There has been some recent discussion around the use by insolvency practitioners of the security of payment legislation. The benefits of engaging this process are obvious – there is an opportunity to secure payment for the insolvent company in a quick and cost efficient manner while also avoiding the financial burden of a security for costs order which the insolvent company (and hence insolvency practitioner) is likely to face in court proceedings.
This article considers these issues from the perspective of theConstruction Contracts Act 2004 (WA) (the Act) only. The position here is significantly different to the east coast model (as established by Brodyn v Dasein  NSWSC 1230) which has been the subject of recent comment (Robert Fenwick Elliot, “Support for the Bust?”, wordpress).
A consideration of these issues requires one to address a series of ancillary points, which we will consider in turn.
1. Can insolvent companies adjudicate on the basis of a construction contract that has been terminated as a result of the insolvency?
Following the decision of His Honour Justice Beech in Hamersley Iron Pty Ltd v James  WASC 10 (Hamersley) it appears that the answer is yes – although it depends.
In particular, it depends upon what is sought to be adjudicated (namely payment for performance of obligations under the relevant construction contract); when the obligations were performed for which payment is sought; and when the application for adjudication is launched.
The Hamersley case relates to the enforcement of an adjudication by an insolvent company in circumstances where there was a counterclaim by the company defending the enforcement application. For the purposes of this article the timeline of events in the Hamersley case is important:
- Work comprising contractual obligations was performed;
- 4 February 2014 - Payment claim served by contractor;
- 11 February 2014 - Administrators, receivers and managers were appointed;
- 17 February 2014 - Payment dispute arose;
- 24 February 2014 termination of the contract occurred; and
- 17 March 2014, an adjudication application was served.
So although the work was done and the contractual right to be paid existed prior to termination, and the payment claim was submitted prior to the appointment of administrators, receivers and managers, the commencement of the adjudication process under the Act did not occur until after the contract was terminated.
The crux of the issue as to whether an insolvent company can adjudicate in respect of a contract terminated as a result of the insolvency is most likely to lie in whether the rights a party is seeking to enforce under an adjudication have accrued prior to the contract being terminated, rather than prior to the time of the company becoming insolvent.
If this is correct, it will be possible for an insolvency practitioner, upon appointment, to send a payment claim in respect of work performed prior to insolvency, and then adjudicate in respect of that claim if it was disputed by the other party.
This is interesting because of the principle applied by judges under the east coast model in refusing to enforce an adjudication determination for an insolvent company on the basis that “[O]nce the subcontractor ceased to be a going concern, it no longer needs cash flow and the mischief to be covered by the Act [in this instance the east coast model act] is not present in that situation.” This rationale has not been applied in a manner that prevents the use of the adjudication process in these circumstances in W.A.
The same rationale could be extrapolated to apply to insolvent companies attempting to adjudicate in circumstances where their contract is terminated due to insolvency in relation to rights which only accrue upon termination. To the extent that these rights are contractual, it may still be that adjudicators are willing to process such claims. However, it is likely that to the extent that rights only accrue under general law, such as a breach of contract, these claims will have to be dealt with via alternate pathways, and outside the provisions of the Act.
Insolvency practitioners should quickly determine upon appointment:
- whether there are outstanding payment claims for which payment is due, but which have not been paid; and/or
- whether the company has performed obligations for which it has not yet made a payment claim. Practitioners should consider promptly sending a payment claim and adjudicating to secure payment.
Insolvency practitioners will also need to consider how quickly and easily they can compile the necessary documentation to demonstrate an entitlement to the monies allegedly due and owing to the company. The documents which are likely to be required are a payment claim, together with supporting evidence of the amount due and such information as the superintendent may reasonably require (such as day work sheets or invoices from third party suppliers for hired equipment).
Insolvency practitioners should also be aware of any time limits that might be contained in the construction contract that might otherwise affect the ability to submit a payment claim. As an example, a final claim for payment should be made within 28 days of the expiry of the defects liability period in order to avoid being time barred (Australian Standard AS2124).
Can insolvency practitioners use the adjudication process to secure payment of a payment claim to companies in liquidation?
Yes; unless there is a valid counterclaim.
