17 Dec 2018

FIOCCO REPORT RELEASED ON REFORM OF CONSTRUCTION INDUSTRY SECURITY OF PAYMENT

Last week, Barrister, John Fiocco’s report to the WA Minister for Commerce titled Security of Payment Reform in the WA Building and Construction Industry (“Fiocco Report”) was published. The report addressed the vexed question of how to ensure subcontractors get paid what their work is worth, particularly in the face of increasingly frequent head contractor insolvency. It is the most recent of 7 Parliamentary reports to address this question over the past 15 years.

The Fiocco Report largely adopted the following recommendations made by John Murray last year:

(a) apply the “east coast model” of security of payment laws around Australia; and
(b) legislate for a system of statutory, “deemed” trust accounts to protect retention monies and progress payments in the hands of, or payable to, insolvent head contractors, from being lost to the subcontractors that have earned them.

The “east coast model” favoured by the Fiocco Report refers to the system of rapid pay dispute adjudication that requires payment claims to be made and answered by the exchange of payment schedules. In one form or another, this is how pay disputes are adjudicated in every Australian state and territory except those on the “west coast”. The “west coast” exceptions are Western Australia and the Northern Territory, where the payment rights that an adjudicator applies in determining a pay dispute are simply the payment rights that the construction contract sets out.

We at HHG Legal Group see benefit in applying either the east coast or the west coast model of adjudication consistently around the country. There is obvious benefit in having one set of rules that allows subcontractors to take basically the same steps to recover the progress payments that they have earned by their labour, regardless of where in Australia they did their work. Many construction companies operate around Australia as do the companies that supply them the money, labour, materials and professional services that they need; and the peak construction industry bodies such as MBA, HIA and CCF have a national presence. A harmonised security of payment regime would allow efficient and reliable processes and procedures to be developed for:

(a) contractors and subcontractors to make and respond to adjudication applications;
(b) adjudicators to determine adjudication applications;
(c) professional service providers to assist with and educate contractors about their security of payment rights; and
(d) industry bodies to advocate for security of payment funding and reform.

These overriding benefits seem to us to apply equally under the east coast or west coast model. In this light, it makes sense that the Fiocco Report, in proposing law reforms for WA only, would seek to achieve consistency by proposing that WA adopt the east coast model, rather than waiting for the “eastern states” to adopt the west coast model.

The other proposed reform, the adoption of statutory, “deemed” trust accounts, seems to be somewhat misunderstood by certain industry advocates. The proposal is simply that, if a head contractor becomes insolvent, the money that each subcontractor has earned, but not been paid, at the time of the insolvency, be treated by the law as if it were being held on trust for that subcontractor. The Fiocco report (sensibly, in our respectful view) proposes that these trusts be “cascading”. This means that where several tiers of subcontractor sit below an insolvent contractor, each of them will be both:

(a) the beneficiary of trust money held by their principal; and
(b) the trustee, for themselves and their own subcontractors, of the trust money that they hold or are entitled to be paid.

We consider this to be a good first step towards protecting the flow of money down the contractual chain from being disrupted, at the point of insolvency, by (at least) the following:

(a) the claims of third party, secured creditors (e.g. banks); and
(b) the principal’s right to set off claims for delay and defects against the insolvent contractor’s payment claims. (For a while, the WA Supreme Court cast doubt over this right of set-off in

Hamersley Iron Pty Ltd v Forge Group Power Pty ltd (in Liquidation) (Receivers and Managers Appointed) [2017] WASC 152. However, on appeal from that decision, the WA Court of Appeal said the right existed in Hamersley Iron Pty Ltd v Forge Group Power Pty Ltd (in Liquidation) (Receivers and Managers Appointed) [2018] WASCA 163): see this article for more.
The deemed statutory trusts proposed in the Fiocco and Murray Reports are not the complete solution to protecting subcontractors’ payment rights, in our view. That would also require:

(a) proper and timely registration on the Personal Property Securities Register, of subcontractors’ Personal Property Security Interests in progress payment, retention monies and material supplies; and
(b) applying to adjudicate payment disputes as soon as they arise – and certainly, long before the expiry of the 90-business-day time limit that now applies a result of changes to the Construction Contracts Act 2004 in 2016.

Continuing industry education should help construction contractors at all levels of the contracting chain protect their payment rights in these ways. HHG Legal Group is proud to be leading the way in this area, through regular education sessions presented by special counsel, Daniel Morris, in partnership with the WA Building Commission, and with other construction industry groups, as well as HHG’s regular boardroom Q&As.

Only one complete trust-based solution to subcontractors not getting paid as a result of head contractor insolvency has so far been proposed and trialed in WA which does not require subcontractors to take any additional steps to protect themselves. That solution involves the use of Project Bank Accounts – these quarantine all monies that a principal pays its contractor on account of a particular project in three special purpose trust accounts. They prescribe, step-by-step, precisely what is to be done with that money, by whom, under what conditions and when.

In WA, Project Bank Accounts are currently only used in certain Building Management and Work projects. Proposals to apply these more broadly have been met with widespread criticism across all sectors of the construction industry. It is generally considered that Project Bank Accounts:
(a) are expensive and inefficient to administer;
(b) would increase the cost of construction project delivery by tying the contractors that would be bound to administer the regime, in unnecessary red tape; and
(c) ironically, would cause further insolvencies by tying up money that would otherwise be available to contractors to fund other projects, thereby disrupting cash flow when contractors need it the most.

We agree generally with these observations, but only as they apply to Project Bank Accounts, as distinct from the statutory, deemed trust accounts proposed in the Fiocco Report. The latter, we see as striking the right balance between administrative efficiency and subcontractor protection, with industry education largely filling the gap over time.

This article was written by Daniel Morris, Special Counsel in the Commercial Litigation team at HHG Legal Group.

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