Anatomy of the Screw

Submission to the Cole Royal Commission

A description of the system of rorting and collusion operating in the Australian commercial construction sector

We contend that, in the commercial construction sector of the building industry, the industrial relations system works to institutionalise an anti-competitive environment which benefits "inside" players.  By comparison, the housing sector appears to be a model of competition.

We submit that the Cole Royal Commission should make recommendations that would break up the institutional anti-competitiveness regime in commercial construction and instead institutionalise competition in that sector.

1. BACKGROUND:  A SYSTEM OF CASCADING CONTRACTS

The Australian building industry operates under contractual arrangements that are common to any industry in a market-based economy -- namely, a system of cascading contracts.

In the commercial construction sector, the cascading contracts are typified by the following structures:

1. Someone wants a building built (the developer/client).
2. The client contracts a specialist builder to organise the construction.  (The head contractor.)
3. The head contractor is a specialist at organising others to undertake the work and is, in essence, a contract manager directly employing only those staff needed to manage the contracts.  The head contractor usually undertakes little direct physical construction.
4. The head contractor contracts the physical work to businesses (the subcontractors) who specialise in particular aspects of the physical work and employ the people who do the work.  (For example, crane companies, electrical contractors, plumbing contractors, etc.)

There are deviations from this typical structure.  In some instances:

• One entity alone undertakes all activity -- from financier, developer, builder, employer of construction personnel and manager/agent to the selling/letting of the finished product.  (For instance, Meriton Apartments.)
• Sometimes, the head contractor will undertake direct employment of most of the on-site workers and undertakes the construction as well as the management of contracts with specialist sub-contractors.  (For example, Grocon.)

A useful comparison can be made with the domestic housing industry, which generally conforms to the typical structure but with an additional layer of contracting where

• The physical work is done by people who are themselves sub-contractors.  (For instance, individual trade electricians, plumbers, carpenters, etc.)

2. THE ESSENTIAL DISTINGUISHING FEATURES OF CONTRACTUAL ARRANGEMENTS

What distinguishes the contractual arrangements through the cascading contract chain is that the contracts are commercial contracts described under common law as "contracts for services".  It is this form of contract that is the key legal underpinning in a market economy, because the "contract for services" has the essential legal and economic features that enable a free market to function.  Some of these features are:

• The contract can only be entered into by parties who freely offer and freely accept the contract.
• The contract cannot be entered into under duress.  Coercion or duress to enter a "contract for services", or coercion to agree to clauses within it, can lead to the contract being declared unconscionable or being nullified.
• Exit from the contract is at the discretion of each party, subject only to sanctions freely agreed to under the contract at the time at which it was entered.
• The terms of the contract must be clear and understandable.
• Each party exercises equal rights to control the terms of the contract.
• It is illegal for parties seeking to enter into contracts to collude to fix prices between different contracts within a contract chain.
• It is illegal for parties to collude to limit the capacity of other entities to enter into the contract chain.

These essential contractual features, along with others, enable competitive market activity to take place.  Where parties seek to collude or otherwise to subvert the integrity of the "contract for services", both the common law and statute law have mechanisms for applying sanctions against such law-breakers.

Where the integrity of the contract for services is maintained, free markets have the greatest opportunity to deliver well being to individuals and the community.  A primary function of government is to provide a policing function to ensure that the integrity of "contract for services" is maintained.  There are always individuals who, when engaged in commercial activity, want, desire and work towards maximising personal return by breaching that integrity.  The difficult policing task is to identify collusion, because collusion can often be masked by arrangements which appear to be legitimate.

3. THE RORTING OF THE CONSTRUCTION INDUSTRY

We submit that the Australian commercial construction industry is one where breach of the integrity of the "contract for services" is rampant in certain sectors.  In these sectors, a form of collusive price-fixing and anti-competitive activity has become institutionalised and is effectively sanctioned under Australian law.  The principal area of such anti-competitive activity is the commercial building sector, particularly concentrated in the metropolitan CBDs, but also active in metropolitan areas outside the CBDs and in some large regional centres.  It is limited in regional country areas and nearly non-existent as a system in the traditional housing industry.

