A Supreme Court of New South Wales decision in February 2014 is a timely reminder to creditors to ensure that agreements clearly articulate arrangements where funds are to be held on trust for a specific purpose.  The Court revisited the question of the entitlement to retention funds and competing creditor claims in the matter of National Buildplan Group Pty Ltd (subject to deed of company arrangement)(Buildplan)[1].

Buildplan was, prior to its administration, involved in the construction of residential, commercial, civil and mining infrastructure projects.  Its creditors included employees, secured creditors and unsecured creditors including a large number of subcontractors owed payments for retention monies under the contracts between each subcontractor and Buildplan.  Buildplan was engaged by a number of State government entities to undertake design and construction works in respect of various projects in New South Wales.  In some cases, these contracts were terminated after Buildplan was placed in administration and the government entity took steps to complete the works and rectify defects, resulting in those entities making claims in the administration of Buildplan as creditors.

The government contracts required Buildplan to hold subcontractor retention money retained by it as security in trust and deposit these monies in a trust account.  In addition, the government contracts stated that if Buildplan received payment for work done by a subcontractor who was not paid in full for that work, then the difference was to be held on trust for the subcontractor.

Buildplan initially operated a single bank account for its general operations where remittances were deposited and from which it paid subcontractors and the retention amounts due to them after the expiry of the particular defects period.

Buildplan did not comply with the requirements under the government contracts to deposit the retention payments for subcontractors in a separate bank account for each project.  However Buildplan used electronic software to maintain its financial recordings including details of the retention amounts and the identity of the subcontractors.  Buildplan was later advised by a government entity that the government contract required it to hold retention monies in a separate bank account on trust for the subcontractors, which it subsequently arranged.  Buildplan then opened a single retention money account.  Four lump sum payments, totalling $1,343,657, were deposited in the retention account and one withdrawal of $250,000 was made by Buildplan.

The company was distressed and administrators were appointed to Buildplan.  At the second meeting of creditors under Part 5.3A of the Corporations Act (Act), its creditors resolved that the company execute a deed of company arrangement (DOCA).  The DOCA noted that the retention amount was held on trust by Buildplan for various subcontractors and that the deed administrators would seek the Court’s direction as to which creditors, and the amounts, to whom monies should be distributed in accordance with the Court’s directions.

The administrators applied to the Court for directions under s447D of the Act to determine whether the monies in the retention account were held on trust for the subcontractors that carried out works under the government contracts and as to the proper distribution of funds.

Having examined all of the relevant facts to determine whether the company intended to create a trust[2], the Court found that the monies in the retention account were intended to be held on trust for subcontractors in respect of government contracts.  The relevant facts the Court took into account were:

  • The terms of the government contracts state that retention amounts in respect of subcontractor payments were to be held by Buildplan in trust and required a statutory declaration that those funds would be held on trust.
  • The purpose for which the retention account was opened and the manner in which it was operated including evidence from Buildplan’s officers that the account was opened to be held for all subcontractors in respect of work performed pursuant to subcontracts in New South Wales government projects.  However the Court noted that monies deposited in the account were for whole amounts and not referrable to particular subcontractors.

The administrators then proposed four scenarios to the Court as to how the funds were to be distributed.  The Court found that a distribution on a pro-rata basis to the subcontractors of government contracts was consistent with the purpose for which the retention account was established, that Buildplan did not keep separate records showing a breakdown of the lump sum payments to enable monies to be allocated to specific contractors and the fact that the deposit payments were made in lump sums.  The Court decided the rule in Clayton’s Case[3] did not apply in these circumstances and that a proportionate distribution was appropriate where trust money is mixed.

Clayton’s Case applies generally a “first in, first out” approach.  Where a trustee mixes money for 2 or more trusts in one account and then removes money, the trustee is deemed to have taken out the money first deposited in the account.  It is designed to facilitate tracing of money where the equities are equal and there may be difficulties in ascertaining the proportionate share to each trust.  The Court however found that it was appropriate to apply a pro-rata distribution in respect of the subcontractors of government contracts only.

There was no evidence that the subcontractors, other than those engaged on government projects, had within the terms of their contracts the requirement to set up trust arrangements with respect to retention monies accordingly those subcontractors were not able to share in the monies that the Court found was held on trust for the subcontractors owed retentions in respect of the government contracts.

This decision illustrates the power and effectiveness of contract terms that create a trust arrangement particularly when a company is subsequently under administration or liquidation.

Should a third party be holding funds for you for a specific purpose, it is critical to ensure that the contract accurately records the creation of a trust, that the funds are to be held on trust and that they are in fact kept separate from other money.  Importantly these steps are required to be undertaken to ensure that the funds are impressed with the trust for the particular intended purpose.  That way you shall take priority over other creditor claims in respect of those funds.