Insolvent contractors in New South Wales may be able to pursue debts through the Security of Payment Act regime

On 17 February 2023, Justice Ball of the New South Wales Supreme Court handed down his decision in Kennedy Civil Contracting Pty Ltd (Administrators Appointed) v Richard Crookes Construction Pty Ltd; In the matter of Kennedy Civil Contracting Pty Ltd [2023] NSWSC 99.

Facts

Kennedy Civil Contracting Pty Ltd (Administrators Appointed) (KCC) commenced proceedings against Richard Crookes Construction Pty Ltd (Richard Crookes) for failure to make payment of $683,928.49 (plus interest) in accordance with payment claims made under the Building and Construction Industry Security of Payment Act 1999 (NSW) (SOP Act) and which were served under two separate subcontracts for civil, stormwater and associated works at a project at Bankstown Airport in NSW (SOPA Proceedings).

Shortly prior to filing the SOPA Proceedings, KCC entered into voluntary administration, and was an entity described by the administrators as ‘hopelessly insolvent’. Notwithstanding this, the administrators recommended, and the creditors voted that a holding Deed of Company Arrangement (DOCA) be entered into, for the dominant purpose of pursuing Richard Crookes for payment of the payment claims.

It was common ground that the payment claims were validly made under the SOP Act.

Richard Crookes then commenced separate proceedings under the Corporations Act 2001 (Cth) (Corporations Act) seeking to terminate KCC’s DOCA, which was alleged to be for an improper purpose, namely circumventing the operation of s32B of the SOP Act, which precludes a company in liquidation from serving a payment claim or enforcing a payment claim (Corporations Act Proceeding). Richard Crookes also filed a notice of motion in the SOPA Proceedings seeking to have those proceedings dismissed as an abuse of the court’s process.

Both sets of proceedings were listed for hearing before Justice Ball.

The DOCA

The DOCA, which is a binding arrangement between a company and its creditors governing how the company’s affairs will be dealt with, was carefully drafted to permit KCC to avoid liquidation temporarily, and simply to pursue Richard Crookes for payment for outstanding payment claims under the SOP Act.

The DOCA provided, in effect, that the amount due and payable by Richard Crookes in respect of the payment claims and as claimed in the SOPA Proceedings, would be held in trust until the final resolution of any claim by Richard Crookes. As such, the funds would not become available for distribution to the creditors until any claim made by Richard Crookes had been finally resolved.

Given this drafting, the ‘pay now, argue later’ principle which underpins the SOP Act is still preserved under the DOCA.

Section 32B of the SOP Act

In its defence, Richard Crookes relied upon section 32B of the SOP Act, which provides:

“a corporation in liquidation cannot… take action under this Part to enforce a payment claim”.

Richard Crookes argued that the DOCA was consequently entered into for a wrongful purpose as it was entered into to defeat the operation of section 32B of the SOP Act. It was their submission that, the purpose of the section (and SOP Act as a whole) was to ensure cash flow for solvent entities undertaking work under its scope, and not for payment to be made which would benefit the creditors of an already failed company. As such, it was argued that the DOCA should be terminated pursuant to s445D(1) of the Corporations Act or otherwise stayed as an abuse of process.

In rebuttal of Richard Crookes position, KCC relied upon a strict interpretation of the section, arguing that it plainly seeks to deny the benefit of the SOP Act to a company in liquidation, not any company that is insolvent.

The Decision

Justice Ball ordered that the Corporations Act Proceeding must be dismissed and that KCC is entitled to judgment on its claim in the SOPA Proceedings. His Honour noted that it is not correct to characterise KCC’s claim as an attempt to avoid the operation of section 32B, rather, it has organised its affairs so that it falls outside of the scope of that section, whilst ensuring that the policy of the SOP Act is preserved to permit interim payment.

In Kennedy Civil Contracting Pty Ltd (Administrators Appointed) v Richard Crookes Construction Pty Ltd (No 2) [2023] NSWSC 248, Justice Ball made orders dismissing the motion in the SOPA Proceedings and dismissing the Corporations Act Proceedings however also stayed these orders pending a notice of appeal.

Key Takeaways

The decision of Justice Ball has key takeaways for principals, contractors and others in the construction industry:

1. principals administering contracts and subcontracts must ensure that they continue to uphold their obligations under the SOP Act notwithstanding that the contracting entity is insolvent or has entered into administration;
2. contractors should continue to submit valid payment claims under the SOP Act, aside from the fact that they may be entering into administration; and
3. administrators should ensure that any DOCA that is subject to outstanding payment claims under the SOP Act, is drafted clearly to preserve the rights of a respondent (under SOP Act) to make any final contractual claim (for the amount of such payment claims), so as to avoid the risk of subversion of s32B of the SOP Act.

Notwithstanding the above commentary and subject to an appropriately drafted DOCA as described above, respondents to payment claims should still consider seeking a stay of any proceedings to enforce payment claims (prior to the filing of an adjudication certificate), if the contractor is, or has demonstrated a likelihood of becoming insolvent. In deciding whether to grant a stay the Court will seek to balance the competing policies of the SOP Act as described by Ball J in Hakea Holdings Pty Ltd v Denham Constructions Pty Ltd [2016] NSWSC 1120 (and more recently supported by Richmond J in Piety Constructions Pty Ltd v Megacrane Holdings Pty Ltd [2023] NSWSC 309):

“One is that contractors should be paid promptly for the work that they have done. The other is that any payment under the Act is not intended to affect the rights of the parties under the relevant construction contract. To give effect to the second of these policies, the SOP Act specifically provides in s 32 that the court or tribunal hearing a dispute under the relevant construction contract may make such orders as it considers appropriate for the restitution of any amount paid as a result of an adjudication determination. That right may prove to be worthless if the contractor is or becomes insolvent.”

The factors that the court will take into account (see para [6] of the judgment in Hakea Holdings Pty Ltd) in balancing the competing policies include the following:

1. the strength of the applicant’s claim;
2. the basis of the applicant’s claim. Obviously, an important factor is whether the applicant challenges the adjudicator’s determination. Another important factor is whether the applicant challenges the debt the subject of the adjudication determination. The absence of a challenge to the debt is a powerful factor against the grant of a stay;
3. the likelihood that the contractor will be unable to repay the amount the subject of the determination. It is accepted in this context that the policy of the Act is generally to place the risk of insolvency on the applicant. However, where there are strong reasons for believing that the applicant will be unable to recover any amount paid, that fact favours granting a stay; and
4. the risk that the contractor will become insolvent if a stay is granted.

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Authored By:

Matthew Taylor, Partner
Ryan James, Lawyer