4. WHY INSTITUTIONALISED RORTING IS POSSIBLE

Collusion and anti-competitive practices are institutionalised in industrial relations law through two vehicles:  mandatory wage-fixing and the prescription of management and operational practices.  By comparison, the Trade Practices Act seeks to prevent and quarantine collusion and anti-competitiveness from other areas of commerce.  But grey areas are created when employment law and commercial law cross paths.  Faced with this general uncertainty, government and policy-makers are unsure about how to fulfill their obligations to police anti-competitive and price-fixing behaviour.  The blurring between the two forms of contract (the commercial "contract for services" and the employment "contract of service") creates opportunities for collusion even if, on the face of it, the contracting business are in active competition.

In summary, there is an unhealthy crossover of industrial relations law into trades practices domains in a way that neuters the anti-competitive measures within the Trade Practice Act and enables (or perhaps in some cases, forces) players to use the anti-competitive and price-fixing powers of industrial relations law to rort commercial law.

5. EXPLANATION

5.1 EMPLOYMENT LAW:  Employment law is, by its contractual nature, the very opposite of commercial law.  The employment contract is known as a "contract of service" and, since the Second World War, has developed the following economic and legal features:

• Parties enter the employment contract of their own free will.
• Only one party can exit the contract of their own free will (the employee).
• The other party (the employer) cannot exit the contract freely unless in strict compliance with procedures established under statute.  Ultimately, the power of the employer to exit the contract (other than through business closure) resides with third-party tribunals.
• One party (the employer) has a theoretical right to exclusive control of the terms of the contract, but this right has been removed from the employer and delivered to third-party tribunals who predetermine many, and in some cases most, of those terms.
• The post-World War II employment contract is a contract in which price-fixing (through wage-setting) is a primary institutional function of third-parties.  Through this, the contracting parties (employees and employers) are impeded from competing on price.  That is to say, wages have a floor which, in the commercial building sector, mostly replaces the market rate and constitutes the "paid rate".  Hence, employers cannot compete with one another on labour price and, likewise, employees are also severely constrained from competing with one another by offering superior quality of service.  In these situations, labour typically constitutes about 80 per cent of the costs involved in commercial building and, through the formal elimination of this part of competition, a so-called "level playing field" is created between otherwise competing businesses. ⁽¹⁾
• Further, the nature of tribunal regulation is such that most operational or management functions of labour are also ultimately controlled by tribunals, thus limiting the way in which labour functions.

This institutionalised price-fixing, anti-competitive dynamic is formally constrained to transactions under employment contracts within firms.  In transactions between firms, prices cannot be fixed because the contracts are commercial "contracts for services".  The "level playing field" created on labour prices and practices, however, underpins the cost base of commercial contracts, thereby restricting the competition possible under commercial contracts.  With prices and practices suppressed as points of competitive difference between firms, the major remaining competitive difference between them is their ability to curry favour with unions.  When seen though this perspective, the real "power" of unions in the commercial building sector is not their capacity to damage firms, but the perception of their capacity to grant favours to firms.

5.2 CONSTRAINING THE TRADE PRACTICES ACT:  The institutional process that aids the limitation of competition to non-labour issues is set in legislation under the Trade Practices Act where the policing powers of the ACCC are restricted to the commercial contract.  The ACCC cannot investigate or interfere in any price-fixing or other anti-competitive activity that occurs under employment contracts.

Part 1 Section 4 [Interpretations] of the Trade Practices Act defines the contracts involving "services" over which the Act has powers.  The clause embraces a wide range of contract types but excludes contracts relating to "... rights or benefits being the supply of goods or the performance of work under a contract of service". [employment contracts].  This exclusion clause specifically prevents the ACCC from having authority over anti-competitive or collusive conduct occurring under an employment contract.

This significant exclusion has wide ramifications for the way in which business is done in Australia.  In the Australian commercial building sector, highly developed anti-competitive, collusive, cost-raising dynamics have emerged that exploit this limitation of the powers of the Trade Practices Act.

