Background

The construction industry faces perennial problems of poor cash flow and insolvency rates far higher than the industry’s share of national gross domestic product (in recent years the construction industry has produced 8 to 10% of national GDP, but accounted for 23% of all external administrations).1

‘Proof of payment’ requirements

Parliaments have regularly introduced or reformed legislation to address these problems, including, most recently in New South Wales, prohibiting a head contractor from submitting a payment claim to a principal unless the payment claim is accompanied by a supporting statement declaring that it has paid all of its subcontractors all amounts due and payable.

It was also made an offence to submit a supporting statement that is known to be materially false or misleading (the maximum penalty being $22,000 or 3 months imprisonment, or both).

These important requirements were introduced into the Building and Construction Industry Security of Payment Act 1999 (NSW) (Security of Payment Act) as a measure to ensure that subcontractors are being paid on a timely basis and are not suffering unduly by being lower down on the chain of cash flow.

While other States and Territories have not introduced this specific legislative requirement, it has become standard practice nationally in construction contracts to require a contractor to submit, with each payment claim, a statutory declaration certifying that all monies owed to subcontractors have been paid.

Unfortunately, these requirements appear to have been less effective than intended. There is evidence that contractors have been providing statements attesting that payment obligations to subcontractors have been satisfied, when, in fact, the subcontractors have not been paid. There is also evidence that contractors have been manipulating the meaning of when amounts become ‘due and payable’ to subcontractors in an attempt to justify delayed payment or non-payment.

This can have serious flow-on effects for smaller subcontractors, many of whom are already operating with substantial cash flow pressure.

ASIC surveillance campaign

ASIC recently completed a surveillance program which reviewed the use of proof of payment declarations by contractors and monitored the integrity of payment systems in the building and construction industry.

ASIC monitored eight large Australian commercial construction projects for a three-month period. It undertook surveillance of payment process and systems of 40 small and large-sized contractors and issued warning letters to contractors whose proof of payment declarations were found to be deficient. The offending contractors were advised to review their internal compliance systems and processes.2

Recommendations

Enhanced regulatory surveillance and prosecution of falsified declarations will be useful in deterring some unlawful behaviour, although realistically the resources available to regulators to ramp up efforts in this regard may be limited.

Ultimately, the problems that flow from insolvent or financially stressed subcontractors impact on principals and head contractors and result in delayed, more expensive or poorer quality projects delivered to customers and the community. To address these problems principals and head contractors should consider processes and information requirements that can be implemented in construction contracts and projects to ensure there is greater transparency and certainty around payment of subcontractors.

Moving more of the payment claim process and data into electronic form, which can be immediately analysed and reported by software may enable principals and head contractors to identify and investigate anomalies more quickly. That in turn should improve transparency and good payment practices down the chain of subcontractors and alleviate some of the perennial cycle of insolvency that the construction industry has experienced in the past.

We are aware of initiatives in this vein and will report on them in a future article.