Skip to content

Update on Security of Payment Laws

22/11/2018

The  Building and Construction Industry Security of Payment Amendment Bill 2018 passed both Houses of Parliament yesterday, 21 November 2018.   It awaits assent and will take effect on a date to be fixed by Proclamation. A copy of the Bill can be found here.

Advertisements

Security of payment reforms

25/10/2018

nsw Parliament Building

NSW is reforming security of payment laws which protect contractors and suppliers to construction projects. An amending Bill was introduced yesterday into the NSW Parliament to promote cash flow and transparency in the contracting chain.

Progress claims

The concept of a “reference date” will be removed from the legislation.  Progress claims may be served on or after the last day of every month in which construction work is done or materials supplied.   But a contractor doesn’t have to wait if the contract allows a progress claim mid-month.  A further progress claim also can be issued after early termination of the contract.

Work done over several months can be included in a single progress claim.  Work that has previously been the subject of a progress claim can be recycled into progress claims for subsequent months.

A principal will still have 15 business days to process a progress claim by the head contractor.   But the head contractor will be obliged to pay its subcontractors within 20 business days after receipt of a progress claim (down from 30 business days).

A contractor in liquidation will be prohibited from serving a payment claim.  However, contractors in voluntary administration or other forms of external administration will still be able to use the system.

Adjudication

The legislation will permit a Code of Practice to be applied to ANAs.  The content of that Code of Practice won’t be known until regulations are drafted and gazetted in early 2019.

Applicants can withdraw an adjudication application before it is determined.  However, if the respondent objects, the adjudicator can proceed if he thinks it is the “interests of justice” to do so.

The timeframe within which an adjudicator must make a decision has been simplified.  A determination must be provided within 10 days from receipt of an adjudication response or (where the respondent did not provide a payment schedule) 10 days from acceptance of the application.  The determination must be served on both the applicant and respondent and not just the ANA.

Importantly, a determination may not be entirely invalid where the adjudicator has misconceived or exceeded his role.  The legislation will authorise the Supreme Court to overturn the incorrect part of the determination, rather than the whole.   In this correspondent’s opinion, that will lead to more litigation, not less.

Compliance and enforcement

Fair Trading officers will be empowered to issue on-the-spot fines for some offences

They will also be given increased investigatory powers.  They may question people, demand records, demand entry to premises, seize records and  other things under pain of substantial penalties, even if the person or records are outside NSW.   They will then have two years  from time of the alleged offence  to prosecute  (up from 6 months).

Penalties will be increased.  For example, a corporation may be fined up to $110,000 if it does not provide, or provides false, supporting statements.

Company directors and managers will also be exposed to prosecution if:

  • they are personally involved or concerned in the commission of an offence by the company or
  • if they fail to take reasonable steps to prevent the commission of the offence.

Hear all about the changes in a security of payment masterclass on Tuesday 30 October 2018.  You can book at http://www.kreisson.com.au.

What’s with the queues at the NSW Supreme Court?

21/09/2018

Anyone passing the Law Courts Building in Queens Square, Sydney recently will have noticed the  queue at the security checkpoint.   Anyone with business in the Supreme Court  will have waited  longer than usual for their turn at the registry counter.   The number of  civil claims brought in the Supreme Court has spiked dramatically.  But the District Court civil registry in Goulburn Street is deserted.  What’s going on?

Well, lawyers are starting to catch on to the fact that the jurisdiction of the NSW District Court is limited .

Under the District Court Act 1973,44(1)(a), the District Court has jurisdiction to hear and dispose of actions which “if brought in the Supreme Court would be assigned to the Common Law Division of that Court, and in which the amount (if any) claims does not exceed the Court’s jurisdiction limit …”, namely; $750,000 .

That reference is to the business of the Common Law Division as it stood when the section was introduced into the Act, namely;  2 February 1998 – Forsyth v DCT [2007] HCA 8.

The Supreme Court Act 1970 (as  at 2 February 1998) assigned matters amongst several Divisions, including the Common Law List, the Commercial List and others.

Section 53(3E) assigned to “the Commercial Division all proceedings of a commercial nature which are required by or under any act or by or in accordance with the rules from time to time in force to be commenced heard or determined in that Division.”

