Proposed Security of Payment amendments released in NSW – the good, the bad and the controversial

By Scott Higgins, Partner and Carlo Garofali, Consultant

Summary

The NSW Government is seeking public and stakeholder feedback (closing on 18 September 2018) on proposed amendments to the Building and Construction Industry Security of Payments Act (the Act).

The NSW Government has released:

  1. an Exposure Draft of the Building and Construction Industry Security of Payment Amendment Bill 2018 (the Bill); and
  2. a consultation paper on a proposal for “deemed” statutory trusts (Consultation Paper).

Both initiatives arise from a full review of the Act commenced by NSW Fair Trading in 2015 and they have been released following the more wide-scale report by Mr John Murray AM into all jurisdictions of security of payment commissioned and released by the Federal Government on 21 May 2018 (the Murray Review).  Please click here for a discussion of that report.

This article will set out the key changes that are presently proposed in NSW and also look at some of the discussion items which have not been addressed.

Key Features of the Bill

The most important reforms are to three areas that have produced arguably the most consternation for parties and a source of much litigation over many years:

  1. the application of ‘reference dates’;
  2. the use of adjudication after termination of a contract; and
  3. whether jurisdictional error infects the whole determination.

The amendments are clearly aimed at creating more certainty and avoiding a key area that has driven much of the litigation in NSW over the past years, including one matter that proceeded to the High Court.

Amendments are also being proposed to the prompt payment timeframes, investigation and compliance provisions with increased penalties, and reducing the threshold for retention trusts to $10 million.

Key changes contained in the exposure draft of the Bill include:

  1. re-inserting the requirement for the endorsement of payment claims (to avoid the risk of claimants inadvertently serving more than one progress claim for each reference date);
  2. allowing claimants to make a final payment claim where a contract has been terminated prior to an applicable reference date, to cover work done, services or related goods supplied, up to the date of termination;
    shortening the timeframe for a progress payment to be made:

    1. by a principal to a head contractor to be a maximum of 10 business days (currently 15 days); and
    2. by a head contractor to a subcontractor to be a maximum of 20 business days (currently 30 days);
  3. providing a statutory minimum entitlement to make a payment claim at least once per month, for work done within that month, or more frequently if so provided under the contract (for instance, those contracts requiring payment to be made in a single or one-off instance, or according to milestones);
  4. redefining an adjudicator’s timeframe for determining an adjudication to be within 10 business days of receipt of the adjudication response (formerly within 10 business days of the date that the adjudicator notified the parties that they accepted the application);
  5. enable the Supreme Court to sever, where appropriate, part of an adjudicator’s determination that is affected by a jurisdictional error, and in the process, confirm that the balance of the adjudication decision remains enforceable;
  6. providing that a corporation in liquidation cannot serve a payment claim on a person or take any action to enforce a payment claim (including by making an application for adjudication of the claim) or an adjudication determination;
  7. reducing the threshold requiring head contractors to pay retention moneys into a trust account, from projects currently with a value of at least $20 million to projects with a value of at least $10 million;
  8. enabling subcontractors to inspect the records of a retention money trust account;
  9. enabling the Minister to make a code of practice for Authorised Nominating Authorities (the Code will be drafted and released for public consultation at a later date); and
  10. implementation of new powers to investigate, monitor and enforce compliance with the Act.

NSW Fair Trading state that the feedback it received pursuant to its 2015 review of the Act confirmed strong support for the continued operation of the Act.  The reforms are a manifestation of the NSW Government’s commitment to eliminate many sources of confusion, and streamline some of the processes to better enable it to deliver the Act’s objectives more effectively. The reforms are broadly consistent with the Recommendations of the Murray Review.

Areas of the 2015 NSW Fair Trading review that have not been addressed by the amendments

Interestingly, the proposed amendments do not deal with any of the following issues from the NSW Fair Trading review:

  1. The ability of the claimant to choose its Adjudication Nomination Authority (ANA). Removing that right and investing it in a government agency was one of a number of fundamental changes that had been made in Queensland and which were strongly supported by respondents to ensure a more fair and balanced regime without any actual or perceived conflicts of interest, but it was strongly opposed by claimants and ANAs.
  2. Any distinction in timeframes or otherwise for more complex (or higher-value) claims as in Queensland or otherwise any limit on jurisdiction up to a certain value of claim.
  3. Any ability for the respondent to make claims and receive adjudicated amounts – as is the case in the ‘West Coast Model’ (WA and NT).

