Peter Gracia unravels a tale of dubious accounting.
In June 2005 I wrote an article for Construction Manager entitled “Psst… Don’t Tell the Client – How to Fiddle Open-Book Accounting”, prompted by the veritable frenzy in the market to use open book contracts. Even at that time, the correlation between open book systems and best value and accountability was never clear to see.
Almost a decade later, when the market place is cut throat and sharp practice is prevalent, the public sector has made life a whole lot easier for mega-build main contractors by insisting on the use of the NEC3 Option C & D: Target Cost contracts. In sunny Wales, where I ply my trade as an adjudicator, claims consultant and procurement adviser, we have a series of framework agreements where NEC3 Option C is the contract of choice. But while NEC3 might be good for my business because of all the lovely disputes and arguments it generates – just get a roomful of adjudicators together and listen to what’s in their caseload – it’s not exactly helping the local economy.
So what’s the problem with NEC 3 Target Cost? The key issue is that main contractors often submit lever arch files of documentation that can swamp the client’s project manager. They’re supposed to submit applications based on what they’ve paid out to subcontractors and suppliers, but in fact, main contractors often present invoices, rather than receipts, which are two very different things. In a market where main contractors can often claim they’re entitled to “discounts” or “rebates”, the application might not relate to what’s flowing down to the supply chain and local economy.
Some main contractors can be even more creative in their accounting. Let’s say there’s a subcontractor involved in the redevelopment of a local town centre working for Mega Build main contractor and framework member. The subcontractor’s original works value is in the region of £2m. Having issued various payment certificates to the subcontractor, which go unpaid, resulting in it being cash-starved, Mega Build then insists the contract price has to be reduced by substantial sums.
Discussing the rebate
In addition, Mega Build calls the subcontractor in to discuss the “rebate” it was entitled to. Nothing too unusual so far, since the parties had originally talked about a rebate and often 2.5% is claimed for “early payment”, which really is a sour joke.
Mega Build starts by asking for 16%. After much discussion, it tells the subcontractor it will receive a cheque by the end of the week for an outstanding payment of some £300,000 – if it agrees to then write a cheque for £50,000 direct to a local rugby club.
A little unorthodox, but is this actually fraud? Let’s remember that Mega Build’s framework agreement uses the NEC3 Target Cost options. Under that Mega Build is entitled to apply for the price for works done to date, which is defined as including payments made to subcontractors.
If you are the cost consultants for the local authority client, you will note that Mega Build has included in its payment application copies of bank transfer payments it has issued to the subcontractor. If Mega Build can show you proof of its £300,000 payment to the subcontractor, surely that is good enough to allow Mega Build the money claimed, plus of course its fee on top?
Mega Build might well argue in the above scenario that it is entitled to the “rebate” agreed with the subcontractor and can ask the subcontractor to pay that money to whoever it chooses. It might even go so far as to argue this money is directly benefiting the local community by helping out the local rugby club. But Mega Build would certainly have some difficulty explaining why it has been paid the full whack by the local authority plus a fee on top!
But even if you catch them at this stage, they may still argue they have hit the target cost and so are entitled to a gain/pain share under NEC3 – thus exposing yet another angle of these abuse prone contracts. Main contractors can exploit the NEC3 payment system mid-way through the contract, then get another shot at the end when the gain/pain is applied. A case of jam today, and some more jam tomorrow!
No doubt the hospitality suite in Mega Build’s local rugby club has lots of smiling pictures of Mr Mega Build helping out the disadvantaged professional rugby players, but this does not build roads or schools or the hospitals the taxpayers think they are funding.
Here are the items I talked about back in 2005 as key areas for fiddling – and they’re still very much with us:
- Supply chain abuses: basically receiving a discount from key suppliers across a group of companies or even between companies in the same group which is divided up at the end of the year and unseen by the client. This should be a disallowed cost. Clients and project managers should look through Companies House records to find linked companies or ask the contractor to identify any such relationships in the tender.
- Subcontractor abuses: showing the client payment certificates then subsequently issuing pay less notices and reducing the actual amount paid over. So many permutations exist for abuse at this point it is impossible to list them all. Clients and project managers can try actually getting the subcontractors in the room without the main contractor – you will learn far more about what is actually happening than listening to most main contractors.
- Definitions of cost: make sure client and contractor are talking about the same thing. Particular difficulties arise where the contractor has to forecast elements of cost that might occur in a compensation event. This crystal ball approach is removed if lump sums and rates can be used (see below).
- Double counting of staff and resources: establish what should be in the fee or what is covered in a schedule of cost components (if used). If anyone has any sense using the NEC3 forms they will junk the schedule of cost components when assessing compensation events and adopt agreed rates and lump sums instead. In a rare moment of good sense the 2013 versions of NEC3 now allow the use of agreed rates and lump sums in assessing compensation events across the Main Options C, E and F rather than just the Main Option A.
There are lots of Mega Build companies throughout the UK whose life is made much easier by the use of abuse-prone and easily fiddled contracts like the NEC3. This situation is not helped by the continuous stream of positive reinforcement that NEC3 gets ie hype, via organisations funded by local government to promote best practice.
If you are a local authority with limited internal resources and no experience using these types of contract you are exposing yourself to high levels of risk by using such forms. Another contributory factor is that Mega Build is actually asked by the best practice groups to tell other unsuspecting clients what a marvellous job it has done – usually in the hospitality suite of Mega Build’s local rugby club!
Peter Gracia FCIOB is an adjudicator, claims consultant and procurement advisor. Visit www.graciaconsult.com for details
