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By: HHG Legal Group
West Perth, Australia

Never do subcontractors have more reason to be worried than when head contractors become insolvent and no longer have the financial means to pay their subcontractors for the work they have done.  Indeed, the need ensure that cash flows to the subcontractors who need it the most is the very purpose of security of payment legislation.

In Hammersley Iron Pty Ltd v James [2015] WASC 10 Beech J of the WA Supreme Court may be said to have struck the right balance between the right of employees and subcontractors of insolvent head contractors, to be paid for the work they have done and the right of principals to prove and set off their counterclaims in the liquidation.  Beech J achieved this simply and practically by staying the head contractor’s application for leave to enforce an adjudication award under security of payment legislation pending determination of the counterclaims which the principal said it was entitled to set off against that award under section 553C of the Corporations Act.  At the same time, his Honour allowed the contractor to bring its application back before the Court if the principal did not take timely steps to prosecute the counterclaims which it relied on as the basis for staying the contractor’s application.   By allowing for the principal’s foreshadowed counterclaims (remember, it hadn’t claimed them yet) to be heard and determined before the insolvent contractor was allowed to enforce the adjudication award, Beech J’s decision was consistent with the policy of both the mutual set-off provisions of the Corporations Act and the security of payment provisions which governed the adjudication.  This is further considered in the article linked below:

More recently, in the Victorian Supreme Court, Vickery J took a very different approach in Façade Treatment Engineering Ltd v Brookfield Multiplex Constructions Pty Ltd.  In that case, Vickery J held that security of payment legislation was, in some cases, unconstitutional because it was capable of operating inconsistently with s553C of the Corporations Act where (in this order):

(a) a contractor obtains an adjudication award under security of payment legislation;

(b) that contractor then becomes insolvent;

(c) that contractor then applies for leave to enforce the adjudication award; and

(d) the principal resists this application by the insolvent contractor, in reliance on counterclaims which the principal says it is entitled to set off against the contractor’s claims under s553C.

According to Vickery J, when these very specific facts apply, security of payment legislation is invalid because of section 109 of the Commonwealth Constitution, which reads:

"Inconsistency of laws

When a law of a State is inconsistent with a law of the Commonwealth, the latter shall prevail, and the former shall, to the extent of the inconsistency, be invalid."

However, on one view, security of payment legislation, far from being inconsistent with s553C, can be made to operate alongside it, just as Beech J has one in Hammersley Iron.

Vickery J then says that where security of payment legislation is invalid because of inconsistency with Commonwealth law, it can be revalidated if the principal’s asserted counterclaims fail or are not progressed through the court in a timely way.  His Honour seeks to justify this finding by quoting a passage from a textbook on statutory interpretation.  However, as we read it, this passage says that the only way to revalidate a State law that is invalid because of inconsistency with a Commonwealth law is to repeal the Commonwealth law.

Vickery J concludes his judgment by saying that, having found security of payment legislation to be invalid (but only in limited circumstances and for a limited time), he did not have to:

“consider the second and alternative limb of the reasoning…in Brodyn [Pty Ltd v Dasein Constructions Pty Ltd [2004] NSWSC 1230] that, in construing security of payment legislation, it manifests an intention to operate only when the head contractor and the subcontractor are going concerns, and should be so construed”. 

This may be seen as a missed opportunity to give consideration to the basic purpose of security of payment legislation.  The legislation is there to provide contractors with a quick and informal way to keep cash flowing down the contractual chain in accordance with the contractual payment regime until the works under contract are substantially completed.  Where the principal or head contractor becomes insolvent, that contractual payment regime no longer applies and so, neither does security of payment legislation.  The contractual payment regime might appear to have survived the contractor’s insolvency in cases like Hammersley Iron and Façade However, in those cases, before the contractor became insolvent, it had already had its payment claims adjudicated.  All that was left for the insolvent contractor (or its liquidators) to do once it had become insolvent was to enforce the payment award which had already been made.  This means that, when the adjudication award was made in each case, no constitutional issue of the kind identified in Façade could have arisen.

In recent commentary, it was said that in fact, the decisions in Hammersley Iron and Façade were consistent because they both led to:

(a) the insolvent contractor having no immediate entitlement to enforce its adjudication award pending determination of the principal’s asserted counterclaims; and

(b) the contractor not losing its right to enforce the adjudication award later, should the asserted counterclaims be either dismissed by the court or abandoned by the principal.

That may be so at this early stage, each contractor having just applied for leave to enforce its adjudication award.  In due course, however, the two approaches are likely to lead to very different outcomes. For a start, unlike in Façade, the approach in Hammersley Iron recognises that courts have a discretion, which security of payment legislation gives them, to decide in each case whether and when to allow contractors to enforce their adjudication awards.  If, in exercising this discretion, a court does not take proper account of what the principal says are its rights of set-off under s553C, the principal can appeal on the basis that the court’s discretion in that particular case has miscarried.

However, if the courts start adopting the approach taken in Façade, they are likely to end up dismissing, as a matter of course (rather than a considered exercise of judicial discretion), all applications by insolvent contractors for leave to enforce their adjudication awards.  This is likely because, if there is any prospect at all that perhaps, one day, the principal might possibly have prosecuted its asserted counterclaims, and succeeded, and taken steps to set them off against the contractor’s entitlements under section 553C, then this would, on Vickery J’s reasoning, make prior enforcement of the contractor’s adjudication award unconstitutional.  This lingering risk of unconstitutionality could lead to permanent unenforceability of payment awards based merely on an asserted counterclaim, however unmeritorious, even if the principal never actually takes substantive action against the contractor.  This would be bad news for subcontractors and employees of the insolvent contractor who might well depend, for their own solvency or cash flow, on the cash injection that an enforceable payment award would have yielded.

Principals resisting future applications by insolvent contractors to enforce payment awards might consider arguing instead that the contractual payment regime, and the adjudication based on it, totally failed when the contractor became insolvent.   This argument, explained in our Daniel Morris's Brooking Prize winning paper,[1] would leave the liquidator to make an alternative claim outside the contract for the fair value (quantum meruit) of works done by the contractor before it had become insolvent.  This kind of application tends to be complex, and difficult and expensive to prove, which would make it a far less attractive option for any liquidator than simply enforcing an existing payment award.

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[1] “Restitution sans Rescission: Exposing the Myth of a Fallacy”, Australian Law Journal (2015) 89 ALJ 117.