Principals or contractors dealing with insolvent downstream companies should ensure they can properly substantiate any counterclaims.
Usually a principal is not entitled to rely on a set-off or counterclaim to resist court proceedings to recover a debt under the Building and Construction Industry Security of Payment Act 2002 (Vic) (SOP Act). However because of the operation of section 553C of the Corporations Act, the situation is different if the claimant is in liquidation.
Insolvent subcontractor’s claim
In Façade Treatment Engineering Limited v Brookfield Multiplex Construction Pty Ltd  VSC 41 the plaintiff subcontractor sought judgment for unpaid amounts claimed in two payment claims under the SOP Act. It alleged the contractor provided no payment schedule in response to either claim.
Section 16(2)(a)(i) of the SOP Act provides that where a payment claim has been validly submitted under the SOP Act and no payment schedule in response is provided, the claimant may recover the unpaid portion of the claimed amount as a debt. Section 16(4)(b) of the SOP Act provides that a defendant to recovery proceedings for a debt under the SOP Act is not entitled to raise a counterclaim in those proceedings.
The subcontractor was placed into liquidation on 6 February 2013, before the proceeding to obtain judgment was commenced, but after it submitted the relevant payment claims.
Contractor's counterclaims and set-off defence
The contractor maintained it had significant counterclaims against the subcontractor for liquidated damages and for failure to complete the work under the subcontract. It claimed that the quantum of these claims exceeded the subcontractor’s entitlement to judgment under the SOP Act.
The contractor submitted that it was entitled to set off its counterclaims against the subcontractor's entitlements under the SOP Act, pursuant to section 553C of the Corporations Act.
Section 553C of the Corporations Act provides a statutory set-off scheme which operates where there have been "mutual credits, mutual debts or other mutual dealings" between an insolvent company that is being wound up, and a person who has a debt or claim against the insolvent company. The set-off under section 553C is self-executing — it occurs automatically at the time of liquidation.
Conflict between section 553C and the SOP Act resolved
The case turned on whether the subcontractor's claim to judgment under section 16 of the SOP Act failed because of the operation of section 553C of the Corporations Act.
Justice Vickery referred to cases that illustrate the usual operation of the SOP Act, which is to protect contractors' cash flows, allowing claimants to recover entitlements under the SOP Act regardless of the existence of set-off or counterclaim.
However, His Honour found that it would “fly directly in the face” of the scheme established by section 553C of the Corporations Act for a company in liquidation to enter judgment for a monetary entitlement claimed under section 16(2)(a)(i) of the SOP Act without taking into account any cross claim or defence by way of set-off.
Justice Vickery found that the conflict between the statutory set-off under section 553C of the Corporations Act, and the prohibition on bringing a counterclaim in section 16(4)(b) of the SOP Act, is resolved by section 109 of the Constitution. That section provides that where a law of a State is inconsistent with a law of the Commonwealth, the latter shall prevail to the extent of the inconsistency.
On this basis, Justice Vickery held that no judgment should be entered under section 16(2) of the SOP Act in favour with the subcontractor. His findings are consistent with the recent West Australian case of Hamersley Iron Pty Ltd v James  WASC 10, which also found that section 553C of the Corporations Act overrides any prohibition on set-off contained in State security of payment legislation.
When "notice" of insolvency is assessed under section 553C(2)
One limitation of section 553C is contained in section 553C(2). It provides that a person may not claim the benefit of a set-off if that person had "notice" of the fact that the company was insolvent at the time of "giving credit to the company, or at the time of receiving credit from the company".
The subcontractor submitted that the relevant date to assess the operation of section 553(2) was the time when the contractor was liable under the SOP Act to pay the payment claims and the contractor had notice of its insolvency at this time, thereby precluding it to claim the benefit of a set-off under section 553C.
Justice Vickery disagreed, finding that the relevant date was the date the parties entered into the subcontract. At this date the contractor had no notice of the subcontractor’s insolvency and therefore section 553(2) did not operate to preclude the set-off.
A subsidiary question considered by Justice Vickery was whether an email from the respondent contractor to the claimant subcontractor asserting that a payment claim was invalid could constitute a valid payment schedule under the SOP Act.
In the course of concluding that the email did constitute a payment schedule under the SOP Act, Justice Vickery observed that section 15(2)(d) of the SOP Act contemplates the possibility of a prescribed form of payment schedule. His Honour appears to give some support to the introduction of a prescribed form, on the basis that the issue may not have been litigated had there been a prescribed form.
Liquidators will need to consider any claims against the insolvent company which may be set off against entitlements the insolvent company may have under the SOP Act.
Principals or contractors dealing with insolvent downstream companies should ensure they are in a position to properly substantiate any counterclaims they may have so as to gain the benefit of section 553C of the Corporations Act.