Hundreds of large and small construction companies operating in NSW have become insolvent in the past few years. This has left many subcontractors out-of-pocket. In August 2012, the NSW Government took a step towards reducing the rate of insolvency in NSW, and the disastrous effect this can have on subcontractors (in particular) by launching an inquiry into insolvency in the construction industry.

The inquiry, chaired by Mr Bruce Collins QC, released its final report in January 2013. The inquiry’s findings are set out in comprehensive detail. It makes 44 recommendations for change.

The window for making written submissions in response to the final report has now passed. The next step is for the Government to indicate which of the recommendations it will seek to implement. While it is currently difficult to foresee the recommendations that are likely to be implemented, below we comment on some of the more significant recommendations that promise, if implemented, to dramatically alter NSW’s construction industry.

The statutory construction trust

While it is a relatively new concept in the Australian construction industry, the statutory construction trust has been used successfully in parts of North America for decades. The report includes a detailed analysis of construction trusts and in fact over one-third of the recommendations it makes relate to the construction trust it proposes should be adopted.

Without the statutory construction trust, the status quo often plays out as follows:

  1. A subcontractor submits a payment claim to the head contractor;
  2. The head contractor incorporates the subcontractor’s payment claim (to the extent it considers it is valid) in its payment claim to the principal;
  3. The principal pays the head contractor’s payment claim, leaving the head contractor free to do whatever it likes with those funds (including the proportion of the funds that relate to the subcontractor’s payment claim). It may, for instance, use the funds to clear a bank overdraft, or pay subcontractors on another job;
  4. The head contractor pays the subcontractor (from whatever source of funds it likes) by the due date under its contract with the subcontractor.

The report identifies that a fundamental problem with the status quo arises when a head contractor becomes insolvent after it is paid by the principal but before the subcontractor is entitled to be paid. This often leaves the subcontractor out-of-pocket and, as an unsecured creditor of the head contractor, unlikely to recover much if anything of the amount it is entitled to be paid. Given the report observes that roughly 80% of a head contractor’s payment claims relate to payment for work performed by its subcontractors, it is easy to see why it promotes a change to the status quo.

While it is not seen as a panacea, the statutory construction trust is presented as part of the solution to this problem—at least for large projects worth upwards of $1 million. The statutory construction trust is said to ensure that the actual funds paid by the principal to the head contractor relating to the subcontractor’s work are paid (via the trust) directly to the subcontractor and are not used by the head contractor for some other end.

In summary, the proposed model would operate as follows:

  1. The head contractor creates a trust bank account for the project in question that is segregated from any other bank account operated by the head contractor;
  2. The payment by the principal to the head contractor is paid directly into the trust bank account;
  3. On or before the due date for payment of the subcontractor’s payment claim, the head contractor pays the subcontractor funds directly from the trust account;
  4. Assuming funds remain in the trust account after the subcontractor has been paid (including interest but excluding any retentions), the head contractor may use the remaining funds however it likes;
  5. Once the head contractor has paid the subcontractor the amount to which it is entitled, its obligations end (until the next progress payment is made by the principal to the head contractor).

The same arrangement will apply to all parties down the contractual chain: i.e. a subcontractor will need to establish a trust bank account for its sub-subcontractors and follow the above process.

A related recommendation is a statutory requirement for a head-contractor’s payment claim to be paid within 15 days, and for a subcontractor’s payment claim to be paid within 28 days. Non-compliance would be an offence and would attract penalty interest. This recommendation is intended to ensure prompt payment out of the trust accounts.

The report also suggests it is important that the statutory construction trust ‘neatly dovetails’ with the existing Building and Construction Industry Security of Payment Act 1999 (NSW) (the NSW Act). It accordingly suggests that any disputes arising between the parties as to what is due and payable in or out of the construction trust should be dealt with under the existing adjudication process under the NSW Act.

Adjudication under the NSW Act is aimed at ensuring the prompt delivery of a decision on what is payable (which is binding on the parties unless and until a party brings court or arbitration proceedings). Aligning the NSW Act with a new statutory construction trust regime will sensibly help to ensure that, even in the event of a dispute, money will promptly move in and out of the trust.

The report also recommends that the existing payment claim / payment schedule regime under the NSW Act should also apply to payments in and out of the statutory construction trust.

Creation of a NSW Building and Construction Authority

The report recommends the creation of a new authority to control and regulate the building and construction industry in NSW. The report suggests that the establishment of such a body is the only way to institute, implement, and monitor appropriate building reforms.

The report notes that, in Queensland, all policy and services in relation to building and construction are coordinated and provided by a single body (the Queensland Building Services Authority). It observes that the Queensland Building Services Authority is involved in such matters as licensing contractors, educating consumers and contractors, implementing and enforcing legislative reform, and performing financial audits.

The report recommends that the NSW Government undertake a cost-benefit exercise to ascertain whether a single building authority would be worthwhile.

Licensing system for all commercial builders

The report laments that, apart from the Northern Territory, NSW is the only Australian jurisdiction that does not require commercial builders to be licensed. The report considers in detail and applauds the Queensland licensing model, and particularly the financial requirements that accompany the types of licences available in Queensland.

The report recommends a licensing system requiring commercial contractors to qualify for various licensing categories based on the financial backing they can show for a particular project.

Licensing in this way (along with other measures, such as financial auditing and education) is said to prevent contractors from committing to projects that they may not be able to financially withstand.

What the recommendations mean for you

The recommendations noted above are just some of the 44 recommendations made by the inquiry. The Government must now review the recommendations and ponder public submissions before it reaches a view on which recommendations it wishes to adopt. Many of the recommendations promise to shake-up the construction industry in NSW. Watch this space.