The above amendments are seen by many lawyers as being important amendments to introduce a more fair and balanced system.

However, there is understandable concern amongst many industry stakeholders with some of the Queensland-style amendments and the West Coast model given that it may confine the system to lower amounts of claims, lengthen the process, create more administrative burdens on the state and diminishes the role and impact of ANAs.

The Code of Practice may go some way towards addressing the problems with the present system in NSW, but it will be a question of what such a Code actually tackles and the effectiveness of reporting and enforcement of compliance with that Code which will determine whether the regulation of ANAs proves to be a fundamental shift towards a more balanced system.

Consultation Paper – Statutory Trusts

Another notable omission from the Bill is the recommendation pertaining to deemed statutory trusts (applying for the whole project and cascading down the subcontracting chain) for projects of $1 million or more.  The NSW Government has instead elected to make this controversial initiative the subject of a Consultation Paper, which includes the following statement:

The proposal in this paper recognises the strong support for establishing statutory trusts in previous enquiries and reflects the NSW Government’s desire to consult on meaningful reforms to security of payment laws to better protect subcontractors, while ensuring that regulatory burden to business is minimised.

Indeed, elsewhere in the paper it is conceded that “the proposal in this paper is sensitive to industry feedback…”  Moreover, it is further conceded that “consideration has not been given to potential macroeconomic or flow-on impacts that could arise”.  [Emphasis added]

It is reasonable to assume that the renewed interest in the statutory trust model in NSW is being driven by the resurrection of the issue by John Murray AO in his recently published review.

The Consultation Paper highlights some key features of the trust models proposed by the Law Reform Commission of WA of 1998 – yes you read correctly – 20 years ago, the Collins Inquiry Report of 2012 (Collins Inquiry) and the Murray Review recommendation from May of this year and seeks comments on these models.

Interestingly, the NSW Fair Trading review does not mention the trial of Project Bank Accounts on certain government projects to which it committed to after the Collins Inquiry.  That may well have something to do with the criticisms that John Murray reserves for the Project Bank Account system that has now been introduced in Queensland (costly and administratively burdensome and without applying all the way down the contracting chain).

The author’s comments on the trust model set out in the Collins Inquiry are outlined in  Lawyers Weekly featured here.

Limited approach to ‘undisputed’ amounts

One of the key aspects of that Collins proposal, as outlined in that article, was that it only attached to undisputed amounts:

Progress payments would be deposited into the trust account and the contractor would discharge its trustee obligations by paying undisputed amounts to subcontractors in accordance with its contractual requirements and in the order dictated by date of receipt of subcontractor progress claims (in line with the Inquiry’s recommended ‘prompt payment’ amendments).  Only once payment obligations to subcontractors are satisfied can the head contractor pay amounts to its own bank account.

The above approach removes a lot of the consternation about amounts being ‘locked up’ whilst disputes are ongoing, because it is only the undisputed amount (which is required to be paid promptly) that is protected by the trust and trustees can access funds for themselves once subcontractors are paid the certified amount that is owing.

The fact is that this model may provide very little relief to subcontractors who are still subject to spurious set-offs and write-downs of claims by head-contractors. The adjudication system would still be a crucial tool for subcontractor claimants looking to recover amounts that are disputed by the head contractor, irrespective of the implementation of any deemed trust.

Protection against insolvency

Instead, the statutory trust proposed by Collins QC is all about insulating subcontractors from head-contractor insolvency, and ensuring that flows down the chain.

The NSW Fair Trading review notes that insolvency in the building and construction industry is disproportionately high, accounting for approximately 20 per cent of insolvencies occurring nationally.  Conversely, the sector accounts for only 8 per cent of total industry output in NSW, and just over 8 per cent of the workforce.

To date, subcontractors typically are unsecured creditors following insolvency of their debtors and are often left without any realistic recourse to recover debts.  If there is one unequivocal benefit of establishing deemed statutory trusts, it is the elevation of subcontractors who are left unpaid by underfunded trusts to status of secured creditor.

