Most construction contracts allow for a principal or head contractor to require the other contractor or subcontractor to provide a form of security. The purpose is to protect the principal or head contractor from loss should the other party breach the contact or fail to perform its obligations.
The simplest form of security constitutes the principal withholding a specified sum of money from a contractor / subcontractor’s progress payments. This is known as a retention amount or cash security.
The timing of release of the retention amount after work is completed by the subcontractor is sometimes contentious. Many contracts do not allow release of retention monies until certain events under the head contract are achieved. In this respect, security of payment legislation across all jurisdictions of Australia prohibit ‘pay when paid’ provisions.
In its simplest form, a ‘pay when paid’ provision is a contract term that makes payment to a contractor / subcontractor contingent upon the head contractor or principal being paid. However, the legislation goes further to catch certain other provisions which by their nature, will constitute a ‘pay when paid’ provision.
In Maxcon Constructions Pty Ltd v Vadasz  HCA 5 the High Court took a broad approach in defining a ‘pay when paid’ provision and determined that certain terms tying the release of retention monies to an event under the head contract will constitute a ‘pay when paid’ provision and be void.
Maxcon Constructions Pty Ltd (Maxcon) (as head contractor) entered into a contract with Mr Vadasz (as subcontractor) for the design and construction of piling for an apartment building.
The contract provided for security in the form of a cash retention of 5% of the contract sum which was to be released to Mr Vadasz once the certificate of occupancy for the building issued.
Mr Vadasz completed the work under the contract and served a payment schedule on Maxcon from which Maxcon deducted retention monies. Mr Vadasz subsequently applied for the matter to be adjudicated and the adjudicator determined that the retention constituted a ‘pay when paid’ provision and was therefore void.
Maxcon appealed, asserting that the adjudicator had made an error.
‘Pay when paid’ provisions void
A ‘pay when paid’ provision is generally defined as a contract term that:
- makes the liability of one party to pay money owing to the other contingent upon some payment to the first party by a third party; or
- makes the due date for payment from one party to the other party, the due date for payment by the third party to the first party; or
- otherwise makes the liability to pay money owing, or the date for payment of that money, contingent or dependent on the operation of another contract.
The Court found that the clause making release of the retention money contingent upon issue of the occupation certificate fell within the third category of ‘pay when paid’ provisions and was therefore void.
In its reasoning the Court considered issue of the occupancy certificate was:
‘…dependent upon certification by the builder, Maxcon, that the building work had been performed in accordance with the issued documents, including the head contract between Maxcon and the owner of the land [and] issue of the certificate depended on completion of the whole project in accordance with the provisions of the head contract.’
In other words, release of the retention monies was essentially contingent upon completion of building work under another contract (i.e. between Maxcon and the landowner).
As a consequence:
‘…the due dates for payment of the retention sum were dependent on something unrelated to Mr Vadasz’s performance. They were dependent on the operation of another contract – namely, the completion of the head contract, which in turn would have enabled a certificate of occupancy to be issued.’
Clauses in construction contracts that tie the release of retention monies to an event under the head contract and not to the subcontractor’s performance (and other obligations under the contract) will likely constitute a ‘pay when paid’ clause, and be void.
Subcontractors may now be able recover retention monies earlier than once thought.
Principals and head contractors should review contracts to ensure that they are not relying on terms that breach security of payment legislation.