“At noon last Friday, instead of receiving nearly $76,000 from a major client, we were given – two minutes before it (the client) closed before the Christmas break – $1,900.”
So began the refrain of one unnamed contractor, as described in the final report of the Federal Government’s Review of Security of Payment Laws prepared by John Murray OAM, which was released in May.
No explanation for the low payment figure was given. A phone message at the client’s office indicated that the firm was closed and would reopen in three weeks.
As a result, the subcontractor’s own employees and subcontractors (including several one-man sub-subcontractors) who had expected to receive money before Christmas got nothing and understandably felt left down.
Shockingly, some underpayment had been expected, as the head contractor client in question was known to boast about how much money was owed to subcontractors – money it used to fund development works on its own account.
That case illustrates what the Senate Inquiry into Construction Industry Insolvencies described as a ‘culture of non-payment’ within the building and construction sector.
It also highlights the need for effective operation of laws relating to security of payment (SOP).
At its core, SOP refers to an entitlement for various participants within the construction project chain to receive progress payments for work undertaken as part of a building contract.
First introduced in New South Wales in 1999, the concept is now enshrined in legislation throughout every state and territory. Nevertheless, differences have emerged throughout various jurisdictions about how SOP legislation operates in practice.
In particular, the model of legislation in place throughout Queensland, New South Wales, Victoria, South Australia, Tasmania and the ACT (the East Coast Model) differs markedly from that in Western Australia or the Northern Territory (the West Coast Model).
In December 2016, the Federal Government commissioned Murray to conduct a nationwide review of SOP legislation and to identify areas of best practice.
In his final report, Murray makes 76 recommendations, covering best practice models, the objectives of the legislation, key definitions, the application of the legislation, rights to progress payments, processes for recovering payments, adjudication of disputes, provisions relating to adjudicators, unfair contract terms, statutory trusts and miscellaneous items.
A detailed description of all areas is beyond the scope of this discussion. Nevertheless, some key points can be noted:
A nationally consistent approach is needed
Whilst stopping short of recommending specific federal legislation, Murray asserted that Australia must work toward a nationally consistent approach toward SOP with harmonised legislation across the country.
Currently, Australia has eight separate pieces of legislation in relation to SOP. Moreover, despite the need for nationally consistent legislation having been noted as far back as the Cole Royal Commission in 2003, widespread divergence across jurisdictions remains.
This, Murray argues, is a farce. Australia’s construction industry is a national industry whose participants, whether large or small, routinely operate across jurisdictional boundaries. A business operating in South Australia, Victoria or Queensland should enjoy the same rights and protections as those in New South Wales, Western Australia or Tasmania.
Instead, they are subject to differences in what can be claimed; the time frames under which the payment claim, payment schedule, adjudication application and adjudication response must be lodged; and the respondent’s ability to raise reasons in an adjudication response.
A national approach would reduce the complexity and administrative burden associated with operating across multiple jurisdictions. There are almost two decades of experience upon which a national approach could be found. Besides, the push for national consistency enjoyed widespread support across industry.
East beats West
Notwithstanding differences across individual states, basic concepts which underlie SOP legislation throughout Australia have broadly fallen into two models: the East Coast model followed across most states and the West Coast model followed in Western Australia and the Northern Territory.
Modelled broadly around NSW legislation first introduced in 1999, the East Coast Model provides subcontractors and others who perform building work with a statutory right to receive progress payments. This operates in conjunction with, and in some cases overrides, any contractual arrangements made by the parties. The model then establishes a process through which these rights can be enacted and a prompt adjudication regime when disputes occur.
Modelled around legislation in the UK, meanwhile, the West Coast Model does not establish a statutory right to receive progress payments which overrides contractual provisions but rather merely establishes an adjudication regime through which the parties can enforce their rights to payments which are provided for under that contract.
A further difference between the two models relates to how the respondent (payer) is required to act when served with a payment claim. Under the East Coast Model, the respondent is given a certain time period in which to respond to a payment claim via a payment schedule. Where they do not intend to pay the full amount claimed, most states require them to provide reasons for not doing so. Where payment schedules are not forwarded within the required time, the respondent then becomes automatically liable to pay the full amount claimed.
By contrast, under the West Coast Model, those who receive payment claims are not required to include reasons for rejecting the claim. Nor are they deemed to be automatically liable to pay the claimed amount where they do not respond with a payment schedule.
Primarily because of these last points, Murray says the East Coast Model provides greater protection for the ability of those performing building work to receive prompt payment for their services. Not only does this provide greater certainty through the statutory right to prompt payment, the requirement to provide a payment schedule and (in most states) reasons for rejection of any amount gives those who perform the work clarity about where they stand with regard to claimed payments.
The legislation should be one-tiered and simple
Special changes introduced throughout Queensland in 2014 divide claims made under SOP legislation into two categories: standard claims and complex claims. Complex claims are those which exceed $750,000 or relate to a latent condition or a time related cost.
With complex claims, respondents have more time to respond to payment schedules, more time to respond to an application for adjudication (and the ability to apply to an adjudicator for a further extension of time), and are afforded rights to raise new reasons for withholding payment in their adjudication response over and above those given in their payment schedules.
Those who favour this type of arrangement argue that there is an imbalance under the more typical one-tier system which sees those who perform work given up to a year to submit their payment claim but respondents then given only a short period of time to respond with a payment schedule. In the case of complex claims, it is argued that giving respondents more time delivers a fairer and more equitable system.
Whilst acknowledging this point, Murray says experience in Queensland has shown that the two-tier system is complex, confusing, misconceived, costly and slow. In many cases, he says complex claims have taken between five and six months to resolve, defeating the idea of those who perform work being able to receive timely payment. For numerous reasons, Murray also says the system is unduly complex and difficult for claimants. Finally, Queensland saw significant rises in adjudicator fees following the two-tier system’s introduction, he notes.
