1. Summary

In a decision likely to be followed by Australian courts, the High Court of New Zealand has confirmed that the step-in rights (or ‘take out’) clause in a construction contract can create a security interest.  These clauses grant the principal (or financier) rights to complete the works (sometimes using the contractor’s equipment and materials) where, for example, the contractor has become insolvent. The case and the particular provision are summarised in part 4 below.

As they will likely constitute a security interest under Australian law, step-in rights of this type may only be effective if they have been properly perfected under the PPSA.

Financiers should assume that step-in rights under construction contracts and tripartite agreements will create a security interest where such clauses grant the financier rights in property (for example, the right to take possession and use the contractor’s equipment to finish the works and to sell the equipment to recover the outstanding monies) and take the steps we have outlined below. This is especially the case given that the provision in question was substantially similar to provisions used in a number of Australian Standard construction contracts (for example, clauses 39.5 and 39.6 of AS4092-2000),

Step-in rights that do not give an interest in property (and only a right to complete the works with, for example, the principal’s own material and equipment) may not constitute a security interest.

2. What if I do nothing?

  1. Financiers (and principals) may not be able to effectively exercise their step-in rights under the relevant tripartite (or construction contract) unless they have taken steps to perfect their relevant security interest.  
  2. Financiers who fail to ensure that the principal perfects any security interest granted in favour of that principal may be disadvantaged (given that the financiers will ultimately have the benefit of such security interest).
  3. Even where a financier (or principal) has perfected its security interest, it may not be able to exercise its rights under that security interest where the contractor has granted security to another financier.

3. Three things financiers should do

  1. Require principals to perfect:  Financiers need to ensure that security interests granted in favour of both themselves but also obligors under financing documents are adequately perfected.  Financiers should include an obligation in the finance documents on the principal to perfect any security interest granted in its favour within applicable time limits. In complex projects, such obligations may be required throughout the contract train (ie from project co through to the builder and relevant subcontractors) and may need to be included in relevant tripartite agreements.

Financiers should also ensure that the relevant construction contract (and subcontracts, where relevant) and the tripartite agreement contain adequate PPS-drafting to ensure that the financier (who ultimately has the benefit of each relevant security interest) can exercise its rights to step-in with minimal delay.

  1. Register a Financing Statement:  Financiers should ensure the step-in rights in the tripartite agreement itself are also perfected by registering a financing statement on the Personal Property Securities Register. 

Financiers should also review arrangements currently in place to determine whether they create a security interest and perfect accordingly. In certain circumstances (i.e. where the arrangements were entered into prior to 1 February 2012) financiers may have protection under the transitional provisions of the PPSA. However, you should ensure that such reviews are finalised and relevant steps are taken prior to the end of January 2014 (the end of the transitional period).

  1. Consider intercreditor agreements:  Consideration should be given to whether intercreditor agreements with other secured creditors are appropriate.

4. The case

When are step-in rights a security interest?

McCloy v Manukau Institute of Technology [ 2013 ] NZHC 936 concerned a dispute between the receivers of a construction contractor called Mainzeal (the Contractor) and the principal (Hobson Gardens) (the Principal). In completing the works, the Contractor had placed two large hoists on site. 

The contract provided that, if receivers were appointed to the Contractor and the receivers failed to take over the works, the Principal had the right to use the Contractor’s hoists to finish the works and to sell the hoists to recover liabilities owing to the principal. 

The court held that these provisions were “clearly intended to provide [the Principal] with a form of security over [the Contractor’s] interest in… the construction machinery (and therefore the hoists).” 

Accordingly, the particular clause granted an interest in personal property (the construction machinery) which secured the obligations of the contractor to complete the contract.

When will step-in rights rank behind other security interests in the same assets?

Bank of New Zealand (BNZ) had previously registered a General Security Agreement and a number of specific security interests over the Contractor. The court therefore applied the priority rules set out in the NZ PPSA and held that BNZ had a prior-ranking security interest in the relevant assets.