On 28 September 2018, the NSW Supreme Court in Greenwood Futures v DSD Builders (No. 2) [2018] NSWSC extended a stay of a judgment in favour of a contractor based upon a Security of Payment Act NSW (SOPA) adjudication on the basis that the contractor was at risk of insolvency. This is consistent with previous decisions of the court in similar circumstances.

On 18 September 2017 and 1 July 2018, new retrospective insolvent trading laws came into force. Designed to protect companies in the process of restructuring (and to ensure higher chance of recovery from insolvency events), the new regime introduced, of significance:

  • a ‘safe harbour’ for company directors from personal liability for companies trading insolvent
  • a stay on the enforcement of ipso facto clauses during a period of restructuring of a company (that is a clause entitling the other party to terminate the financially distressed party on the basis of that financial distress alone).

Given the prevalence of contractor insolvency, the new regime is likely to be utilised by contractors in the building and construction industry. Notwithstanding, there appears to be the potential for the reforms to conflict with the courts’ approach towards contractor insolvency under Security of Payment legislation.

The safe harbour regime

Essentially, the new safe harbour scheme protects directors from insolvent trading liability if the director can show that they are developing a course of action which is ‘reasonably likely’ to lead to a ‘better outcome’ for the company than administration or liquidation. The period of safe harbour can continue from the point the director begins to develop the course of action up to the point an administrator or liquidator is appointed to the company.

Accordingly, if the director of a company can show that it is abiding by the conditions to move the company away from insolvency (as specified in the legislation), a company/director may have grounds to assert ‘safe harbour’ in proceedings against that director for insolvent trading.

A contractor in financial distress, may well use the Security of Payment regime to improve cash flow, as presumably the sort of ‘better outcomes’ they might be looking for involve being paid for the work they have done.

SOPA’s approach towards contractor pre-insolvency

There have been a number of cases, whereby the courts have stayed or prevented the enforcement of an adjudication determination (or judgment) where it is established that the beneficiary of that determination (or judgment) is insolvent or at risk of going insolvent. The underlying rationale is that the interim nature of the regime would be negated should the contractor go into liquidation before final resolution of any dispute over the payment. In other words transferring the risk of insolvency onto the party liable to make payment.

For example, in the Supreme Court NSW decision of Hakea Holdings Pty Limited v Denham Constructions Pty Ltd; BaptistCare NSW & ACT v Denham Constructions Pty Ltd [2016] NSWSC 1120, the Court granted a stay in enforcement of a determination in favour of the contractor on the basis that the contractor was at risk of becoming insolvent, and consequently, would not be able to pay any debt challenged by the applicant. See also: R J Neller Building Pty Ltd v Ainsworth [2009] 1 Qd R 390 and Shade Systems Pty Ltd v Probuild Constructions (Aust) Pty Ltd [2018] NSWCA 33.

In the more recent decision of Greenwood Futures v DSD Builders [2018] NSWSC, the Supreme Court of NSW similarly granted the stay of a judgment on the basis “that there [was] a very real risk” of the contractor becoming insolvent. In that case, the Court considered the financial position of the contractor and re-structuring practices of the contractor’s directors. The Court found that the directors were engaged in structuring their affairs in such a way so as to avoid paying their liabilities. By way of example, the directors would plague respondents with a succession of payment claims and adjudication applications and would consign insolvent companies to liquidation, creating new companies to take their place.

What to expect?

As the underlying facts of the above cases pre-date the introduction of the new insolvency laws, the application of the ‘safe harbour’ reforms was not in issue. However it seems that if the directors of such companies were seeking to trade their way out of insolvency then those efforts might have been easily frustrated, by nature of the very regime implemented by the legislature to improve their chances of avoiding insolvency.

Where courts have historically stayed the enforcement of an adjudication determination where it can be shown that the contractor is on the verge of insolvency, it will be interesting to see how the courts will grapple with the purpose of the insolvency reforms in considering whether a stay ought to be granted.