INSOLVENCY IN CONSTRUCTION FIRMS

INSOLVENCY IN CONSTRUCTION FIRMS

Insolvency may be broadly defined as an inability of a business entity to meet pending financial commitments. For a construction firm, such a situation creates conditions whereby a business entity is unable to fulfill its contractual obligations with regard to work-in-progress or creditors owing De Valence (1994.)

The term “insolvency” means the financial failure of individuals and companies and their position before and after the start of a formal insolvency procedure, Douglas, C. (1985).

Insolvency may also be described as the inability to pay one’s debt as and when they become due, Burnett, R. (1991). This means that if a creditor calls upon a debtor to pay his debts and there is insufficient cash to meet the payment, the creditor may take legal action for pay payment of such debt from the debtor.

There are indications to suggest that during times of adverse conditions, the occurrence of insolvent conditions seem to be on the increase. Whether such adverse conditions and mounting insolvencies are mutually exclusive remains a subject of debate. The occurrence of these financial failures seems to have adversely affected business concerns operating within the Nigeria civil engineering construction sector.

The term “insolvency” means the financial failure of individuals and companies and their position before and after the start of a formal insolvency procedure Fisk, E. R. (1997) . There are two different categories of insolvencies, namely short term insolvency and long term insolvency. The former means that there is a cash flow crisis where not enough money is coming in to meet a company’s outgoings and the latter means that the company is able to pay its debts as they fall due but its balance sheet shows a deficiency of assets over liabilities, Clough, R.H. and Sears, G. A. (1994).

Contractors in the building industry are known to have low profit margins, low fixed assets and low capital but high cash flow and high return on capital employed, Fisk, E. R. (1997). Financing of contractors is generated internally from positive cash flow and retained profits and externally from short term finance, which is usually an overdraft repayable on demand. The short term finance will be able to support items such as working capital, stock and work in progress.

However, for growth, there is a need for long term external finance in the form of equity investments and long term loans.

The unique nature of the construction industry has caused a large number of insolvencies each year [6]. Due to high interest rates and a generally poor economic climate, significant financial pressures are imposed on many companies in the construction industry. Companies with high levels of borrowing and an insufficient capital base are therefore forced into liquidation. The construction industry always ranks high among the annual number of liquidation. There are two

striking features of insolvency in the construction industry Hall G. (1992). Firstly, a fifth of the bankrupts were builders. Secondly, the building trade is the only sector that has displayed obvious vulnerability towards insolvency.

Two forms of insolvency exist as recognised by law, namely commercial and factual insolvency.

Commercial insolvency occurs where a business entity is unable to service its debts even though its assets may exceed its liabilities, whereas factual insolvency is where a firm’s liabilities exceeds its assets.

References

Burnett R.G (1991) Insolvency and the sub-contractor, Occasional Paper 48. Chartered

Clough, R.H. and Sears, G. A. (1994) Construction Contracting. (6th edition) John Wiley & Sons Inc., New York

De Valence (1994.)Douglas, C. (1985).Burnett, R. (1991).

Douglas, C.R. (1985) An Investigation into Some of the Major Problems Facing Small Building Firms, Unpublished B.Sc. Dissertation, University of Cape Town.

Fisk, E. R. (1997) Construction Project Administration. (5th edition) Prentice Hall, New Jersey.

Hall G. (1992) Reasons for Insolvency amongst Small Firms – Reviews and Fresh