Analysis of recent amendments made to security of payment legislation in New South Wales
1 Introduction
1.1 Sub-contracting and security of payment
The Australian building and construction industry is a project-based industry and consists of a large number of small private firms (ABS, 2004). In project-based industries like the building and construction industry the delivery of projects to
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clients typically requires a head-contractor to purchase ‘sub-projects’ and expertise from a large number of external trade suppliers. Consequently, head-contractors in the construction industry often act as ‘systems integrators’ and take responsibility for actively coordinating a network of sub-contractors (Martinsuo and Ahola, 2010).
According to Harris and McCaffer (2001), the practice by head-contractors of sub-contracting the works under the head-contract has been on the rise in Australia since the 1980’s. However, Uher and Davenport (2009) place the shift to sub-contracting as early as the late 1960’s, which was about the time when most Western economies began to experience periodic economic downturns when head-contractors’ economic capacity as direct employers of tradespeople began to diminish. Harris and McCaffer (2001) and Uher and Davenport (2009) agree that sub-contracting has now become widespread in the construction industry and is an essential component of the project procurement structure and delivery process.
To appreciate how prolific sub-contracting is in the construction industry in Australian, the National Electrical and Communications Association in Australia indicates that about ‘95% of the labour content’ on construction projects, and
‘75% of the total project value’, is undertaken by sub-contractors (Cole, 2003). As at the end of June 2003, there were about 340,000 construction businesses operating in Australia with employment of just over 700,000 people. Trade service businesses accounted for about 270,000 (or about 80%) of all construction businesses and employed just over 500,000 people, which represents about 75%
of the total construction employment. The majority of trade service businesses (about 70%) were earning an annual income of less than AU$100,000 (ABS, 2004).
The reasons for the widespread use of sub-contracting in the construction industry are many. However, according to Goldfayl (1999), one notable advantage to head-contractors of sub-contracting relevant here is the ability of head-head-contractors to divest much of the financial risk of delivery of the works under the head-contract to sub-contractors – the advantage for head-contractors being improved cash flow through the effective up-front financing of the bulk of a project by sub-contractors (Maqsood et. al., 2003). This reduces head-contractors’ need for interim borrowings and so reduces head-contractors project costs. This, of course, makes good commercial sense for head-contractors and their clients. However, it is the systematic abuse of sub-contracting that appreciably contributes to the security of payment problem in the construction industry – the abuse being to wrongfully delay and devalue payments to sub-contractors due under the sub-contract to further enhance the financial position of the head-contractor.
Typically, construction projects are characterised by a hierarchical chain of contracts involving cascading payment obligations (Commonwealth Government, 2002). Under this hierarchical chain the Principal (sometimes called ‘the Employer’ or ‘the Owner’) pays the head-contractor, the head-contractor then pays the sub-contractor and the sub-contractor then pays sub-sub-contractors and suppliers. While money flows smoothly down the construction chain, all is well.
However, all too often one party in the chain does not pay the other party for work done contrary to the contract between them. If the head-contractor wants to reduce its overdraft or is short of money, there is a temptation to delay or withhold
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passing on payments down the chain. Sometimes the head-contractor will simply not want to part with money to project participants down the chain. Sometimes the head-contractor is dishonest and, in effect, takes the sub-contractor’s money with no intention of ever paying the sub-contractor. Sometimes, instead of passing money down the chain, the head-contractor uses the money to pay other creditors.
In any event, a delay or failure to make payments by one participant higher up in the contractual chain can create significant financial strain on many more project participants lower down in the chain. Ongoing delays or failures by a head-contractor to pass money down the chain can reduce sub-head-contractors’ cash flow to zero. If this happens, a sub-contractor may be forced to carry bad debts, and in extreme cases, may be forced into some form of insolvency (Commonwealth Government, 2002).
The problem is not new. More than 100 years ago, the NSW Government enacted the Contractors Debts Act 1897 as a means of providing some security of payment to workers and tradespeople during the construction of the NSW railways. The Contractors Debts Act 1897 has since been replaced by the Contractors Debts Act 1997 (NSW), but it has not materially altered the scheme under the Contractors Debts Act 1897. Section 14 of the Contractors Debts Act 1997 (NSW) provides that if court proceedings are commenced by an unpaid sub-contractor against a head-sub-contractor for recovery of money for work carried out or materials supplied, the court may make an ‘attachment order’ against the Principal. The Principal served with the attachment order has to retain from progress payments to the head-contractor sufficient money to cover the debt due to the sub-contractor. If, while the order is in effect, the Principal fails to withhold the money, the sub-contractor can sue the Principal for the amount.
If under an attachment order money is retained by the Principal, the sub-contractor upon obtaining judgment against the head-contractor asks the court for a ‘debt certificate’ under s 7 of the Contractors Debts Act 1997 (NSW). If the sub-contractor serves on the Principal a copy of the debt certificate and a ‘notice of claim’ the effect is that the money owed by the Principal to the head-contractor is assigned to the sub-contractor. However, the Contractors Debts Act 1997 (NSW) has been rarely used. This is because, to obtain the attachment order, the sub-contractor had to commence litigation and satisfy the court that the head-contractor owes the sub-head-contractor money for work carried out or materials supplied. Litigation is costly, time consuming and requires engaging a lawyer.