5.3 THE ISSUE OF THOSE WHO CONTROL CONTRACTS BUT WHO ARE NOT PARTIES TO CONTRACTS.  The collusive system pivots around unions who are not party to any contracts, either contracts for services or contracts of service, yet who exert critical control over them nonetheless.  Unions play an overarching role in the creation of employment contracts and, in the commercial building sector, apply duress to parties whereby they force parties to agree to terms in commercial contracts.  The terms of commercial contract allegedly relate to employment issues, but they commonly embrace commercial issues under the guise of employment.  (For example, service fee issues).  Normally, duress in a commercial contract nullifies the contract, but unions can claim immunity from the Trade Practice Act under the pretext of "employment or industrial activity".  The ACCC is reduced to the status of a bystander.  If unions were not able to claim this "employment" jurisdictional protection, the full force of the Trade Practices Act could (and perhaps, would) be brought to bear, thus protecting those who are subject to such duress.

Unions, however, do not act alone in this matter.  Unions could not exert duress unless it was to the commercial advantage of specific players in the building industry.  Particular head contractors (and sometimes sub-contractors) find the duress exerted by unions to be to their commercial advantage, because it facilitates the winning and retention of construction jobs.  Although head contractors and sub-contractors may often complain publicly about union activity, this is frequently nothing more than a mask for the willing and collusive involvement of some head contractors and some sub-contractors in reinforcing, supporting and applying duress against competitors or would-be competitors.

The system operates like this.  ["Top draw" or "get out of jail free card"]

1. When a tender is announced for a building project, the developer/client must ensure that they award the tender to a head contractor who can guarantee that the building will actually be built.
2. Head contractors have relationships with unions through which, early in the tender process, the head contractors and unions will informally discuss the tender and reach "handshake" agreement on the broad parameters of the labour issues that would apply on site.  Frequently, the handshake is semi-formalised through the "top draw", where the contractor (sometimes also some sub-contractors) and the unions draw up an agreement that is placed in the "top draw".  Unions sometimes refer to these agreements as "Get out of jail free cards".
3. With these union/head contractor informal agreements in place, the head contractor can proceed with the tender.
4. Only bidders who have secured an informal agreement with the union can seriously tender, because any developer with any experience in the industry will know which head contractors have union approval and which do not.

This process is central to the mutually supportive relationship between unions, head contractors and sometimes some sub-contractors.  By cooperating with unions, head contractors are delivered a system that limits the number of entities that can contemplate bidding.  Potential new bidders are excluded and the players in the market are limited to those who sustain union relationships.

The second phase of the system begins after tenders have been awarded to head contractors.  It involves an elaborate public and institutional process of endorsement of the "top draw" agreements.  Most senior players in the process are aware of the "top draw" outcome that must eventuate -- and everyone plays along.

1. Sub-contractors apply to head contractors to undertake the specialised tasks required for construction.  Head contractors make it clear to sub-contractors that part of the terms of the commercial contracts stipulate that the sub-contractors must ensure industrial relations peace during the construction phase.  It is common for the insertion of financial penalty clauses in the contracts so that head contractors can recover "losses" from sub-contractors as a result of industrial activity relating to a sub-contractor.
2. Unions will present sub-contractors with EBA ambit claims built around the "top draw" agreements, but with other items included to give room for the appearance of "negotiations".
3. Sub-contractors are forced to agree to union-approved employment agreements, because of the masked collusive actions of unions and head contractors.  The formal union negotiations are either done indirectly through an employer industry association or directly with the union.  This elaborate process which sanctions predetermined "top draw" deals works, although the process is not always perfect.  However, the typical outcome is the industrial relations system's legalisation of commercially collusive deals.  Industry awards were once the preferred mechanism for the unions, but these have been replaced with pattern enterprise bargaining agreements.  (That is, de facto industry awards.)
4. There are simple mechanisms of duress applied against sub-contractors to enforce the system:
• If a union is unhappy with the negotiations with a sub-contractor or industry association, the union will make a lot of public noise about their displeasure and raise the spectre of industrial action.  This is usually enough to intimidate most sub-contractors.
• If this does not work, the next common step is for the union to unofficially contact the head contractor who, in turn, unofficially contacts the sub-contractor, reminding the sub-contractor of the requirement for industrial peace under the pain of financial sanctions.  Most of the time, this means a phone call which includes the threat, "if you don't fix this matter, you won't get any more jobs".
• If this fails, and industrial action occurs, the head contractor will impose financial sanctions against the sub-contractor by withholding regular payments (in part or in full).
• The ultimate sanction is imposed when a sub-contractor is put out of business by all head contractors refusing to use the sub-contractor because of a "poor history of industrial relations".