Accordingly, Murray says a two-tier system should be rejected and a singular process should apply for all claims. That said, he acknowledges that the scheme should be designed with sufficient flexibility so as to afford additional time for respondents to reply to claims which involve large amounts, extensive documentation or which relate to complex technical issues.
Also processes and documentation should be as straightforward, he says.
It should apply to all contracts – including residential
Unless a limited range of circumstances apply (for example, the claimant corporation being in liquidation), SOP legislation should apply to all construction contracts – oral as well as written).
Importantly, Murray says coverage should extend to cover contracts with home owners which are made in respect of domestic home building. At the moment, neither Queensland, NSW, Victoria, South Australia or the ACT enable builders who carry out work in the residential sector to make claims against home owners under the Act even though subcontractors who carry out work on the same project are able to make claims against the builder.
Murray, however, recommends that builders should be able to make claims against home owners. He acknowledges that additional safeguards for consumer protection will be required and that the relationship between a builder and a home owner is different from that of a builder and a subcontractor.
Nevertheless, he argues that a process which sees subcontractors and suppliers able to take advantage of the SOP Act on home building contracts but not builders is inherently wrong. Residential builders, Murray argues, face similar pressures to their subcontractors when they do not receive payment for building work carried out.
Statutory trusts are a must
Whilst much of the focus of SOP laws to date has revolved around enshrining rights to progress payments and providing a mechanism for rapid dispute resolution, less attention has been given to preventing situations where subcontractors, suppliers and those further down the construction chain are impacted by the insolvency of head contractors or other parties who sit above them. A particular problem can occur where principals pay money to head contractors in respect of work performed by subcontractors but head contractors simply use this for their own working capital.
To resolve this, Murray says a deemed statutory trust model should apply to all parts of the contractual payment chain for construction projects worth more than $1 million.
Under this model, head contractors who receive amounts from principals in respect of work performed by subcontractors would be required to hold that amount in a statutory trust until such time as it is paid to the relevant subcontractor. Likewise, any subcontractors who receive amounts which relate to work performed by sub-subcontractors or suppliers would be required to hold these in a statutory trust for the sole purposes of paying those parties, and so on down the contractual chain.
In short, throughout all parts of the construction chain, any money paid to those which are higher up in the chain for work performed by those lower down are considered to be money held in trust until it ultimately reaches the party who performed the work.
This, Murray said, would help to protect subcontractors, sub-subcontractors and suppliers from insolvency or improper conduct further up the construction chain.
He says the Federal Government should work with states to establish a nationally consistent deemed statutory trust model.
In this context, it is important to distinguish statutory trusts from project bank accounts (PBAs), which have been legislated in Queensland and trialled in other states. Under a PBA, a principal deposits contractual payments into a special bank account which is operated and maintained by the head contractor. Relevant payments are then made to the head contractor and their immediate subcontractors directly from this account.
A difference between statutory trusts and PBAs is that statutory trusts see money held in trust right down the chain by each party who receives money which relates to work or services performed by parties beneath them. A PBA, however, merely sees money held in an account by a principal for the specific purposes of payment to their direct subcontractors. Thus, whilst PBAs protect ‘tier one’ subcontractors who deal directly with the principal, they do not protect those sub-subcontractors and suppliers who operate further down the contractual chain.
For this reason, Murray says statutory trusts rather than PBAs provide the most comprehensive protection across the construction chain.
According to Contractors Debt Recovery managing director Anthony Igra, lessons learned through the inquiry boil down into two key points.
First, SOP legislation is a national issue which needs to be resolved on a nationwide basis. Experience of state based legislation in the past, Igra says, was that different states have inevitably pulled in different directions. Rather, solutions need to be dealt with at a national level and be nationally consistent.
Second, the inquiry has shown that states typically do a poor job in assessing the need for change. Indeed, Igra says, much content of state legislation is not based around factual evidence.
In NSW, he says amendments which removed a requirement for a claimant to state that their claims for progress payments were being made under the Act and which automatically deemed a payment claim to be a claim made under the Act unless otherwise stated were based on misguided and unproven assumptions about subcontractors being bullied and intimidated into not using the Act. In fact, he says this has left claimants with fewer options as they do not have an option to ‘opt in’ to use the Act if they so choose.
This can be seen elsewhere as well. Victoria has made numerous changes to its legislation over the years on the basis of ‘imagined’ problems which had not in fact been proven or demonstrated in reality, Igra says. Western Australia, on the other hand, has preserved parts of their Act where are dreadfully troublesome. A 28-day time limit on making claims, Igra says, is ludicrous and unrealistically short. Yet the state has persisted with this without realising how this inhibits contractor and subcontractors from making claims.
Going forward, Igra says the Federal Government needs to take the lead and implement national legislation. As a first step, he says the Commonwealth should establish a working group with states to look at how this could be done.
Beyond that, states should not wait and should look at changes which they themselves could make within their own jurisdiction.
Igra says the most significant and impactful recommendations involve bringing residential work into the ambit of the Act and the introduction of statutory trusts. The second of these, he says, will finally put an end to non-viable companies limping on by using money owed to those further down the chain for their own working capital.
A further interesting recommendation from Murray, Igra notes, is one which would limit the ability to make a claim under the Act (and effectively, the ability to use the Act) to those who hold any relevant licenses which are required to perform the work in question in their relevant jurisdiction. This makes sense, Igra says. Those who do not hold required licenses cannot legally perform work. They should therefore not be allowed to use legislation in a way which assists them to receive payment for work which they were never allowed to perform.
Effective security of payment laws are needed for those who perform building work to receive prompt payment for their services.
Following the review, Australia has a blueprint for what effective laws look like.