The money is frozen in the hands of the Principal until the litigation is complete, which may be months or years. In the meantime, sub-contractors may be forced into insolvency through lack of cash flow.
1.2 Security of payment legislation in New South Wales
Following the introduction of the Housing Grants, Construction and Regeneration Act 1996 (UK), the Building and Construction Industry Security of Payment Act 1999 (NSW) (‘the NSW Act’) was introduced by the Carr Labour Government in an attempt to counter the security of payment problem in the NSW construction industry. The NSW Act was assented to on 5 October 1999 and commenced on 26 March 2000. New South Wales was the first Australian jurisdiction to introduce this type of legislation.
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As a consequence of a formal review undertaken at the end of the NSW Act’s first three years of operation, the NSW Act was significantly amended by the Building and Construction Industry Security of Payment Amendment Act 2002 (NSW). The NSW Act (as amended by the Building and Construction Industry Security of Payment Amendment Act 2002) commenced on 3 March 2003.
The object of the NSW Act:
is to ensure that any person who undertakes to carry out construction work (or who undertakes to supply related goods and services) under a construction contract is entitled to receive, and is able to recover, progress payments in relation to the carrying out of that work and the supplying of those goods and services.1
To achieve this objective, the NSW Act has introduced new statutory rights for claimants, such as: a right to progress payments;2 a right to interest on late payments;3 a right to suspend work;4 and a right of lien.5 The NSW Act also renders void ‘pay-when-paid’ clauses in construction contracts.6 The parties cannot contract out of the NSW Act.7
The NSW Act also introduced a unique form of ‘rapid adjudication’ to deal with disputes over the amount of progress payments due, whereby an independent adjudicator makes an interim determination as to the amount of progress payment to be paid to a claimant by a respondent. Only a claimant (i.e., the person who has contracted to carry out construction work or to provide related goods and services) can initiate the adjudication process, however, both parties are entitled to make submissions to the adjudicator (subject to s. 20(2B) of the NSW Act). An adjudicator can only be appointed by an Authorised Nominating Authority (ANA) chosen by the claimant.8 An extended overview of the operation and performance of the NSW Act is provided by Brand and Uher (2010). A detailed review of the NSW Act, and comparable legislation operating in Australia, is provided by Davenport (2010).
Prior to the introduction of the NSW Act it was not feasible to sue for progress payments. By the time the matter was finally heard by a court, the sub-contract would be complete and any right to progress payments would be replaced by the final accounting between the parties. The sub-contractor would then want a final judgment not merely a judgment for an interim payment. The NSW Act changed that; it enables a sub-contractor to make claims for progress payments and have them adjudicated in a matter of weeks. Suddenly, it became feasible to sue for progress payments. Judgment could be obtained by simply filing an adjudication certificate. Nevertheless, whilst adjudication speeds up the passing of money down the line, it does not remove the ability of a head-contractor, in the interim, to use for the head-contractor’s own purposes money which is for the
1Building and Construction Industry Security of Payment Act 1999 (NSW) s. 3.
2Building and Construction Industry Security of Payment Act 1999 (NSW) s. 8(1).
3Building and Construction Industry Security of Payment Act 1999 (NSW) s. 11(2).
4Building and Construction Industry Security of Payment Act 1999 (NSW) ss. 15(2), 16(2), 24(1).
5Building and Construction Industry Security of Payment Act 1999 (NSW) s. 11(3).
6Building and Construction Industry Security of Payment Act 1999 (NSW) s. 12(1).
7Building and Construction Industry Security of Payment Act 1999 (NSW) s. 34.
8Building and Construction Industry Security of Payment Act 1999 (NSW) s. 17(3)(b).
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contractor’s work. If that ability is removed, the incentive to delay and withhold the money is removed.
Subsequent to the introduction of the NSW Act, section 7(1A) of the Contractors Debts Act 1997 (NSW) was amended by the insertion of s 7(1)(A), which provides:
If an adjudication certificate within the meaning of the Building and Construction Industry Security of Payment Act 1999 has been filed as a judgment for a debt in accordance with section 25 of that Act, the court may, by order made on the application by the person who filed the adjudication certificate, issue a debt certificate in respect of that debt under this section.
Nevertheless, the problem still remained that to freeze moneys in the hands of the Principal until the adjudication certificate is filed, the claimant had to commence legal proceedings in parallel with adjudication proceedings. However, that would be an abuse of process; the two proceedings cannot co-exist. The consequence was that a sub-contractor was unable to freeze moneys in the hands of the Principal if the sub-contractor submitted the payment claim for adjudication. The NSW Government has now rectified the problem in the Building and Construction Industry Security of Payment Amendment Act 2010 (NSW), which is discussed in detail below.