The appointment of voluntary administrators to Probuild in March 2022 sent shockwaves through the construction industry. External administrations of other recognised brands such as Grocon, ABD Group, Privium and Condev have also caught media attention. Overall, external administrations in the construction industry have been increasing, notwithstanding that the insolvency numbers generally have declined to historical 20-year lows. The insolvency of each builder impacts numerous parties including developers, principals, sub-contractors, suppliers, consultants and employees. The ripple out effect can be significant.

When a builder enters external administration, principals are often uncertain of their rights and how best to mitigate their loss and finish any development. This article gives a high level summary of the issues that commonly arise and some relevant considerations.

The relevant processes

Construction contracts often state that an insolvency event arises where, relevantly:

Many standard form contracts are outdated and their insolvency related clauses should be reviewed.

In simple terms, principals need to carefully consider their position before exercising any rights during the external administration of a company, but particularly where the relevant process involves voluntary administration, small business restructuring, a managing controller or a creditors’ scheme of arrangement. The relevant processes are very briefly summarised below.

Liquidation

Liquidation involves the appointment of a liquidator to investigate and wind-up the company’s affairs. To the extent possible, the liquidator will facilitate a distribution of funds to unsecured creditors. Liquidation is generally the end of a company and concludes with a company being deregistered.

Once a liquidator is appointed to a company, they are able to exercise all of the rights previously held by a company, such as the rights a builder has under a contract. Liquidators also have powers to take steps to unwind transactions entered into by the company within certain periods (called voidable transactions). It is not uncommon for liquidators to make claims against principals in relation to developments, such as for payment of progress claims.

As a general proposition, liquidation is the simplest external administration process for a principal as it is unlikely that the builder will continue to trade, and the focus can immediately move to completing the development. Although court proceedings against the company are stayed, there is no stay on a principal exercising contractual rights, such as calling securities (usually bank guarantees). In practice, there is no urgency in calling on bank guarantees as the bank remains obliged to make payments notwithstanding the liquidation of the company.

Voluntary administration

Voluntary administration is a process that allows a company and its directors time to consider whether the company can be restructured or whether the company should enter liquidation. The purpose of voluntary administration is to maximise the chances of the company or its business continuing in existence. If this is not possible, administration is intended to achieve a better return for the company's creditors and members than would result from an immediate winding up of the company.

Depending on the circumstances and the terms of the contract, a principal may be unable to exercise their rights where administrators are appointed. When the company is subject to voluntary administration, there is stay on the exercise of contractual rights where the right arises solely from the appointment of the voluntary administrators, the company’s finance position during the voluntary administration or a reason that is in substance contrary to the intention of the stay (called the ipso facto stay). There are numerous exceptions to the ipso facto stay including, most relevantly, exceptions for take-out rights or where there are non-performance or non-payment defaults. The ipso facto stay can be extended or lifted by a Court and the voluntary administrator can consent to the rights being exercised. There are various other stays, including in relation to Court proceedings and restricting the rights of some secured creditors.

The voluntary administrators may recommend that creditors approve a Deed of Company Arrangement (DOCA). A DOCA is a binding arrangement between a company and its creditors governing how the company’s affairs will be dealt with. A DOCA binds all creditors and may resolve all debts that arose by the date specified in the DOCA, potentially including future or contingent claims. The precise effect of each DOCA depends on its terms.

If a DOCA is not possible, the voluntary administrators will, after conducting preliminary investigations into the company’s affairs, recommend that the company be placed in liquidation. It is also possible that control of the company returns to the directors, but this is uncommon. Importantly, the ipso facto stay may extend beyond the administration period.

Managing controller, receivership and mortgagees in possession

Receivership is an insolvency procedure where a receiver or receiver and manager is appointed over some or all of the company’s assets, either by court order or by a secured creditor enforcing a security interest.

A mortgagee in possession is a lender who has exercised its right to take control of property due to breaches of its security. A mortgagee in possession will frequently appoint an agent who will oversee the sale of the secured property for the benefit of the mortgagee.

The ipso facto stay on the exercise of contractual rights applies where a ‘managing controller’ is appointed, which is generally a receiver and manager appointed over the whole or substantially all of the property of the company. Again, if receivers are appointed, principals need to carefully consider their position before taking any steps.

Small Business Restructuring (SBR)

As the name suggests, the SBR process is only relevant for small businesses that have total liabilities less than $1 million. The intention of the SBR process is to allow the directors to remain in control of the company while they develop a restructuring plan that may be approved by the company’s creditors.

The SBR process commenced in January 2021, but as of January 2022 had been used for less than thirty companies. The uptake of SBR may increase for smaller builders, and it is important that principals are aware that the ipso facto stay may restrict the exercise of contractual rights based on the SBR process.

Creditors’ scheme of arrangement

A creditors’ scheme of arrangement is a procedure that allows a company to restructure through a Court approved and binding agreement between the company and its creditors. In practice, schemes of arrangement are far less common than voluntary administration. For completeness, the ipso facto stay on the enforcement of certain contractual rights also arises for a scheme.

Potential mitigation steps

There are various steps that principals can take to mitigate the risks arising from their builder entering external administration. The steps that should be taken will depend on the circumstances, but some considerations that often arise are set out below.

At and before the contract

It is vitally important that a contract contains appropriate provisions allowing a principal to take out or terminate the contract. There also must be appropriate security for the performance of the builder’s obligations. In general terms, bank guarantees are preferable.

Principals should also protect their position by registering security interests that arise under the contract on the Personal Property Securities Register. Depending on the terms of the contact, security interests may arise in relation to, for example, monies held in retention accounts or the right to take works out of the hands of the builder and deal with any goods or equipment of the builder on site.

Appropriate due diligence before entering into a contract is important, but so too is ongoing review of the builder’s position through, for example, finance audits and requiring the builder to provide details of any sub-contractors or suppliers. Principals should generally ensure that payment is not made for unfixed plant or materials unless the builder provides additional security and/or appropriate assurances.

Prior to practical completion

Principals should ensure that show cause notices and payment schedules are issued within any relevant timeframes to ensure that any breaches are documented. Prior to practical completion, principals should ensure that the builder has complied with all obligations under the contract (such as those relating to insurance and assignment of warranties). Doing so mitigates the potential impacts of an external administration as it is generally far more difficult to obtain details of insurance and warranties later.

When external administrators are appointed

The steps that principals should take will depend on the type of external administration and circumstances at the time. However, general considerations that principals should take into account include the following:

  1. confirming the type of external administration and individual/s appointed is critical
  2. principals need to urgently confirm the details and status of any project, including matters such as the date of the contract, whether there are any known issues or defects, any potential or anticipated defects or claims against the builder and any other amounts owing to the builder
  3. principals should take steps to confirm any amounts that are or may be payable to them, often through a process involving the superintendent. Payment schedules under the relevant security of payment legislation in each state should be considered as well as rights to set-off
  4. it is important to consider whether there are any impediments to exercising any rights under the contract and, for example, whether the ipso facto stay may arise. Subject to this, notices to take out the works or terminate the contract should be considered. Notices to call on any securities (such as bank guarantees) can also be considered
  5. the focus should be on completing the project and confirming the implications of the external administration. Matters such as lodging a proof of debt in liquidation or administration are generally a lower priority but should be considered.

Conclusion

While the voluntary administration of most of the Probuild entities continues, the precise impact and flow out effects remain unclear. However, in view of the significant pressures facing the construction industry, principals should take the opportunity to take stock and consider whether there are any steps they can take to protect their position.