Urszula Altson – Welcome to a special addition of Corrs High Vis. My name is Urszula Altson, I am a Special Counsel in the Projects Group and it is my pleasure to be facilitating today’s podcast. Let me start by introducing Joe Barbaro. Joe is a partner in our Projects Practice Group, he has a diverse practice and advises government and private sector clients. Joe has experience in both transactional work, dispute work and everything in between. Today we will reflect on the last 12 months and discuss the landscape in which the infrastructure and construction industry finds itself in. So, Joe could you tell us about the most significant challenges in the construction industry that you have observed over the past year?
Joseph Barbaro – Well thanks Urszula. It’s definitely been pretty interesting and exciting time to be an advisor in the project space. 2023 has seen us move with the sort of clear 12 months post COVID and lockdowns to get a little bit more normality I guess into our lives and into the way we are doing business but at the same time I think there definitely are some hangovers and legacy issues from that COVID experience.
I think if I was to look at the key areas of challenge and activity in the sector the market is in transition, there is a considerable shift in focussing where expenditure is being outlaid when it comes to infrastructure, so after a very heavy time with the focus – particularly say in Victoria and in states like New South Wales – on transport, particularly rail, we are seeking that a number of projects are coming towards their conclusion and now there is a very heavy shift in investment into the energy sector as well as a desire, I am not sure that the expenditure has yet occurred but there is definitely a desire to focus a lot more on the housing sector as well which presents some interesting challenges but there’s clearly a dire need in both of those spaces to support the community’s needs. That’s all been within what is a very challenging market generally in terms of economic risk and with shifts in activity there comes uncertainty in terms of where work will come from, while at the same time you get new competition around future opportunity. So it’s a very dynamic market but a market that’s been impacted by a range of pressures.
That hangover I mentioned earlier is certainly still quite relevant as I suppose the impact and scarcity of resources (whether they be human resources, whether they be materials etc) continues to be a key issue and I certainly look forward to discussing where we think that’s at.
There’s definitely a change also in the governments approach to infrastructure spend but also regulation – there’s been a number of important initiatives both being implemented as well as things we can see coming in the pipeline which will make a difference in our space. Then I think the last thing is really to recognise that because it is such a dynamic market risk assessment and the approach to managing risk has got to be multifaceted. You cannot sort of set and forget, things are not just going to go the way they’ve always gone and it needs to be a more dynamic response.
Urszula Altson – Thanks Joe, and what about the commercial challenges that you’ve been seeing?
Joeseph Barbaro – There are a number of areas of challenge so certainly supply chain uncertainty was something that featured very heavily in 2021/2022 and continued to play its part in 2023.
Certainly, my sense is that that is improving and there’s a greater confidence around understanding supply chain, around capacity, and the ability to actually plan things. The same could be said in terms of a very difficult market when it comes to pricing and inflation.
I’d be sharing no particular secret to say that prices have been escalating and particularly certain materials have been very difficult for the sector whether it be steel or even timber at points in time for the housing sector. Our sense from the data, but also anecdotally from our clients across the sector, is that that is abating. That’s not to say the prices are necessarily coming down but rather that they are more predictable.
In terms of COVID-19 direct impacts, I think the market has broadly settled there in terms of the way it both contracts and attempts to allocate risk for COVID-19 issues. COVID-19 still features very much as a risk that needs to be managed and definitely owners and principals expect contractors to deal with it. In terms of being sort of a top issue I think it’s coming off the list because the way in which we address it seems to be better understood and I think there’s less of an immediate fear that something dramatic is going to happen which is uncontrollable. But I think something we might talk a little bit later is the fact that COVID-19 very much highlighted for contractors and suppliers, the real challenge of dealing with things outside of your control, and I think the expectation increasingly is that whether its COVID-19 or anything else we need to do better there.
Extreme weather events – there’s been plenty of them and there continue to be more of them. I know we’re coming into El Niño, there’s issues around bushfires, at the same time you have floods. I think, generally, even contracting for the risk sharing of the one in a 100-year storms seems to be shifting and you know we’re talking about the one in 20 year or the one in 30 year storms so I think there is definitely again an appreciation that these extreme weather events are occurring more frequently with greater impact and that’s impacting the risk allocation across the market.
I mentioned earlier supply chain, I think linked to that is labour shortages, whether it be through migration and the skills shortages, whether it be continued competition between projects and across the states for the same resources to deliver the same types of projects and I don’t know that that’s necessarily going to abate. Even though the competition perhaps for transport resources might abate slightly there is a huge pipeline of transmission infrastructure that needs to be built, by way of an example. Where is Australia going to get all of those resources to do what needs to be done across our country.
