks arise and the profitability and financial results of the companies involved in road projects suffer," says Konrad Jaskóła, president of the management board of Polimex-Mostostal. And it is service providers and suppliers who suffer most. You do not need to wait long to see the results. As Robert Nowak points out: "Payment delays can result in the bankruptcies of companies that do not have a strong financial base. They could also force a construction company that wants to stay on the market to implement internal solutions to enable it to function properly, even when faced with such delays in payments."
To pay or not to pay?
The constructors of the stadiums in Warsaw and Wrocław are also struggling with problems related to regular cashflow. Hydrobudowa Polska, part of the PBG group and the general contractor of the National Stadium, reached a settlement in April this year, under which the company is to settle payments towards its subcontractors. Krzysztof Woch, the investor relations director of Hydrobudowa Polska, points out that payment gridlocks result from the fact that the ordering party (the National Sports Centre) commissions a great deal of additional and replacement work related to design changes, the settlement of which takes place after many months. Consequently the cost of financing this work is borne by the contractor, which of course has had a negative influence on the profitability of the work on the project. "The net value of the additional work already settled [on April 6th 2012] amounts to nearly PLN 130 mln. We are getting close to reaching an agreement on remuneration for the next phase of the project, which we have priced at around ?PLN 20 mln. However, a considerable amount of work commissioned by the ordering party is still waiting for a financial settlement. For comparison, the value of the main contract amounts to PLN 1.235 bln, which shows that the scale of changes introduced during its execution was very significant," adds Krzysztof Woch. However, an announcement published by the National Sports Centre (NCS) states that it is not responsible for the delays and instead that it is the general contractor that has problems with settling its payments. "Since concluding the contract for the construction of the National Stadium in Warsaw, the NCS has been punctual in settling its liabilities with the consortium of the general contractor, which has already received 95 pct of the basic contract value. In spite of this, the consortium has still had problems settling payments to its subcontractors. In order to assist all the companies the consortium owes money to, the NCS has decided to agree to a deal to ensure that funds transferred onto the account of the general contractor go directly to the subcontractors. On the day of signing the agreement, April 6th, the money was transferred into a special account held by the general contractor," states Robert Wojtaś, president of the management board of the National Sports Centre. A representative of Hydrobudowa Polska confirms that the signed settlement has cleared payment gridlocks. According to the agreement, the ordering party has transferred the final 5 pct of the remuneration for the basic contract (a gross amount of over PLN 72 mln). "The amount was immediately transferred to subcontractors. The settlement also provides for prompt remuneration for the next agreed stage of additional work (a gross sum of PLN 29 mln) and the acceleration of payments related to other outstanding issues," outlines Krzysztof Woch.
Payment gridlocks are also a nightmare for those working on the construction of Wrocław City Stadium. Imtech, which is installing internal fittings for the venue, has withdrawn from its contract with the general contractor - Max Bögl. It accuses the company of deferring payments of invoiced and due liabilities. "Such situations impact upon our company's operations quite seriously. Still, we can cope with payment delays - mainly because of our solid financial basis - but we cannot afford to act as a secondary investor in any project we participate in. And this is what such situations lead to - Imtech invests its own capital (through payments to its subcontractors) while constantly waiting for payments from general contractors that unlawfully withhold them," claims Robert Nowak. However, according to Max Bögl, Imtech Polska's current due invoices were paid on March 13th 2012 and April 3rd 2012. To date Max Bögl has secured an amount of PLN 2.6 mln to cover the claims of subcontractors of Imtech Polska, which will be paid if Imtech Polska fails to present a complete clearance of accounts with its subcontractors. Max Bögl Polska does not exclude making direct payments of due amounts to the subcontractors of Imtech Polska.