This exercise in duress is facilitated by unions, but is ultimately enforced by the community of head contractors.  Sometimes this works to the perceived advantage of some sub-contractors, because the "level playing field" means that it is extremely difficult for any one sub-contractor to gain a competitive advantage over another sub-contractor, and new entrants are largely excluded from the market.  Sometimes, sub-contractors willing comply with the "game", because it keeps competitors out of their market.  (In some instances, the market is so heavily organised that sub-contractors "know" the geographic regions in which they can tender and the areas where they should not tender.)

5.4 FINANCIAL LEVERAGE. One issue of emerging importance is the developing dominance of industry superannuation and redundancy funds as financiers of commercial building projects.  Due to direct controlling cross-linkages between the funds and unions, the funds stand to become additional sources of collusive pressure.  The situation is developing where the collusion is such that only projects financed through the industry funds will be capable of being built on time or within budget.  If the existing system of collusion is not dealt with firmly, a dominant and pivotal position over financing of commercial CBD construction sites could well emerge.

6. WHY THE COLLUSION OCCURS

This process of collusion, duress, market control and anti-competitive activity provides many benefits for some of the key players.  It is a complex process motivated by rent-seeking where:

• The number of head contractors is tightly controlled.
• The number of sub-contractors is well-controlled.
• Unions maintain their dominant control of sites and secure forced membership.  Membership revenue, however, is insufficient for union needs and other forms of payment to unions are therefore organised, including sub-contractors employing union officials who only do union work, industry superannuation and redundancy funds paying for "training" and other services that are not delivered, sub-contractors and head contractors making direct payments to unions for "peace", and cash payments to union officials.

7. WHO PAYS?

The disadvantages of the system include:

1. Clients and end-consumers (tenants and purchasers) tend to pay more for the price of buildings because productivity is artificially kept below that which could be attained.  Buildings cost more than they should.
2. Remuneration for workers is restricted to the productivity-constraining parameters of the "big picture" deals orchestrated by unions and head contractors.
3. After a number of iterations and experience with the system, contractors tend to earn "normal" profits.  Unrealised potential profit is never quantified or exposed.
4. Head contractors and sub-contractors must be mindful of inter-union politics to ensure that they cut deals with those union officials in factional control.  This can be problematic, and can lead to commercial loss if losing factions are backed.

8. KEY FEATURES THAT ALLOW OR DISALLOW THE COLLUSION

CBD sites lend themselves to the collusive, pressure tactics because:

1. Large sums of money are at stake on single sites.
2. Physical entry and exit points to sites are small in number and easily blocked.
3. Control of large cranes enables quick blocking of materials flow on sites.
4. Workers on sites are forced to be employees.
5. Entities in the contract chain (notably, head contractors) structure contracts to avoid losses to themsleves.

Non-CBD sites are less subject to collusive, pressure tactics because:

1. Projects are usually of smaller size, involving smaller amounts of money, and are built more quickly than CBD sites.
2. Portable cranes can be used, with a wide choice of small companies willing to provide and operate cranes.
3. Developer/clients tend to be the future occupiers and exert strong control over the construction tender and process.  Losses are directly felt and the causes of losses are quickly identified by the developer/occupier.
4. There is a greater capacity to use independent contractors for specialised tasks.