The Act provides for the quick resolution of payment disputes through an adjudication process. The object is to keep money flowing under construction contracts. The process involves a 28 day application period (one must launch within 28 days of the date upon which the payment dispute arises), 14 day response period, and 14 day determination period, and generally each party bears their own costs.
As a “cash flow” process, adjudication, despite its lack of finality in terms of determining entitlement, can be a useful tool for insolvency practitioners to recoup unpaid payment claims owed to an insolvent company because of its speed and efficiency. So liquidators and other insolvency practitioners should be aware of its utility – and its limitations.
Ordinarily, once an adjudication determination is made, the successful party can apply for leave to enforce it (section 43 of the Act). This is required before taking steps under the Civil Judgments Enforcement Act 2004 (WA) (e.g. applying for a means inquiry or property (seizure and sale) order).
Leave is generally granted, however, due to the policy concerns which arise in relation to companies in liquidation, discussed below, the Supreme Court of Western Australia inHamersley has recently ruled that the grant of leave cannot be presumed in those circumstances. This is because an adjudication determination does not finally determine entitlement. This in turn means that there is a distinct possibility that a payment, or a portion there of, made to a company in liquidation could ultimately be finally determined as due and owing to the paying party – but of course, it would be unlikely that such a sum could be recovered from a company in liquidation.
It was held in Telstra v Worthing (1999) 197 CLR 61 that when a State law, if valid, would alter impair or detract from the operation of a law of the Commonwealth Parliament, then to that extent it is invalid. By analogy, adjudicators under the Act considering a determination in circumstances involving an insolvent contractor must apply section 553C of theCorporations Act 2001 (Cth) (Corporations Act) and this applies regardless of whose favour the balance operates in (i.e. whether the party seeking to make a claim or the party defending is insolvent).
Section 553C sets out a process for mutual credit and set off between an insolvent company that is being wound up and a person/company seeking to have a claim admitted against the insolvent company. The final result is that “only the balance of the account is admissible to proof against the company, or is payable to the company, as the case may be”.
Such a consideration allows for the set off of any monies which may be due to the respondent with only the balance being payable to the applicant, preserving the respondent’s interest in any counterclaim. This places a burden on the respondent to ensure that any off-setting claims are properly identified and substantiated at the time of responding so that the response demonstrates that the alleged monies are, on the balance of probabilities, owed to the respondent in compliance with the contract.
If, however, the adjudicator fails to apply section 553C at all (or its consideration is inapplicable at the time of adjudication because the relevant party is not yet insolvent), the judge may consider the implications of this section upon hearing an application to enforce the determination. Otherwise, if an adjudicator rejects a counterclaim, as was the case inHamersley, the court may still consider whether on the balance of probabilities the counterclaim exists and will exceed the amount claimed pursuant to the adjudication application for the purposes of section 553C.
The threshold for a judge to consider any counterclaim is lower than that of an adjudicator as the merits of counterclaim do not have to be determined. The test for a judge is that “a serious question to be tried” is raised by the alleged counterclaim, if so, that will be sufficient grounds so as to not grant leave. If a judge finds that this is the case, that will mean there are sufficient grounds to refuse to grant leave to enforce the determination.
Does section 553C(2) help?
That section provides that a person will lose its entitlement to claim the benefit of a set off under section 553C if, at the time of giving or receiving credit to the insolvent company, the person had notice of the company’s insolvency.
However, in Façade Treatment Engineering Pty Ltd (in liq) vBrookfield Multiplex Constructions Pty Ltd  VSC 41 (Façade), Justice Vickery determined that the relevant date for the purpose of “notice” under section 533C was the date that the subcontract was entered into between the parties, which suggests the section is of limited assistance to the situation of insolvency arising during the project works.
Such a position would need to be reconsidered in light of a long term contract. It is suggested it is neither just nor reasonable to allow a company that has current notice of the insolvency of a company to which it is providing credit to rely on its knowledge and the company’s status at the time of entering into the contract some years prior, in maintaining a set off.
Ultimately, it appears that where a counterclaim may be brought by the principal, and there is no requirement for it to have already been brought, the court will not grant leave under section 43 of the Act to enforce a determination until those counterclaims have been heard.