Impacts on Head-Contractors

Whilst implementation of deemed statutory trusts may very well protect the cash flow of subcontractors typically most affected by insolvencies, it is important to understand that it is alleviating only a symptom of insolvency and it is not redressing the underlying cause (and nor is it intended to).

The Consultation Paper acknowledges that margins in the industry typically are low.  It is not uncommon for contractors or subcontractors to underbid a project (intentionally or otherwise) and to accept enormous risk transfer in order to seek continuity of work and maintain cash flow.  This unfortunately common practice only encourages a more adversarial approach and a ‘claims culture’ to develop as contractors look to claw back losses via claims and principals utilise strong contracting positions to resist claims or make counter-claims relating to quality of work or delays. The problem is particularly acute in infrastructure and government projects where the risk profiles are particularly Principal-friendly.

That reality is unlikely to change with the imposition of the statutory trust model – which is not a panacea to any of these issues and is purely targeted at assisting subcontractors when things really go wrong.

However, it is precisely because of these conditions that head-contractors consider themselves particularly vulnerable to any significant change to their working capital and financing arrangements and hence express understandable concern about the imposition of statutory trusts.

The restrictions on cash-flow that would ordinarily be held by the head-contractor are a significant change to they way business has been done in this country and the additional administration and risk that comes with any new trustee obligations will inevitably increase the cost-burden on head-contractors (and some subcontractors with the cascading nature of the trust).

The extent or otherwise of that burden remains the subject of some considerable controversy with proponents of the statutory trust claiming it is overblown and contractor organisations suggesting the end of the world as we know it.  The reality is likely to be somewhere in between, but the particular vulnerability of head-contractors and the underlying structural issues which persist cannot be ignored.

Some of the issues that the authors think need to be fully considered during the consultation period include:

  1. If a principal either ignores the prompt payment terms or otherwise does not comply, but a head contractor retains its payment obligations downstream (the current position under the Act), how does a head contractor honour its obligations when it has such a reduced pool of working capital? How is compliance enforced at the time payment is due and in order to prevent head contractors being squeezed and put to the brink of collapse?
  2. Does the prohibition on ‘pay when paid’ regimes need to be reconsidered as part of any statutory trust system? Head contractors that are required to pay subcontractors within 20 business days of a payment claim and who no longer have access to a larger pool of working capital will be particularly susceptible to any sort of out-of-cycle (e.g. due to late claims or otherwise) payment issues from the principal or any failure or refusal by the principal to make payment within the 10 day period.
  3. The problem of contracts that are not back-to-back whereby subcontractors might insist on more favourable terms (particularly in current boom market) and head contractors have less favourable terms upstream. The lesser pool of working capital will make it very difficult for head contractors to withstand any divergence (a likely scenario where contractual liabilities and risk profiles differ) in payments received from the principal and payment liabilities to subcontractors.
  4. How is non-compliance of prompt-payment going to be enforced in real-time and to avoid these sorts of issues for head-contractors? Removing the prohibition of pay when paid would seem to resolve this issue for head contractors, but that is unlikely to present as a course that is desirable for subcontractors.
  5. Could these issues result in a substantial tightening of the market with lesser-capitalised head contractors being put out of business and a lessening of competition in the process with power more concentrated in a limited number of well-funded companies? Is this desirable?

A closer analysis by the NSW Government of the North American experience would be worthwhile here.  In the meantime, this issue is sure to get a lot of attention from industry stakeholders in submissions to the NSW Government during this consultation period.

Feedback requested

To facilitate the feedback process, the Consultation Paper includes over 30 questions relating to different options of how a cascading deemed statutory trust might be established and operated.  NSW Fair Trading requested that comments be lodged by 18 September 2018 to the following address: securityofpayment2018@finance.nsw.gov.au

For further information, please do not hesitate to contact us.

Get the latest news insights and articles straight to your inbox, simply enter your details.

Form
  • First Name
  • Last Name
  • Email

Projects & Construction

Security of Payment, Statutory Trusts and Unfair Contract Terms: The Murray Review – Building Trust and Harmony