Insolvency continues to play a big part in exposure for participants and I think, you know, another interesting thing I see is a trend is that as the scale of projects continues to increase our clients are participating in groups, whether it be on the owner side in terms of splitting risk, and joint venturing, or equally on the contractor side, the capacity to both take whole large projects to market but also for contractors and suppliers to want to take on that risk, is definitely a different mindset and I think those who have been burnt in the last year or two years are increasing looking at ways to mitigate their risk.
Urszula Altson – We’ve seen a lot of media attention on insolvency in construction. What have you observed in your practice?
Joeseph Barbaro – In terms of insolvency the data suggests that construction insolvency is at an all-time high. In terms of overall insolvencies, there’s not been the huge avalanche that was perhaps predicted more generally across the economy coming out of COVID and there are probably a number of reasons for that, including money still going into the system through government programs.
There was also the ipso facto law changes which supported a number of businesses who might otherwise have been tipped into administration or beyond administration not being able to see out their contracts with clients. But I have definitely seen a significant increase in activity involving insolvency, particularly I’d say in the building sector more so than in the infrastructure sector.
I think the building sector has had tighter margins, has had greater competition for labour and materials compared to the infrastructure sector, or in a sense competing with the infrastructure sector, which has put a lot more pressure on those particular projects, and I think there’s a long history of a pipeline of fixed price contracts which has put a lot of contractors under pressure.
So we certainly have seen builders, an example of Porter Davis Homes, going into administration. But another interesting trend has been a number of development or development managers who have historically been contracted by major funds and owners to deliver developments for them in the building sector who have wrapped their risk and promised to deliver projects for the owners and the fund managers but very much relied on the ability to pass through all that risk to their contractors and as their contractors have strained or fallen over so too have a number of those developers. So we have certainly seen the sort of pass through model being put under a great deal of stress as the margins aren’t there.
Another, I suppose, observation that’s made is that perhaps even during COVID with the increase in housing prices, land that perhaps had been bought at a lower cost base earlier in the cycle allowed a number of developers to sort of hide some of their inefficiencies, inexperience and exposure to cost increases … [then] when they’ve gone onto their second and third development, as things have tightened up, it’s really exposed that they don’t have the margin at all for error that they’ve had in the past and so we’ve seen a number of stress points show up.
Urszula Altson – Thanks Joe. You also mentioned that there has been a change in the governments’ approach to infrastructure. Where has government spending been focussed?
Joeseph Barbaro – Looking at a national level there’s been a considerable focus across the states in the road, rail and social infrastructure space – but particularly road and rail – but looking at the projections from the commencement of 2023 onwards and I think we are actually experiencing this now there is a huge shift, in fact you’d almost say something beyond usual expectations in terms of the shift towards energy projects.
So out of a $600 billion dollar pipeline at a federal level from 2023 onwards, we’re talking almost 50% of that pipeline being focussed in energy projects, which you know would capture both some traditional energy projects but a lot of renewable energy projects and projects’ links to the infrastructure, such as transmission lines and energy hubs that need to go with it. So that skill set change is coming. And look, other interesting things that will impact the sector associated with energy projects is that they tend not to be located in our cities or proximate to our cities – so there’s a real interesting shift in where labour needs to be found and where the supply chain needs to move in order to service these projects.
They are usually regional and that will be a challenge for the Australian market, one which is already one of the most expensive markets to operate globally – doing work in a less popular and convenient way for those who are involved in it, I think will be an interesting challenge. Now that may work also to the advantage of sectors competing with energy, such as the housing sector once again in being able to support those particular projects without everyone flying off to major government infrastructure.
Urszula Altson – Joe could you tell us a little bit about current market conditions?
Joeseph Barbaro – As I mentioned earlier, I think we’ve definitely come off a period of dealing with much more unforeseen risks associated with COVID, which we’re probably all sick to death of talking about. [For example] for the first time, in certainly my lifetime of working, having the types of conditions imposed on business and work places have never been seen before in terms of full shutdowns and impacts on work forces.
Although interestingly the construction sector was well supported through that period in terms of being able to operate when others didn’t but it had immediate flow on pressures in terms of… things I observed for the first time in over 20 years I was actually looking at things like escalation clauses and price adjustments.
Validity periods for tenders and holding prices through the contracting chain were shortening right down and that sort of opportunity or expectation in fact that owners and principals often had of being able to sit on a price for a period of time was definitely wound back.
I certainly observe that through that trend one thing that is definitely playing a part in market conditions today is a more nuanced and alert contractor and supply chain that is not as prepared to take risks outside of their control that they have in the past. So while COVID brought that about, the types of things that we’re definitely seeing increasing push back on are assumption of risk for approvals, dealing with adjacent owners.
So therefore, the expectation that something which is a third party, that although you are experting and engaging with them, that third party can do things entirely out of your control even if you’ve done all the things you are expected to do and is now being moderated as a risk in contracts.