The problem exists, but no-one's to blame
Where do the problems with the payments of ?liabilities originate from? Price-based competition, say the experts. "The deteriorating economic situation in the construction industry and the expected lower number of contracts from the public sector are forcing construction firms to compete on a price basis in tender procedures. This is exacerbated by the prevailing sense of uncertainty on the financial markets, the approaching end of most of the Euro 2012 projects, the necessity to cut public investment, and the lack of a clear revival of projects in the private sector," explains Tomasz Starzyk. No company officially admits to resorting to a policy of deliberate invoice payment delays; however, experts point out that this is quite a popular phenomenon. "It seems that companies, particularly those in a difficult situation on the market, save themselves by delaying payments of their outstanding amounts to contractors and by hardening their stances in negotiations with subcontractors and material suppliers - because this has a direct influence on lowering contract execution costs. Due to the lower number of tenders, the price competition for new contracts is going to be very tough, which will be harmful to all the participants of investment processes," comments Tomasz Starzyk. Konrad Jaskóła points to another reason. He claims that the increasing payment gridlocks result from the fact that local authorities are imposing payment terms upon construction firms in tender procedures so that a large amount of work is settled only after completing the whole job. Consequently construction companies are forced to finance projects while they are being carried out. This has a negative effect on the financial condition of contractors, particularly in the case of long-term and costly construction projects. Agnieszka Marcinkowska, chief analysis and forecast specialist in KUKE, feels that: "One of the main reasons for construction companies' insolvencies is the involvement of a number of companies in infrastructure projects that are unprofitable for them. It is a segment characterised by relatively low margins. Excessive payment periods, sometimes of as many as 100 days, have sometimes forced the firms to finance the construction work themselves, often going beyond their financial capabilities. For big companies this only means that their financial results are lowered, but for smaller companies this can be the proverbial 'nail in the coffin'.
What about the CEE?
In many investors' minds, Poland is the darling of the CEE, with much of the rest of the region immersed in economic problems of its own. The dissimilarity could not be starker than in Hungary, where the construction market remains depressed. According to Dr Géza Katona of Katona & Partners Attorneys at Law, the main problem faced by the industry is the lack of bank credit. To make matters worse, as Géza Katona explains: "Huge amounts of debt have accumulated in the construction line chain due to the unwillingness of the state sector to pay general contractors. This is a result of the lack of public funds for the investments caused by government's restrictive financial policies." In Romania the problems have mainly been caused by the collapse of the housing boom. According to Mihai Cuc, the managing partner of law firm Enescu & Cuc, around half of all residential developers in Romania have been declared bankrupt in the last two years. The banks, being the preferential creditors, have reclaimed most of the funds that bankrupt companies are left with, frequently leaving others with nothing. Surprisingly, general contractors have not suffered too badly. "In practice the beneficiary pays in advance, at least for the materials. The general contractor incurs some losses, but not enough to be pushed into bankruptcy," says Mr Cuc, explaining that many of them have other projects (often from the public sector) from which they can earn enough to get by. Again, as in Poland it is the subcontractors that suffer. Litigation is both expensive (with a large part of the cost being taxation) and slow. On average it takes 1.5-2 years to obtain a court ruling, and such a ruling is no guarantee that the debt will be paid off. Besides, many subcontractors cannot wait that long. The problem is quite substantial. Last year, according to figures released by Coface Romania, 3,548 bankruptcies were recorded in the construction industry, representing over 15 pct of all those going bust. Indeed, in Romania the construction sector has the dubious distinction of being the industry with the third highest number of bankruptcies, behind retail and logistics. In the Czech Republic the situation seems no better. According to David Šimonek, who heads Baker & McKenzie's real estate and environment practice group: "The building industry is still facing a crisis. This is mainly caused by the total lack of public contracts, namely in the area of infrastructure projects." One example of this is provided by the Czech subsidiary of international construction firm Eiffage, which is currently mired in bankruptcy proceedings. However, Mr Šimonek believes that Eiffage is an exceptional case and that other large constructors will survive, mainly by taking on smaller contracts. This, in turn, has resulted in fewer such contracts being available for the small firms that were once dependent on such work, "and consequently, the threat of insolvency is more urgent with these smaller companies," he says. In one sense, the problems besetting the Czech Republic are similar to those that have arisen in Poland, as many of them stem from the public sector. According to Václav Matyáš, the president of the Czech Association of Building Entrepreneurs (SPS), "the largest debtor is the state."
Even though it would be unreasonable to demand firms in the construction sector to be the judges in their own cases, the problems with payment delays require explanation and cooperation between the companies. Otherwise the results of the sector will continue to worsen and the quality of projects will also suffer.
Agnieszka Marcinkowska
chief analysis,
forecast specialist at KUKE

Bankruptcies in the construction sector
Despite relatively good results in construction and assembly production, which includes project-related and renovation work (a 12 pct increase in February compared to a year earlier), there has been a gradual increase in bankruptcies in the construction industry. During the first three months of the year the ratio of bankruptcies to the total number of companies operating on this market fluctuated in the range of 2.62-2.68 pct. Two years ago it was only 0.80-0.85 pct. A total of 38 companies filed for bankruptcy in the first quarter - 31 pct more of them than in Q4 2011, when 29 bankruptcies were registered, and 15 pct more than in Q1 last year when 33 companies went under. The growth mainly results from the ?tough competition on the market and, in the case of smaller firms, the lack of adequate financial resources for doing business according to the current applied market principles for financing construction projects from the public purse and EU funds.