The Supreme Court Rules 1970, Pt 14 assigned “to the Commercial Division proceedings in the Court: (a) arising out of commercial transactions; or (b) in which there is an issue which has importance in trade or commerce.”

The NTF Group v PA Putney Finance Australia Pty Ltd [2017] NSWSC 1194 was about a debt arising from a business transaction between corporate entities, as well as a cross claim under the Australian Consumer Law.  Had the action been commenced in the Supreme Court, it would have been assigned to the Commercial List in 1998, not to the Common Law List.  Accordingly, the District Court had no jurisdiction to resolve the matter.

The District Court has accepted that reasoning lately in Sapphire Suite Pty Ltd v Bellini Lounge Pty Ltd [2018] NSWDC 160 and Parramatta Operations TC Pty Ltd v Consulting Professional Engineers Pty Ltd [2018] NSWDC 202.

None of this affects the District Court’s jurisdiction to hear common law claims involving amounts less than $750,000,  motor vehicle claims, criminal matters prosecutions under WHS laws, occupational complaints against medical practitioners, a residue of workers compensation matters or any appeal from the Local Court and Childrens Court.

Parker J in  NTF Group expressed the view that the plain wording of the District Court Act 1973  brought “a surprising and unwelcome result”.   We can only wait for a legislative response from the NSW Parliament.

 

 

A mis-guided proposal about unpaid debts in the construction industry.

04/09/2018

Introduction

The NSW Government, through the Department of Finance Services and Innovation, has called for public submissions about a proposal for the imposition of deemed statutory trust on revenues of contractors in the building and construction industry.

Background

The Building and Construction Industry Security of Payment Act 1999 has been in effect since 2000.  It is modelled loosely on UK legislation.

The New South Wales version of the legislation has the basis of similar enactments in Victoria, Queensland, Tasmania and South Australia. That legislation is collectively referred to as the “East Coast  Model”.   It is primarily designed to secure cash-flows, with severe consequences if the parties do not comply with strict timetables. It provides a statutory right which operates in in parallel to any contractual rights to regular progress payments.

Western Australia and the Northern Territory have adopted a substantially different legislative scheme, known as the “West Coast Model”.  That model provides an evaluative system which is focused on providing speedy determinations of contractual rights.

The Legislative Object

The objective of the East Coast Model  of the legislation is to ensure that anyone who carries out construction work or supplies goods and services to construction projects is entitled to receive regular progress payments, whether or not there has been any agreement for such a payment regime.

Progress payments may be recovered by a quick and dirty procedure that involves independent expert determination within what is, sometimes, an impossibly short timeframe.

The Problem

There is a high rate of insolvency within the building and construction industry.

The Senate Economic References Committee expressed the view that anyone performing work under contract should be paid without delay. Remarkably, no-one on the Committee had any background in the building and construction industry or company reconstruction.

The Minister for Employment subsequently commissioned Mr John Murray AM to review security of payment legislation and consider contractual arrangements that restrict construction contractors obtaining payment

Mr Murray did not submit the issues to general public consultation. Instead, he interviewed industry representatives from trade unions, trade associations, regulators and academia as well as some legal practitioners and adjudicators.

The Proposal

Mr Murray discovered that head contractors seek to pass risks to subcontractors with back-to-back contracts, leaving subcontractors vulnerable to late payment and insolvency risks.

He expressed the opinion that “… the most effective way that payments can be secured from misuse and the risk of head contractor insolvency is by implementing a cascading statutory trust. Only such a statutory trust would secure the payment of all subcontractors, including the most vulnerable at the base of the contractual chain”.  .

Mr Murray recommended that a “deemed statutory trust model should apply to all parts of the contractual payment chain for construction projects over $1 million” and urged all Australian Governments to work towards a nationally consistent model.

Public Consultation

The NSW Government has sought public submissions about a proposal for a statutory trust to bind the revenues of contractors in the building and construction industry.  It considers that the proposal will provide greater protection for subcontractors.

The effect of the proposal will be to allow subcontractors in the building and construction industry debts to recover debts in priority to other creditors, whether they are secured, preferred and unsecured.

In the ordinary course, after secured debts are discharged, the costs of the winding up are paid first, then employee entitlements, then unsecured creditors, then shareholders. Within each rank, debts are paid equally and to the extent that the company has insufficient assets to meet those debts, the loss is borne proportionately.