I think contractors have seen that increasingly through the lower margins when the costs went up but their prices were fixed that they need to be rightfully more assertive in aspects of their contracting. So I’d definitely say the pendulum’s sort of swinging back though it’s not as easy for the contractors to press their positions as it was perhaps at points in time through COVID in terms of pricing, time etc but I think it’s still a robust market which allows for fairer conversations around risk allocation than perhaps pre-COVID, I would say.
Urszula Altson – And what would you say the market response is to some of these conditions?
Joeseph Barbaro – Certainly, sort of building on my comment earlier that risk allocation is changing in a number of contracts, I think some other sort of broader picture issues is that the scale of projects and the risk profile is being managed by both sides, if I could call it [that], sort of the owners and developers and the contractors and suppliers by breaking up risk.
So, we’re definitely seeing more joint ventures at the top side. Particularly in new energy projects [where there] are multiple investors, but even in very large infrastructure and real estate projects, sharing the risk – you know – projects that are in the hundreds of millions or going into billions – joint venturing is a way to manage the balance sheet risk or to bring, you know, a stronger balance sheet to the table. But also the breaking up of projects into multiple packages.
Urszula Altson – So we saw that on the North East Link Project that was put to tender as one large package and there was not much appetite in the market for that, so it got broken up into a few smaller more manageable, still very large, but more manageable packages.
Joeseph Barbaro – Yes absolutely and so now you have a PPP package which interfaces with some very large alliance packages, I think recognising different responses from the market in terms of what they both see as acceptable risk but also the right sort of level of opportunity to gain out of a particular scale of project.
I think, interestingly, if we sort of talk about even the energy sector the contracting market is more dynamic I think than say traditional government infrastructure, where there’s a desire typically to have most of the risk wrapped up by a consortium or a contractor. A number of owners in the renewable space are recognising that the suppliers of technology for example or certain key equipment are not prepared to necessarily joint venture and wrap all responsibility for a deliverable and so its really falling back to a developer risk to let multiple contracts to manage the interface in order to bring these particular projects to market.
So, I think definitely multiple packages are an increasing trend. Whether in time as the market gets more comfortable with risk allocation and the types of projects and how easy they are or difficult they are to deliver whether the models will change over time I think that remains to be seen.
Urszula Altson – And I guess the key risk there with breaking up the packages is that interface risk.
Joeseph Barbaro – Yes precisely, so that sort of comfort zone – you get of one point of accountability – is taken back and you know there’s immediately at least the risk of the multiple participants pointing to each other if something goes wrong. But you know a smart, well-resourced owner/developer can very much manage those risks by working collaboratively with the supply chain, understanding those risks, investigating those risks and also putting the right people in their own team, working carefully through them. There’s also a great opportunity, I guess, in not paying a premium on every project we do by trying to sort of deliver what might be perceived as the easiest, most perfect risk allocation of wrapping everything up and expecting everyone to price things which, you know, might have a 1% to a 10% to a 50% chance of occurring. We can end up with a very expensive way of doing our procurements.
So I’m hopeful, actually, that that’s something that the market more generally takes up, a more progressive and assertive way, if you like, of actually contracting and managing risk in order not to just pay a premium for the sake of ease of contracting.
Urszula Altson – Thanks Joe. You mentioned earlier that we are seeing some more intervention through legislation and changes in law. Could you tell us what changes in law have been on your radar?
Joeseph Barbaro – There’s probably three big area in the last 12 months that have really come to the fore for me. The first one is very much in the building space and that’s in a sense the national system of building regulation and building reform which commenced in around 2020 from New South Wales – which I think is really the state that’s led the regulation around building, building control, consumer protection for particularly defects associated with major building work. But we can see that across the states, take for example Victoria [which] has announced building system review and reform which is supposed to be delivered by way of new regulation and legislation later in 2023, that may be a bit optimistic now given the time of year but I’d expect to see that in the coming months. Equally in Queensland.
So I think, we’re actually now also seeing the backend of some of the cases that have been run using legislation out of New South Wales like the Design and Building Practitioners Act, and the ability to actually pursue more than your immediate contracting party for the economic effect of defects in building work, and that’s actually been a pretty powerful tool I think for owners and subsequent owners to actually pursue the raft of building issues that have been you know manifest throughout the building sector.
Urszula Altson – And have you seen that in the context of cladding?
Joeseph Barbaro – Very much so. So the combustible cladding space was an extremely high profile area of concern in building regulation across the country, but I think particularly in Victoria and New South Wales both of which had a number of high profile buildings experiencing issues with combustible cladding.
