The Road to Hell

In February of 2013, Bruce Collins QC’s final report into insolvency in the construction industry in New South Wales was released. It was a lengthy thought-provoking document which canvassed a number of interesting ideas about how the problem of construction insolvency might be addressed. It made some 44 recommendations, central to many of which was the concept of a statutory construction trust.  The idea of such a trust is hardly at the libertarian end of the spectrum – it is to say that a party who undertakes to carry out work for a principal for an agreed sum is not permitted to be paid that sum. Instead, it must be paid into a trust, so it may be shared out among other parties who have undertaken part of the work as subcontractors. It is a bold notion which has gained some traction in large government contracts in the UK[1], but not one which the NSW government is presently prepared to embrace.  Instead, it has cherry-picked a number of the other recommendations out of the report. These are embodied in the Building and Construction Industry Security of Payment Amendment Bill 2013 which, at the time of writing is rapidly passing its way through the legislative process.

Bizarrely, the Bill is anathematic to the central recommendation of the construction trust, and seems set, if passed, not only to reduce the effectiveness of the existing Security of Payment legislation, but itself being the cause of increased insolvency and to cause a mass criminalisation of the NSW construction market. This article examines how Bill works, and why there is good reason to fear these results.

A Melding of the Statutory and the Contractual

The first change is one of some subtlety, perhaps to some degree unintended. The existing legislation sets up a parallel system for contractors and subcontractor to make claims.  They may make their claims in the traditional way under their contracts. Their entitlements pursuant to those claims arise under their contracts, are often dealt with by contractual dispute resolution clauses, and if these do not work, are typically enforced through litigation of arbitration. Alternatively, they may make a claim under section 13 of the Act – a so called “payment claim”. The payment claim has to state that it is a claim made under the Act – which is something different to a claim under the contract. Different rules apply as to numerous aspects, such as when the claim may be made, how it is to be served, its formal content and so forth.  And it is for a different amount – instead of being a claim for whatever might be due under the contract, it is for another statutory creature, the so-called “progress payment”.  This statutory creature is parasitic on the contract, but again there are important differences between a statutory progress payment and a contractual entitlement to payment; by way of example, a contractual entitlement may be fixed in amount by certification[2], whereas the statutory progress payment entitlement may not be[3], and there is different approach to set-off[4]. This “twin-track” system is hardly elegant (nor, one might add necessary – other evaluative systems for the adjudication of contract disputes around the world work rather better than this without any such artifice).  But at least it has been open for the parties to ignore the statutory scheme altogether if they wish, and many do just that.  If a piece of paper does not state that it is payment claim made under the Act, it is not a payment claim, and the Act is not engaged.

A change introduced by the 2013 amendment is that this feature of a “payment claim” – namely the section 13(2)(c) requirement that it must state itself as being made under the Act – has been removed.  Further, a new section 11(1) is introduced in these terms:

Subject to this section and any other law, a progress payment to be made under a construction contract is payable in accordance with the applicable terms of the contract.

 

These changes seems to suggest that the provisions of the Act, as amended, are intended to apply, not just to a statutory payment claim, but rather to meld statutory and contractual claims into one, and the same theme emerges from the explanatory note to the Bill.  Any document which identifies some construction work or related goods or services, and which indicates an amount that the provider claims is due, is potentially going to be a payment claim under the Act.  And that is of considerable significance because of the new supporting statement rules.

The Supporting Statement

The amendment brings a new stipulation at section 13(7) that head contractors may not serve a payment claim unless it is accompanied by a “supporting statement”.  Section 13(9) explains that:

In this section: supporting statement means a statement that is in the form prescribed by the regulations and (without limitation) that includes a declaration to the effect that all subcontractors, if any, have been paid all amounts that have become due and payable in relation to the construction work concerned.

Certainly, it seems to be the intention of the amendments that this requirement applies, not just if the head contractor is minded to invoke the procedures of the Act, but if he makes any claim for payment from the principal.  And the intention is serious: a head contractor who puts in a supporting statement knowing that it is false or misleading in a material particular is liable to 3 months imprisonment or a fine.

What does the provision require? The wording is unclear as to whether it means what it says – “all subcontractors” – or whether words are to be implied limiting the meaning to subcontractors to those directly engaged under contract with the head contractor.  The new definition of subcontractor is very broad, including all the subsubcontractors and those in the supply chain:

subcontractor means a person who is to carry out construction work or supply related goods and services under a construction contract otherwise than as head contractor.

 

And so on a literal interpretation, this new requirement applies to every party in the contractual chain – which might be several links long – who has done work or supplied goods or services in relation to the construction work concerned. And on such a basis, the new requirement is utterly impractical. How is a head contractor to know if all the parties down the contractual chain have paid their bills?  He is unlikely even to know who they are, let alone the details of their finances. So what is he to do? He will know that the normal practice in the construction industry is for the cash flow to flow from top to bottom, such that it is highly unlikely that each party in the contractual chain has paid his own subbies and suppliers before himself being paid. Thus, he cannot provide the supporting statement without committing a criminal offence (section 13(8)) and if he makes the claim without any supporting statement at all, that also will be an offence (section 137)).  His only realistic option, if he to avoid the inevitable insolvency that would attend the no claim at all option, is to criminalise himself.