The proposal will allow subcontractors to leapfrog everyone else and have first call on the  assets of a building company in liquidation.

In  this correspondent’s view, the proposal the proposal is misconceived and ought be rejected, as it is based on false precepts that:

  1. participants in the construction industry repose some special kind of trust and confidence in each other rather than transacting business on an arms-length commercial basis,
  2. there is a moral imperative to protect subcontractors in the construction industry;
  3. federal insolvency laws should not apply to construction contractors;
  4. building subcontractors have a better claim in insolvency to employees and other creditors.

A fiduciary relationship?

The proposal calls for a statutory imposition of a fiduciary obligation on the contractor, irrespective of the arrangements struck with its subcontractors or the circumstances of either party.

In the usual case, a fiduciary relationship exists where one imposes especial trust and confidence in another. The critical feature is the fiduciary undertakes to act for and on behalf of, or in the best interests of, another in a representative capacity and in doing so, places the other’s interests ahead of its own,

The fundamental question is one of intention; for what purpose and for the promotion of whose interests is money received and held? The distinguishing element is that the money was received in order to serve the interest of another person or group of persons in circumstances where it is plain that the trustee is not free to pursue its own interests.

A fiduciary relationship exists where one person reposes trust in another to act in the former’s best interests to the exclusion of the latter’s self-interest. The correct approach is to discover whether the fiduciary undertakes or agrees to act in the interests of another in a legal or practical sense and in doing so, adopts a ‘representative’ character. That sort of relationship should be protected, so that the fiduciary does not abuse its position at the cost of its principal.

There are two jurisprudential theories about the nature of the relationship. They look at the issue from opposite perspectives.  “Entrustment” theory is approached from the viewpoint of the principal and posits that a fiduciary relationship should arise if one person reposes particular trust and confidence in another.   On the other hand, “undertaking” theory is considered from the perspective of a fiduciary who has undertaken to protect another’s interests.

There are a number of well-recognised relationships which are commonly presumed to give rise to fiduciary obligations. For example, company directors must put the company’s interests first.  Solicitors owe loyalty to their clients.  Business partners have to look out for each other’s interests.   But, in most cases, one has to look at the particular facts and relationship to say whether one person has a fiduciary responsibility to another.

The proposal fundamentally mis-conceives how subcontractors on building projects are engaged and administered. No-one can sensibly suggest that subcontractors repose such trust and confidence in contractors as to expect them to pursue the former’s interests to the exclusion of their own.  Contractors will be surprised to learn that they have somehow subordinated their own commercial interests to those of their subcontractors.  Their relationship is a strictly commercial arrangement reached at arms-length, often by a tender process.  Subcontractors are engaged to achieve a result in specialist trades work.  Their relationship is contractual, not fiduciary.

Vulnerability

The core of the proposal is an assumption that subcontractors are vulnerable and unable to protect their own interests.  Mr Murray opined that the “hierarchical contractual chain leaves subcontractors not only vulnerable to the consequences of late payment (and therefore having to draw on their own sources of finance, such as overdraft facilities to meet payment obligations to suppliers and their employees) but also the risk of insolvency of parties higher up the pyramid””

But he forgets that vulnerability is not the touchstone of fiduciary obligation.

It is simplistic and incorrect to claim that vulnerable persons are owed fiduciary duties. Ascendancy, dominance, undue influence, financial dependence, weakness of mind or faintness of will are relevant factors, but only to the extent that they indicate the degree of trust reposed by one in another. There are many relationships where negotiating power is far from equal but there is no fiduciary obligation, such as doctor and patient; priest and penitent; regulatory authority and citizen; banker and customer; insurer and insured, tax collector and taxpayer.  The ‘vulnerability” test was authoritatively debunked in John Alexander’s Clubs Pty Ltd v White City Tennis Club [2010] HCA 19.