An interesting area that personally I’ve been involved with has been the Combustible Cladding Reform in Victoria. A number of our listeners will be familiar with Cladding Safety Victoria who has had about $600 million worth of funding allocated and has been distributing that funding to a number of private owners through funding agreements in order to remove dangerous and inappropriate combustible cladding from a number of buildings and the State has since then been exercising the rights that were created through the Building Act to be subrogated to those owners’ legal rights to pursue the wrong doers if you like who caused or contributed to the use of that particular product. And interestingly only recently a very important case was decided in the County Court in the Owners Corporation and Shangri-la Construction which highlighted a key feature of that legislation which is essentially the removal of the corporate veil and in that particular case the director of the construction company was found personally liable for a new order of $1.2 million dollars of rectification costs associated with the combustible cladding removal in circumstances where the actual construction company was in liquidation at the time of trial.
Urszula Altson – Another area of consumer protection that I’ve read a little bit about is the Unfair Contract Terms. Could you tell us a little bit about that and the changes happening in that area?
Joeseph Barbaro – Absolutely. I think this one … so the Unfair Contract Terms, which form part of the Australian Consumer Law which came into effect on the 9 November of this year, is actually an extension of a pre-existing legislation that perhaps many in the industry weren’t paying so much attention to and that was legislation which essentially prohibited the use of or voided provisions in contracts which were deemed to be unfair.
I think the big development, and it’s caught I think many participants if you like a little bit on the hop, has been the new thresholds which apply to this legislation from November of 2023, which I think will have enormous implications across the sector. And in particular, those thresholds are that the Act applies now to consumer contracts or small business contracts – which will be very much the type of contracts that a number of participants in the projects and construction sector will engage in – where the counterparty has fewer than 100 employees or a turnover of less than $10 million dollars and the fact is it’s an ‘or’ between that 100 employees and the $10 million dollars, and 100 employees we all know, within the sector, is not necessarily a small company.
Urszula Altson – And do you have any tips for our clients on how to prepare for these changes?
Joeseph Barbaro – Well, I think the main thing is, you need to look at your suite of template contracts, and the task that we’ve been doing with many of our clients, is to do a moderation exercise and to look at the risk areas in these contracts.
For example, provisions which curtail one party’s rights only – provisions which are one sided, provisions which are perhaps impossible for performance – and work on moderating them, and the task is actually not as straightforward as it would seem at first blush and so it’s one where you need to actually get a few contributors, I think that’s certainly something I’d recommend to clients. Don’t just send it off to your lawyers to go off and draft and make changes and shut your eyes to what they come back with. It’s actually a bit of a workshop and a conversation around your – and it’s an opportunity to stress test – your approach to risk allocation and the real pinch points for your business. Because you are entitled to protect your legitimate interests and this really can help you focus your mind on what your legitimate interests are as opposed to things which are just in our contracts because they’ve been in there before and we keep pressing them or we keep arguing over them at the negotiating table but perhaps they don’t deliver us a great deal of value.
So, aspects of dealing with this Act have somewhat been frustrating, [but] equally I think there have been some interesting opportunities to learn and improve the way a number of our clients are contracting.
Urszula Altson – Finally what do you see as the major opportunities, trends and outlook for 2024. Is it all doom and gloom or should we be a little bit more optimistic?
Joeseph Barbaro – Great question. Lawyers are known for their optimism aren’t we? So I certainly look to 2024 and beyond with a degree of optimism. While there are a range of challenges which we’ve spoken about, each of them – I know it’s a little cliché to say – each of them presents an opportunity but it’s very much the case. If we take the example of the shift in focus towards different asset classes there is an opportunity there for, you know, major innovation, approaching new construction with greater ambition, So, for example, even the way we do construction with a lower carbon footprint is something which by doing new projects across emerging sectors there’s an opportunity to do things better.
There will be an opportunity, I think, for competition. That’s a great thing. So with a large number of new projects in a different sector there will be the existing participants but those also who will shift their focus from infrastructure like rail into for example the energy sector that should create a sort of a dynamic environment in terms of risk allocation.
I am optimistic also that both owners, and I am talking about government as well as private, and contractors are increasingly open minded and pressing for new ways to contract and allocate risk and hopefully that can be brought to bear in responding to the dynamic environment. A number of assignments at the moment with various clients who are looking at different ways to contract, looking at different ways to improve productivity and that all comes from a place of recognising a challenge and wanting to find new ways to approach the market.
So what I’d encourage all participants, on both sides, to do is to be, as I say, open minded but respectful of each other in the sense that I think there is a genuine desire, overwhelmingly, not all the time, to do better – I think that just requires focus, effort, listening and a preparedness to try new things. So certainly, that’s something I am particularly optimistic about, it really presents a great opportunity for us all.
Urszula Altson – Thank you very much Joe for your insights and thank you to our listeners for joining us in a special addition of Corrs High Vis.
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