The position is better, but not much better, if words are read into the amendment to the effect that the requirement applies only to those subcontractors with whom the head contractor has contracted directly, and not those further down the chain. The experience of statutory declarations (now widely required in the public sector and sometimes in the private sector) in this respect is not good. As the Collins Report itself noted, they have been described as “a joke”, and the cause of “mass dishonesty”.  It is not hard to see why. The money required to pay for construction work comes from the principal, and flows down the contractual chain. Requiring parties who are in the midst of that chain routinely to pay before they are themselves paid is akin to requiring a river to flow downstream before water has arrived from upstream. Of course there are instances where the money does not flow at all, or is much delayed by dispute, and in those cases it is not unreasonable to expect a party to pay notwithstanding that he has not himself been paid.  But such cases are exceptional, and to expect a wholesale reversal of the prevailing economic reality is unrealistic. The practical effect of the requirement for statutory declarations seems all too often one of two things. Either the head contractor just lies about the matter, sometimes with the coerced connivance (as noted in the Collins Report) of his subcontractors, or he manufactures disputes with his subcontractors, so that he can say if challenged that the reason he has not paid his subcontractors what they have claimed is because he does not owe them anything.  Neither of these is a welcome outcome.

The best laws, of course, are those that citizens are generally willing to accept. In this case, the draftsman appears to be on notice that this legislation will be unpopular, and has included draconian powers for the government to investigate and assist prosecutions, including a provision requiring head contractors to provide evidence that tends to incriminate themselves. It is always a bad look when a government rides roughshod over civil liberties in pursuit of unpopular laws.

Is there any real prospect that any of this will work to reduce construction insolvency? Across the board, the answer is that these amendments miss the mark: the Collins Report noted that

the home building sector appears to have a greater proportion of insolvencies than other parts of the industry

and recommended that the Act be extended to cover substantial ($1million +) contracts with residential owners. But that recommendation has not been taken up in these amendments, and would in any event be highly problematic, given the human rights issues that arise out of the East Coast Model.

But even in the commercial sector, the amendments seem much more likely to increase insolvency. Having to routinely paying subcontractors before themselves being paid would put a huge burden on many head contractors: if they were to attempt it, they may well find the financial strain unbearable. And if they do not so pay their subcontractors, there will be considerable enhanced scope for unscrupulous principals to leap on the illegality, not to pay what they owe, and thereby to starve the cash flow all the way down the chain[5].

It is ironic that the whole scheme attaching to these supporting statement statements is anathematic to the central idea in the Collins Report for statutory construction trusts, because if the subcontractors are all to be paid up before the head contractor puts in his monthly claims, then there is nothing that the trust would attach to.  This is not to say that the statutory construction trusts is such a great idea either, rather this amendment has not been properly thought through. 

Removal of Requirement for Reference to the Act on Statutory Payment Claims

It is not just the supporting statement concept that is flawed, but other features also.  The removal of the requirement for claims under the Act[6] to so state is a step in entirely the wrong direction – at the moment we see the widespread practice of the “big hitters” in the industry escaping the Act by making it very clear that subcontractors who use the Act will not get any more work from them in the future. Removing the requirement for the weasel words on statutory payment claims is not going to change that.

But the amendment is worse than pointless.  At present, all parties in the contractual chain are to some extent put on the guard that the words, “This is a payment claim under the Building and Construction Industry Security of Payment Act 1999” should set alarm bells ringing – a payment schedule will need to be provided within 15 business days. The removal of the requirement for those words will mean that a bewilderingly wide range of documents might well now be payment claims within the meaning of the Act; is the respondent supposed to put in payment schedule responding to all of them? Probably, the chaos will do as much or more damage to claimants, since they are likely to repeatedly fall foul of the section 13(5) prohibition on serving more than one payment claim per reference date, so that when they want to rely on a payment claim, they may well eventually find that it is invalid.

Compulsory Payment Terms

Seen against this background, the amendment’s interference with contractual bargains by requiring principals to pay claims within 15 business days of claim (section 11(1A)(a)), and all other parties in chain within 30 business days (section 11(1B)(a)) within 30 business days of claim, is perhaps not the most alarming aspect of the changes.  But this one too is flawed, and may well have the unwelcome side effect of prompting dispute as a means of buying some more time.  Certainly, it is symptomatic of a bizarre schizophrenia that courts are prepared to take a “black letter” approach to onerous contractual mechanisms buried deep in contractual conditions that the commercial decision makers are unlikely to have even read, let alone understood and actually agreed upon, whilst at the same time the legislature is prepared to drive a coach and horses through something as fundamental as agreement on payment terms.

Summary

In the end, of course, the cause of construction insolvency is typically that contractors and subcontractors bid at low or non-existent profit margins.  If they do this time after time, they either pay their bills, in which case they tend to go bust, or they do not pay their bills, in which case those below them in the chain tend to go bust.  It is hard to see how this amendment will assist in resolving this fundamental problem. Unless perhaps it forces so many players out of business that the balance between supply and demand is improved for the survivors.

The road to hell is, they say, paved with good intentions.  But it is hard to imagine that this Bill is the outcome intended by Mr Collins.

Robert Fenwick Elliott

Howard Zelling Chambers, Adelaide