Nor is it true that all subcontractors are commercially vulnerable. Listed companies like Adelaide Brighton Ltd, Brickworks Ltd, Boral Limited, Bluescope Steel, CSR Limited, Fletcher Building Limited Holcim and James Hardie Industries PLC and DowDuPont are major suppliers to the construction industry.  Sophisticated contractors like CIMIC, Lend Lease Building Pty Ltd, CPB Contractors, General Electric, Laing O’Rourke , Kawasaki Heavy Industries, Mondelphous, Spotless and UGL are all willing to take positions as subcontractors in many projects.  Design consultants like Aecom, Arup, Aurecon, Alstom, and Woods Bagot all provide related services and are ready to take advantage of the security of payment legislation.

The proposal also falls into error by superimposing a fiduciary obligation simply to improve the nature or range of remedies available to subcontractors in the course of a commercial dispute.

Fiduciary obligations

The consultation paper demonstrates a narrow understanding of fiduciary duties and equitable remedies. It’s therefore instructive to consider the full range of those duties.  A trustee is not free to pursue its own interests. Instead, it is obliged:

  1. to ensure its self-interests do not come into conflict with those of the beneficiary;
  2. not to  divert any  profit that may be derived from trust money but instead to account to the beneficiary;
  3. to preserve trust money, if necessary; by taking or defending legal proceedings;
  4. to invest trust money;
  5. to deal with trust money exclusively for the benefit of beneficiaries,  to the exclusion of its own interests;
  6. to keep and render proper accounts and allow inspection of the accounts;
  7. to act personally and not delegate the administration of trust money to anyone else, except to the extent allowed by statute or as a matter of necessity;
  8. to act impartially so that any shortfall is shared equally by all beneficiaries;
  9. to insure trust money against forgery, embezzlement, misappropriation and other frauds;
  10. to seek the direction of the Court about proper investment, application and distribution of trust money;
  11. to be exonerated or indemnified for the costs and expenses of administration directly out of the trust money;
  12. to be reimbursed for those costs and expenses by the beneficiaries personally;
  13. to act prudently;
  14. to pay trust money on demand by a beneficiary even if payment is not yet due and
  15. to distribute trust money to a trustee company or the NSW Trustee if a beneficiary cannot be found.

Unintended consequences

Where a fiduciary obligation arises in a contractual context, the obligations of a trustee must accommodate the terms of that contract so they are mutually consistent.  Presumably, the statute will say that any contrary agreement between a contractor and subcontractor is void.

Given the range of trustee’s duties, it’s inevitable that the legislative proposal will have unintended consequences.  For example, a trustee’s creditors are entitled to be subrogated to the rights of exoneration and reimbursement, so that they may have recourse either to the trust money or to the beneficiaries personally. The proposed statutory scheme will be ineffective unless those rights are overridden.

It’s difficult to believe that the Government intends to impose liability on honest and well-meaning contractors who disburses funds to subcontractors in the order that they submit payment claims. But a contractor impressed with a deemed statutory trust will be liable for any loss if it is left with insufficient funds to ensure that shortfalls are shared equally by all beneficiaries.

The obligation to distribute available funds pari passu will inevitably lead to payments to all subcontractors being delayed until the outcome of any adjudication or curial contest about the amount owed to any one of them is known.

In the ordinary course, the directors of a trustee are not responsible to make good any loss of trust money out of their personal assets, unless the proceeds can be traced into their hands. The proposal for accessorial liability will require company directors to make good payments to subcontractors out of their own resources.

It is well established that beneficiaries who are absolutely entitled to trust money can call for its immediate distribution, even though it is not yet due for payment. Subcontractors will therefore be able to demand payment immediately after the funds come into the contractors hands, even though payment is not yet due under either the contract or the Act.

The Economic Dimension

The basis of insolvency law is the inability to pay debts. It reflects every creditor’s primary concern in commercial transactions, namely; to receive payment when it falls due.  That concern is not unique to the building and construction industry.  It applies just as much to the retail and wholesale trades, professional services, technology sectors, personal services and other industries.  Business and personal services businesses are more likely to come under external administration than businesses in the construction trades.

The same arguments in favour of deemed statutory trusts could be equally applied to all small businesses, not just in the construction trades. Murray has not explained why a trades suppliers should be preferred over other suppliers.  Is there any reason to ensure the architect is paid, but not an accountant who provides services to the same builder?

Insolvency is as often attributable to poor strategic management as high cash use or inadequate cash flows. Poor financial control and record keeping is also a common cause of business failure.

