Australia: "I just want to be paid" - overcoming insolvency challenges in the construction industry - the Commonwealth approach

Have the tough times in the construction industry changed? It would appear not despite an uptick in the New South Wales economy. "I just want to be paid" is the title of the report just released by the Senate Economics References Committee.1

It makes 44 recommendations aimed at overcoming many of the challenges faced by the smaller players in the construction industry.

There are myriad reasons why companies go insolvent, but there are recurring structural and cultural challenges plaguing the industry including the illegal use of phoenixing.

In a typical major project, the head contractor engages various major specialist subcontractors, who in turn sub-subcontract smaller packages to smaller subcontractors and suppliers to deliver the project.

The risk allocation under head contracts is often onerous. This results in risks being passed through to those downstream subcontractors and sub-subcontractors that are least able to manage it – from both a financial and project management perspective.

When head contractors and major subcontractors face "cashflow" challenges, there are knock on effects notwithstanding the protection provided by the security of payment legislation in various Australian jurisdictions.

A fundamental challenge is, as the Senate Committee put it, "the completely unacceptable culture of non-payment of subcontractors for work completed on construction projects".

The Committee report comes on the back of various inquiries conducted by various State governments including the Collins Inquiry and the trial use of Project Bank Accounts.2

The Committee supports the use of Project Bank Accounts which they believe would complement a harmonised national security of payment act.

Some of the more significant recommendations that could directly impact the construction industry include:

Project Bank Accounts (PBAs) - a two year trial by the Commonwealth Government of PBAs on no less than twenty construction projects where the Commonwealth's funding for the project exceeds $10 million. The trial should commence as soon as practicable, but no later than 1 July 2016. After the trial, there should be an evaluation of PBAs with a view to making them compulsory on all future Commonwealth funded projects and mandating extending the use of PBAs to private sector construction projects.

Australian Law Reform Commission to conduct an inquiry on statutory trusts for the construction industry, and recommend what statutory model trust account should be adopted for the sector as a whole, including whether it should apply to both public and private sector construction work.

Each state and territory licensing regime should contain three key requirements:

  • that licence holders demonstrate they hold adequate financial backing for the scale of their intended project. This capital backing requirement should be graduated, with increased levels of proof required for more significant projects;
  • that on registration, licence holders provide evidence they have completed an agreed level of financial and business training program(s), including principles of commercial contract law, developed in consultation with industry bodies; and
  • that each licence holder demonstrates it is a fit and proper person to hold a licence.

There are also various recommendations dealing with better monitoring and reporting requirements from administrators and liquidators and superannuation funds (including cooperation with superannuation funds to coordinate measures around early detection of non-payment of superannuation guarantee), the ATO (regarding tax liabilities of business in the construction industry) and ASIC to deal with phoenixing.

PROJECT BANK ACCOUNTS

Project Bank Accounts are not new. They are used in the United Kingdom and are currently being trialed in Western Australia.3 New South Wales' legislation already requires head contractors to use retention trust account for project with values of $20 million or more.

A PBA is a ring-fenced, project-based bank account with trust status that facilitates the direct payment of monies owed by a project principal to both the head contractor and subcontractors.

As part of the contractual arrangements, the principal, head contractor and the subcontractors sign a trust deed providing for the principal to pay the certified amounts under the head contracts into the PBA (subject to any amounts withheld).

The PBA is opened with the mandated bank who, as the trustee, distributes the funds directly to the head contractor and subcontractors.

Importantly, as the PBA is held on trust, a liquidator or administrator cannot access the money in the PBA. PBAs do not cut across the contractual or statutory rights that each party has under their respective contracts, and payments will be made in respect of certified amounts. The trust is not attached to the amounts due to the head contractor, but to the account held by the mandated bank.

By way of analogy, on PPPs or project financed projects, a SPV account is generally set up by the consortium/principal which provides for payments to the head contractor. That account generally can only be drawn down for specific purposes such as certified payments to the head contractor. However, subcontractors will not be paid from that account (and therefore are not protected).

There are a number of complex legal considerations dealing with trust property (who are the beneficiaries of the trust account and proper setting up of the trust), insolvency (such as priority rights between the head contractors and subcontractors/suppliers, liability of the principal to the liquidator/administrator and preference issues), set-off and ownership of moneys in the PBA in the event of termination, and how PBAs sit with the various statutory and common law rights. The PBA concept, being an innovation in the UK, has not yet been challenged in the English courts. In due course, there may be some guidance from those courts.

As expected, PBAs are not popular among the major construction companies as PBAs impinge on their ability to manage cash flows and the overall financial management of their business.

Nevertheless, the PBA concept is a significant development in ensuring that various parties in the construction supply chain are adequately protected. Ultimately, the success of any PBA-like system will hinge on contract documentation being properly drafted to address those complex legal issues.

The challenge now is for the Commonwealth, the States and Territories to work together to develop a co-ordinated and harmonised approach to tackling security of payment and insolvency challenges in the construction industry.

There are differences in the payment structures under the "East Coast" and "West Coast" security of payment legislation including the use of retention trust accounts by head contractors for projects over $20 million in New South Wales, and varying maximum payment terms for head contractors and for subcontractors. In more complex PPP projects, the implications for Commonwealth funded projects will also need to be carefully considered and factored into structuring head contract/subcontract pricing for bids and modelling cashflows.

Footnotes

1 Economics References Committee, 'I just want to be paid'

2See: Construction Industry in NSW: Background to the Insolvency Inquiry and Department of Finance: Project Bank Accounts

3 See more: http://www.corrs.com.au/thinking/insights/head-contractor-insolvency-protecting-supply-chain-payments-construction-projects/

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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