This significantly reduces the utility of bringing an adjudication application for an insolvency practitioner in circumstances where a counterclaim exists (which should in most situations be apparent from the Notice of Response issued in response to the Payment Claim).
Where a counterclaim has not been raised at the time of adjudication and is raised for the first time during the application for leave, it is not clear whether a judge would disregard the counterclaim on the basis that it has not been properly notified.
Under the east coast model, such a scenario would not arise as a respondent is barred from bringing a cross-claim or defence as part of the recovery proceedings. On the principle of achieving justice between the parties, required by section 553C , it would seem likely that if a counterclaim had not been properly notified prior to the recovery proceedings, there would need to be sufficient reasoning for the claim not to have been raised prior in order to allow it to be considered.
One point of concern for applicants using the west coast model, and arising out of the decision in Hamersley, is that the contractor’s application for leave was stayed until either the parties had agreed the quantum of the principal’s counterclaim or the principal had commenced proceedings against the contractor and proved its counterclaim. There was therefore no express requirement imposed on the principal to bring the counterclaim at all, or to do so in a timely manner. Presumably, if the party seeking to enforce did find itself in circumstances where the counterclaim has not been brought after a reasonable period, it could seek to have the court relist its leave application (although that leads to the question as to how long is a reasonable time).
Beech J’s judgment in Hamersley highlights that since insolvency would remove a contractor from the “contractual chain” (and the Act seeks to protect cash flow for companies within that chain) then allowing the contractor to enforce an adjudication award was no longer supported by the policy behind the Act. Such a decision is supported by section 553C which, by its purpose and object, requires “substantial justice” to be achieved between the parties. As such, principals should not be left to prove the monies owing to them (by way of a counterclaim) in the liquidation of a contractor in circumstances where the liquidators had secured recovery of a payment claim owing to the contractor.
As discussed below, similar policy considerations apply in circumstances where a contractor attempts to utilise an adjudication application to receive a better outcome than other creditors in relation to an insolvent principal.
Can contractors utilise the adjudication process to secure payment from principals in liquidation?
Probably not, because the Corporations Act overrides the Act.
The purpose and object of the Act is defined at section 30:
“An Act — to prohibit or modify certain provisions in construction contracts; to imply provisions in construction contracts about certain matters if there are no written provisions about the matters in the contracts; to provide a means for adjudicating payment disputes arising under construction contracts, and for related purposes.”
The Corporations Act Part 5.6, Division 6 “Proof and Ranking of Claims” provides the method of determining the existence and ranking of debts in relation to the winding up of a company whether in insolvency, by the Court or voluntarily. Section 553C of the Corporations Act further provides for mutual credit and set off in relation to insolvent companies.
Section 109 of the Commonwealth Constitution of Australia“Inconsistency of laws” states “When a law of a State is inconsistent with a law of the Commonwealth , the latter shall prevail, and the former shall, to the extent of the inconsistency, be invalid.”
As the Act is a law of the state, in so far as it conflicts with the Corporations Act Part 5.6, Division 6 “Proof and Ranking of Claims”, the Corporations Act prevails and precludes the company from using the Act to alter the ranking of debts. The balance struck by the Corporations Act is thus preserved and the operation of the Act is prevented from expanding beyond its intended purpose.
While Façade related to a default judgment involving a claimant company in liquidation, it covered many of the policy issues relevant to the conflict between security of payment schemes and the provisions of the Corporations Act. While not explicitly stated in the Façade judgment, the policy reasons for avoiding a conflict between the Corporations Act Part 5.6, Division 6 “Proof and Ranking of Claims” and legislation such as the Act include:
- One party cannot be entitled to insist upon receiving 100 cents in the dollar while others must join the pool of creditors and will ultimately receive a lesser amount;
- Substantial justice must be done between the claimant and the insolvent company;
- A company in liquidation is liable to each of its creditors in the manner of the scheme established under the Corporations Act; and
- Each of those creditors may equally challenge or seek to remedy their position in the manner prescribed under the Corporations Act.
Together, these provisions suggest that the operation of the Act is superseded by the Corporations Act in respect of securing payment from principals in liquidation.