Government ought not give companies an escape route from the financial consequences of their contracts, even if they are hard bargains. It leads to what economists call “moral hazard”, that is; a reduced aversion to risk.  The judicial arm of Government will not do so, as “it is ordinarily no part of equity’s function to allow those who do make such bargains to escape from them”. The High Court has said there is no good reason to relieve traders from poor commercial decisions if they are able to judge where their best interests lie, notwithstanding any disparity of bargaining power.  Justice Kirby (undoubtedly, a social progressive) thought to do so would be to drive a “herd of elephants through the marketplace”.

The Productivity Commission has emphasised the important economic role performed by the insolvency system. It facilitates orderly business exits in a way that provides certainty to creditors and prevents a competitive scramble for recovery.  It also provides genuine opportunities for viable companies to restructure.  The Commission’s judgment is that Australia’s insolvency laws work relatively well and do not require wholesale change. Reform should be directed at refining the timing and effectiveness of debt restructures and refining the process of liquidation so that it is inexpensive and expedient.

A Workable Alternative

In  this correspondent’s opinion, a better solution would be a statutory assignment of the contractor’s right to recover payment from its principal.

It could be effected simply by a subcontractor providing the principal with a simple demand corroborated by a copy of an adjudication determination against the contractor.

Payment of the debt to the subcontractor would discharge the principal’s obligation to its contractor. A principal faced with multiple statutory assignments would simply pay them in order of receipt, until its debt is exhausted.  In the event that the principal is placed in external administration, then subcontractors can lodge proofs of debt in the ordinary way.

Div 4 of the Building and Construction Industry Security of Payment Act 2002 (Vic) provides a workable model but can be improved by omitting the requirement to first register an adjudication determination in a Court of competent jurisdiction.

This proposal provides a cheaper, faster and simpler remedy than the process allowed by the Contractors Debts Act 1997. That legislation requires a subcontractor to take Court proceedings to recover money owed for construction work or materials or, alternatively, to register an adjudicator’s determination with a Court.  In either case, an application has to be made to a Court for the issue of a “debt certificate”.  The statute also requires a demand to be in a prescribed form.  Those procedural complications add nothing to the judgement or determination and are administrative barriers to the timely recovery of progress claims.

The proposal is supplementary to the withholding obligations mandated by Division 2A of the Act withholding request. That process prevents a principal making early payment to a contractor until an adjudication application is determined.

This correspondent has offered to work with the Department to draft legislation to give effect to this alternative solution.  Readers are encouraged to make submissions  to Government rejecting the  proposed deemed statutory trust.

Murray Review has misconceived payment withholding requests.

16/08/2018

Uniquely,  security of payment laws in NSW allow a subcontractor to serve a payment withholding request on the principal.  That request can be made at any time after a subcontractor has made an adjudication application.

The principal must then withhold payment of the full amount of the payment claim pending the adjudicator’s determination.  The principal will become liable to pay the subcontractor if it ignores the withholding request and pays what it owes to its contractor.

Image result for withholding construction payment

That wreaks havoc on the orderly cashflow that the legislation seeks to preserve.  A subcontractor’s payment claim is often speculative, at least; in amount.   No significant penalty is imposed on a subcontractor that makes an extravagant payment claim.  At most, the adjudicator might decide that the subcontractor should bear a greater proportion of the adjudicator’s fees.  That just encourages ‘ambit’ claims.

The result is that the principal may be required to withhold far more than a single subcontractor’s fair share of construction costs.  Cashflow to the contractor, subcontractors and suppliers is disrupted.  The disruption lasts well after the adjudicator determines the claim.  In practice, payments to other subcontractors can be delayed for two months.

The Victorian counterpart to the legislation also allows a subcontractor to secure payment from a principal, but only after the correct amount of the progress claim has been determined by an adjudicator or a Court.

The Murray Review did not obtain the views of any stakeholder about the subject.   Nevertheless, it endorsed the NSW withholding arrangements as a “powerful tool” for ensuring that subcontractors receive payment pending any adjudication.  With respect to Mr Murray, that view is misconceived.

The Review also endorsed the imposition of a statutory, cascading trust.  This correspondent doubts that principals have any commercial, ethical or fiduciary duty to ensure that funds paid to their contractors are used to meet subcontractor claims.  But if the Legislature is persuaded otherwise, and gives legal force to the recommendation, then there is no utility in the proposed withholding arrangements.