There is no evidence, on the other hand, that the housing industry suffers from any collusive, pressure tactics because:

1. Construction projects are small (individual houses) and cost blow-outs are directly felt and identified by the developer.  (That is, by the housing development company or future occupier).
2. If cranes are required, they are small and only required for short periods (usually just for one day).
3. If industrial activity hits one site, trades persons can leave that site and immediately continue work on another site in progress.  Economic loss against a particular target cannot be sustained.
4. No entity in the contract chain structures to avoid loss for delays and other problems.
5. The industry is structured almost entirely around independent trade contractors who willingly compete for business on price and quality.  Independent contractors quickly adopt and invent innovative labour practices that improve their service delivery and profit.  The small-business mentality of independent contractors usually leads them to reject union bullying or intimidation.

It needs to be noted that, in some areas, there is a significant cross-over between the domestic housing industry and non-CBD construction.  This occurs because entities that can construct houses can easily transfer their skills to low-rise, multi-storey development and medium-sized commercial work.  In general, housing industry players find themselves subject to attempts at collusive intimidation when they enter the commercial arenas.  Both unions and the major CBD contractors have common self-interests in ensuring that the highly competitive housing industry does not gain entry to the closed CBD domain.  Further, unions seek to gain leverage in the housing territory by controlling factories that mass-produce key components, such as windows and doors.

9. THE ROLE OF THE INDUSTRIAL RELATIONS COMMISSIONS AND TRIBUNALS

The commissions and tribunals are largely unwitting players in the intimidatory cost-enhancing processes and, although not directly involved, they have the effect of legalising the collusion and intimidation.  Their involvement is an outcome of the legislative parameters within which they are required to operate.

10. WHAT CAN BE DONE TO CHANGE THE SYSTEM?

Our submission discusses the general processes by which the collusive, intimidatory contract control system in the construction sector operates.  The Cole Royal Commission is gathering large amounts of evidence on specific instances of "inappropriate behaviour" and persons/entities who have allegedly engaged in inappropriate behaviour.  We hope that the Cole Royal Commission will not simply focus on these specific persons, entities and instances, but look through the specifics to find the nature of the market distortions to which we have pointed, and turn its mind to recommendations that can change the system to one which supports that free market "rivalry" which is the key to efficient operation.

To this end, we suggest that

1. A key focus should be on the "grey" area where industrial relations employment law intrudes into commercial law and either neuters the ACCC or intimidates the ACCC from investigating and condemning collusive practices.  The line between commercial law and employment law should be drawn distinctly and applied with firmness.  If anything, in relation to the building industry, the application of the law should err on the side of strengthening the Trade Practices Act and other pro-competition legislation, rather than the current situation which leans towards the acceptance of collusive and anti-competitive behaviour under industrial relations law.
2. The problem caused by entities that are not party to any contracts being able to apply duress without contract or other sanctions, particularly commercial sanctions, should be carefully considered.  This obviously includes unions, but within the context of public policy, should not be union-specific.  The solution is unlikely to be found by amending industrial relations legislation, because the object of industrial relations legislation is to give players who are not party to contracts, privileges to interfere in, and control, employment contracts.  Answers are more likely to be found through commercial contract law.
3. Points at which duress can be exerted on building sites should be specifically investigated -- the obvious candidate is cranes.  Specific commercial solutions to these particular issues need to be found.
4. The right of persons to contract their labour under whichever form of contract they choose should be policed.  The effective ban on the use of independent contractors on CBD and other building sites inhibits the rights of workers and prevents the competitive advantages achievable by workers in the housing industry from being delivered across the entire building industry.
5. The greatest legacy that the Cole Royal Commission could bestow on the Australian community would be the ultimate delivery of competitive market practices to those sections of the building industry where competition is currently rorted.  We suggest that the housing sector provides a sound model of an effective, free-market system in the building industry.  We recommend that the Cole Royal Commission would achieve great benefit by studying the housing sector closely for the competitive models, practices and policies that encourage competition.

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ENDNOTE

1.  Note:  The formal industrial relations system works to achieve this end but, across the economy, people do compete on labour price by, (a) flouting the IR system (b) working outside the IR system by not being "employed" (independent contractors/small business, etc).  In addition, some attempts have been made to create price competitiveness within the IR system through enterprise bargaining and individual employment agreements.