Posted on February 27, 2013 by
Proposed new statutory trusts for security of payments to contractors
The construction industry accounts for 15% of businesses in New South Wales but up to 30% of these businesses go into administration (source: Terms of Reference, Independent Inquiry into Construction Industry Insolvency in NSW).
When this happens, as the Australian Financial Review noted on 15 November 2012 at page 44:
The collapse of a big contractor has a ripple effect, often ruining scores of subcontractors and suppliers. They are last in the queue as administrators, banks and employees have a first call on the assets.
It is against this background that the New South Wales Government instituted its Independent Inquiry into Construction Industry Insolvency chaired by Bruce Collins QC (Inquiry).
The Inquiry has recommended a number of amendments to Building and Construction Industry Security of Payments Act 1999 (SOPA). Arguably the most significant will be the proposal for statutory trusts for construction payments.
The Inquiry handed down its final report in November 2012 and the Government has now exhibited three consultation summary papers outlining proposed amendments to the SOPA. A link to the Finances and Services web page on the issue is here.
SOPA was originally enacted in NSW and similar legislation has now been enacted in all Australian jurisdictions.
SOPA addressed a common problem for sub-contractos: where a sub-contractor sought payment, a head contractor would sometimes raise issues of quality and workmanship. Disputes over offsetting amounts and claims could see invoices unpaid for months if not years and in the interim the sub-contractor could become insolvent.
SOPA introduced a procedure whereby sub-contractors issue invoices as a payment claim under the Act. If the head contractor disputes the amount, it can issue a payment schedule and in the event of a dispute the matter is sent to adjudication.
The system has short, self executing deadlines and the process is not designed to put an end to cross claims and actions by head contractors against sub-contractors for substandard work.
SOPA therefore attempts to maintain cash flows for sub-contractors allowing work to continue and payments to be made. It assists in ensuring that building contractors have more certainty regarding income and head contractors will be more likely to see projects completed.
However, as the statistics quoted above show, SOPA is not enough to stop many building companies going to the wall.
The Inquiry proposal is that for all building projects valued at over $1,000,000.00, where money is to be paid by a principal to a head contractor for building materials, goods and services (including retention monies), the head contractor will be required to set up a separate bank account to hold the funds on trust for those services.
Likewise, where a contractor holds money for one or a number of sub-contractors, those sums will also be held in a separate account. The same principles will apply to each contractor down the supply chain.
The designated trust account will replace any other account used for the purpose of paying for goods and services.
To make payments from the trust, the head contractor (or other designated trustee paying a contractor) will submit a certificate to the bank stating the amount due to the beneficiary. The head contractor can only draw money from the trust account when all sub-contractors have been paid.
The trustee will be obliged to keep records and maintain auditing standards similar to those already maintained by agents for real estate deposit monies under the Property Stock & Agents Act 2002. Sub-contractors would have defined access rights to those records to ensure their payments are honoured.
Within the SOPA dispute resolution mechanism, adjudicators will be able to make findings on release of payments to beneficiaries for a particular project.
It appears that the NSW Government is considering a radical and innovative step to protect the many sub-contractors who become insolvent due to the fact that they are, as the AFR quote above states, the last in the queue when it comes to picking over the carcass of an insolvent principal or head contractor.
However, the measures are unlikely to be universally embraced. Banks and lenders with varying degrees of security have, to date, enjoyed a priority over unsecured sub-contractors. If funds are to be effectively protected from them during an insolvency event, this is likely to increase the cost of funds available to proponents/developers who will become principals and trustees under the new trust arrangements.
As this is State law, the question also remains: what happens if NSW goes it alone? Will the cost of borrowing in NSW encourage banks and developers to go to less regulated environments?
Further, the finer details of how much needs to be paid into these trust accounts to ensure sub-contractors are paid needs to be carefully defined. Rarely does a project begin with the full amount available for construction from beginning to end. Lenders release funds in tranches on the head contractor or principal achieving certain agreed milestones. The need to keep the sub-contractors’ trust topped up, as well as the additional compliance costs, may well make life easier for sub-contractors, but much harder for principals to finance projects in the first place.