You should get your ipso factos right.

30/07/2018

Commercial contracts generally have clauses allowing termination in the case of breach, or where events occur that flag an problem like imminent insolvency.

Clauses which allow termination in those events, even while essential obligations continue to be performed, are called “ipso facto” clauses.    They allow the other party to exit the contract before it becomes financially exposed.

The Government has made laws to preserve valuable contracts for the purpose of assisting distressed businesses improve their chance of survival.   New restrictions have come into force to preserve opportunities for restructure or sale as a going concern.

The Corporations Act 2001  was amended by the Treasury Laws Amendment (2017 Enterprise Incentives No 2) Act 2017  with effect from 1 July 2018.  It only applies to contracts made after 1 July 2018.  It doesn’t apply to companies that were already in liquidation or that were trading insolvently at that date.  It also exempts contracts for financial products, sales of business, debt priority agreements, complex arrangements with sophisticated parties and some other contracts.

The laws go further than simply delaying termination rights.  They also prevent the exercise of other rights triggered by a party’s distressed “financial position”.  For example, they stop a creditor calling on bank guarantees, cash retentions, suspending works or deliveries or stepping in to take over the remaining work.  But they do not affect parent company guarantees, contractual indemnities, set-offs, rights of  assignment, rights of novation and some other contractual arrangements triggered by insolvency events.

Those rights are stayed and become temporarily unenforceable when a company enters into a scheme of arrangement with its creditors or is in receivership or during voluntary administration.

The new law doesn’t mean that ‘ipso facto” rights are obsolete or illegal.  There are many enforcement rights that are exempt from the statutory regime.   The law is complex, so you should take skilled legal advice in drafting your contracts.  And you should act early to protect your position at the first sign sign of trading problems.

.

Harmonised security of payment.

29/05/2018

Legislative responsibility for security of payment in the construction industry rests with the states and territories.

There are  eight disparate pieces of legislation in Australia which deal with security of payment.  As a prominent judge noted some years ago:

“We now have a national scheme comprising 8 Acts. It is a scheme which has at least two common themes — the recognition of a common objective and a manifest divergence in approach to achieving it”

Since he said that,  the divergences between the states and territories have increased.  In 2017,  the law changed in Queensland and South Australia and there were major legislative reviews in NSW and the Northern Territory.   The escalating trend for each State to introduce its own changes has implications for the  protection afforded to subcontractors, particularly those operating across the country.

“More needs to be done to harmonise the various state and territory security of payments laws so that businesses and subcontractors operating in the building and construction industry are not required to be across several complex pieces of legislation at any given time”

As a result, there are significant differences in the legislation between Australian jurisdictions: differences in what can be claimed; differences in the timeframes for service of payment claims, payment schedules, adjudication applications and adjudication responses; and differences in the material that can be relied upon in an adjudication response.

The approach  in NSW and other Eastern States is to provide a statutory right to progress payments, which is quite separate from any contractual  entitlement.  Disputes can be referred to an independent expert for adjudication in a fast-track  process.   The statutory time-frame prevents the recipient from checking claims thoroughly.  In other words, the NSW-based legislation envisaged the adjudication process as a means to an end, namely; the enforcement of a statutory entitlement to progress payments.

In contrast, Western Australia and the Northern Territory treats adjudication as a mechanism to resolve all disputes arising under a construction contract.  The West Coast model simply provides mechanisms for disputes about construction contracts to be determined “as quickly, informally and inexpensively as possible’.

The need for consistency is well established and can be traced as far back as the 2003 Cole Royal Commission.  The most recent report, published last week by the Department of Jobs and Small Business, points out that

  1. A national industry requires a national approach.
  2. There should be an equality of rights and protections across jurisdictions.
  3. A national approach will reduce complexity and administrative burden.
  4. There is significant practical and legal experience to support a national approach.

The author of the report, John Murray AM, agitates for the consistent implementation of a single system across all states and territories.  It is a long-overdue and essential national reform that can only be achieved with the co-operation of  federal, state and territory governments.  The construction industry operates across State borders.  The costs of industry should not be inflated by legislative inconsistencies from State to State.