Section 440D of the Corporations Act provides that a“proceeding in a court against the company or in relation to any of its property cannot be begun or proceeded with” against a company under administration without the consent of the administrator or leave of the Court.
In Auburn City Council v Austin Australia Pty Ltd  NSWSC141 (Auburn City Council) the company was under administration and the issue was raised as to whether arbitration proceedings are "a proceeding in a court" for the purposes of the Corporations Act section 440D. It was held that the similarities between what arbitrators do and what occurs in courts created by statute do not convert an arbitrator, who is appointed by reason of the arbitration agreement, into a ‘court’ for the purposes of the Corporations Act section 440D. This conclusion is not binding in Western Australia and appears to frustrate the policy of the Corporations Act, which is to allow administrators immediate breathing space by imposing a stay of proceedings on foot at the time of the administration.
However, this case is supported by a recent finding in Letizia v Australian Music Group t/as Allans Billy Hyde Music  FWA 9609 (Letizia) in which the Administrators' objected to the continuation of an unfair dismissal claims whilst Australia Music Group was under administration based on section 440D of the Corporations Act. The Commissioner found that Fair Work Australia was not a ‘court’ and that the employees could continue with their unfair dismissal claims. Again, this was a decision of a single member and is not binding.
These cases are in stark contrast to a large number of cases involving the state and national Industrial Relations Commission which has consistently been found to be a ‘court’ for the purposes of section 440D. The principle is therefore unsettled and will require further review by the legal system before the position can be stated with confidence. In light of Façade, it is likely that Auburn City Council and Letizia are inconsistent with the current position of the courts in respect of adjudicating against insolvent companies.
In a practical sense, the utility in commencing an adjudication against a company in liquidation is obviously doubtful. Any determination is unlikely to improve the contractor’s position as an unsecured creditor. And there will always be challenges in securing payment, because enforcement proceedings will be most certainly caught by the operation of section 440D.
If a contract is terminated due to insolvency, can a party adjudicate to get their retention/security money back?
It depends – on when the insolvency occurs and how the retention money has been treated.
Schedule 1 Division 9 section 11 of the Act obliges a principal to hold retention monies on trust, but there is no obligation to keep those funds in a separate bank account. In circumstances where retention /security monies have been kept separately from other funds it will be easier for the claimant to establish a right to those monies.
If the funds were contractually required to be kept in a separate, identifiable account, but were not in fact so held, then the matter is not so straightforward.
Where the funds have been pooled with other funds and are not clearly identifiable the claimant will simply be in the position of an unsecured creditor and the funds will not be recoverable through the adjudication process.
For the purposes of the Act, a payment dispute arises if:
“…(b) by the time when any money retained by a party under the contract is due to be paid under the contract, the money has not been paid; or (c) by the time when any security held by a party under the contract is due to be returned under the contract, the security has not been returned.”
As stated EC & M Pty Ltd v CTEC Pty Ltd  WASAT 14 at  sections 6(b) and 6(c) of the Act recognise that, in the ordinary course, a payment dispute could arise under the contract when the money retained is due to be paid under the contract or security has not been returned when due to be returned. Division 9, section 11(d) of the Act expressly provides that an adjudicator can make a determination in relation to retention monies.
But the purpose of retention money is to ensure that a contractor properly completes the activities required of them under the contract.
So in the case of a contractor’s insolvency occurring prior to practical completion, the contractor is no longer able to complete the contract, and has probably completed an event of default (as defined in the contract), entitling the principal to terminate the contract. Most standard form contracts provide that in those circumstances, the work can then be taken out of the insolvent contractor’s hands, and completed by others.
Importantly, the retentions or security are expressly reserved for the principal’s use to defray any extra over costs that the principal may incur in completing the works by others. It is only once the works are completed that the final reconciliation is carried out, and only at that point does the contractual right to return of retentions monies (insofar as there are any left) accrue. At that point an insolvency practitioner would be able to use the Act to recoup any remaining retentions, or seek the return of security, for it will be seeking to enforce rights that accrued under and pursuant to express terms of the contract.
A similar position arises if an insolvency practitioner is appointed to a contractor after practical completion, but prior to the issue of the final certificate. In that case, the Act can be used by liquidators to secure the recovery of retention monies, or the return of securities held.