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Construction companies can now be more confident that appointing an administrator will lead to a successful outcome.
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How NSW test case adds up for builders about to pull the pin
31 March 2023
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13 minute read
The construction industry traditionally faces the most cash flow pressure and results in the highest number of insolvencies of any sector. ASIC figures showed 1,284 construction-related companies went into insolvency last financial year and this year, there have already been 1,236. Surging inflation, supply chain issues, spiking materials costs, and labour shortages have created a perfect storm.
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But there are often other factors at play, too. We and others in the insolvency and legal sectors often find the standard response from any debtor upon receiving notification that a liquidator or administrator has been appointed to a company is to immediately assert a cross-claim or damages (often at an inflated amount) to simply avoid paying the insolvent company. They typically do this with impunity because construction litigation is a very expensive and time-consuming process and, as the entity they owe the debt to is insolvent (or facing dire cash flow pressure), they know in the vast majority of cases, it will simply not have the means to pursue them through the court or be able to put up security for costs even if they were to commence proceedings.
The NSW Building and Construction Industry Security of Payment Act 1999 — like other such acts around the country — is intended to improve cash flow in the building and construction industry. All contractors doing construction work or providing goods or services under a construction contract have the right to receive progress payments for work delivered. This is to support cash flow to contractors. The Act operates as a form of alternative dispute resolution that provides interim relief; once a party has paid, they can sue in court and seek restitution for any monies paid under the Act. It’s commonly referred to as a pay now, argue later scheme.
However, the Act hasn’t applied to insolvent companies. Until now.
SOP test case a trailblazer
In February this year, Jirsch Sutherland, working closely with Chamberlains Law Firm, launched a case to test the ambit and scope of section 32B of the SOP Act, which provides that: “A corporation in liquidation cannot serve a payment claim on a person under this part or take action under this part to enforce a payment claim (including by making an application for adjudication of the claim) or an adjudication determination.”
As background, there had previously been some contention under the SOP regime as to whether it should apply to construction companies that were insolvent or in liquidation. In 2016, the Victorian Supreme Court of Appeal said it would not,[[1]] but, in 2019, the NSW Supreme Court of Appeal said it would.[[2]]
After industry consultation and various reviews at both a federal and state level into the SOP regime, NSW enacted an amendment to the SOP Act by inserting the new section (s32B) that expressly provided that the SOP Act would not apply to a construction company in liquidation.
Which is where our case* comes into play. We set out to test the ambit and scope of section 32B.
Our case involved a construction company, Kennedy Civil Contracting (KCC), which went into voluntary administration in August 2022. As administrator, Jirsch Sutherland found the company to be “hopelessly insolvent”. In our assessments, we also found that KCC was owed monies by a range of debtors, including almost $687,000 by Richard Crookes Construction Pty Ltd for civil, stormwater, and associated construction works it had undertaken in November 2021. During the performance of the works, KCC served several payment claims under the SOP Act, and while Richard Crookes responded to some of the claims with payment schedules, they failed to respond to others.
With this in mind, we decided to test the water, with the ultimate aim of being able to provide greater returns to creditors.
Rather than go into liquidation, at a meeting of KCC’s creditors, a vote was carried to execute a holding deed of company arrangement (DOCA), a common tactic used to return a better result to creditors. In the case of KCC, it was for the dominant purpose of pursuing Richard Crookes under the SOP Act. It was acknowledged by KCC’s creditors that the company would inevitably be placed into liquidation in the future and that entering into the holding DOCA was being done simply to “get around” s32B of the SOP Act. The creditors were broadly in favour of implementing a process that would maximise their potential return.
We were bullish in undertaking the case. This is why from a statutory interpretation perspective, the clear wording of section 32B and the fact that liquidation was the only form of external appointment selected by Parliament were strong indicators that our case (that s32B doesn’t apply to administration or entities which are insolvent, provided they aren’t formally in liquidation) would be successful.
On February 10, 2023, the Supreme Court handed down judgement conclusively answering the question of whether the SOP Act can be used on behalf of an entity that’s insolvent. The decision in the Kennedy Civil Contracting Case is the first reported decision testing the ambit and scope of s32B and the implications are far-reaching.
Benefits for construction sector
The benefits for the construction sector will be significant. This sector faces abnormal cash flow pressure when compared to other industries. That position has become even more precarious in the current economic climate due to macro-economic pressures affecting the supply chain, leading to significant increases in the price of materials.
Combined with the ipso facto reforms, construction companies can have more confidence that pulling the trigger to appoint an administrator will not automatically mean that their head contractors or principals on all projects will “slam the chequebook shut”. There is also far greater scope for the outcome of an administration to be successful, for example, by having the company be returned to the directors/shareholders through a DOCA where the deed fund is substantially comprised of funds recovered by using the SOP Act. In essence, while the moratorium on enforcement by creditors while an entity is in administration has always operated as a shield, now the SOP regime can be used as a sword.
In the current economic climate, there are probably a lot of construction companies trying to decide whether to trade out of a precarious solvency position or just pull the pin and appoint a liquidator. For all those entities, they should probably now be considering implementing administration as part of their remedial business strategy.
Implications for the insolvency sector
The implications for insolvency practitioners will be equally significant. Typically, even for claims that have previously been approved, a debtor will stonewall an approach from an administrator, knowing that the administrator likely lacks the resources to pursue them. Now, as a result of this judgement, there’s a far greater chance of holding these debtors to account to ensure a company is paid for the work they performed. This, in turn, has a flow-on benefit of maximising returns to creditors, increasing the prospects of a DOCA returning more to a creditor than if the company is simply wound up.
For a more detailed summary of the case click here.
*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.
Trent Devine is a partner at Jirsch Sutherland and Michael Terry-Whitall is legal director, building and construction, at Chamberlains Law Firm.
[1] Façade Treatment Engineering Pty Ltd (in liq) v Brookfield Multiplex Constructions Ltd [2016] VSCA 247
[2] Seymour Whyte Constructions v Ostwald Bros Pty Ltd (in liq) [2019] NSWCA 11
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