Published: Wed, Mar 20th, 2013 by Mike Newdick
The financial collapse of Mainzeal Property and Construction will have far reaching effects; redundancies, sub-contractors’ temporary loss of access to their tools of trade, disputes as to the ownership of tools, goods and materials on various building sites, the financial impact on sub-contractors with progress payments and retentions be halted and the flow on effects on investors and associated industries.
Construction Contracts Act 2002
Unfortunately, this story seems to echo the headlines of a decade ago with the collapse of a number of then-major players. As a result the Construction Contracts Act 2002 (the Act) was introduced to address some of the problems that the industry faced. The Act is far from perfect and sub-contractors are still exposed to financial risks when entering into contracts with the contractors above them.
Prior to the Act, “pay when paid” clauses made sub-contractors’ payments conditional on the contractor above them being paid. The Act deemed such conditional payments illegal, however, from a practical point of view many contractors (especially small to medium contractors) are unable to pay their subcontractors until they are paid themselves.
While the Act introduced default provisions for progress payments, suspension of works, issuing of a charging order and other methods of securing payment, the contracting parties are still free to decide on the number and amount of progress payments and retention percentages.
Risk with Progress and Retention Payments
Retentions expose contractors to a financial risk for a significant time period (e.g. 6 to 12 months) after expenses such as staff and materials have been incurred and while the completed work awaits final sign off. Most construction contracts allow the head contractor to deduct a percentage of the progress payments due to the sub-contractors as retentions. The retentions are held by the head contractor as security for the due performance of the contract by the sub-contractor and/or to rectify defects during the defects liability/ maintenance period should the sub-contractor fail to do so.
Retentions not only impact on a sub-contractor’s cash flow but there is a real risk that retentions may be further delayed or lost where the retention holder goes into receivership or liquidation. When entering into a construction contract it is important to review the clauses in relation to progress payments and retentions in detail. If the sub-contractor has bargaining power they can request that the retentions are held in a special account. While it does not guarantee payment of the retentions from the receiver or liquidator it allows the sub-contractor to point to their retention funds and it may prevent the retentions being absorbed by the head contractor as ordinary working capital in the led up to any receivership or liquidation.
Another issue that many of the Mainzeal’s subcontractors faced is that the receiver lawfully prevented them from entering various building sites to collect their equipment and unpaid goods and materials. Receivers and liquidators argue that it is necessary to restrict access to prevent a free-for-all and to enable the controlled removal of the sub-contractors’ equipment and goods, along with reducing the risk of damage to the building site and complying with health and safety requirements.
Given the potential access issues, it is important that equipment is clearly marked to enable identification and that the ownership of unpaid goods and materials is set out in the contract. Once goods and materials have been permanently fixed to the building (e.g. windows or cabinetry installed etc.) the ownership automatically passes to the owner of the land – even where the goods and materials have not been paid for. When the goods and materials are unfixed the ownership will depend on the terms of the contract. It is vital that the contract states that ownership of the unfixed goods and materials does not pass until payment has been received in full. Sub-contractors must also ensure that the other contracting party is under an obligation to store unpaid for goods and material separately and in a manner which identifies the ownership to reduce any debate when the receiver or liquidator takes control of the building site.
To ensure maximum protection sub-contractors should register their security interest in the goods and materials on the Personal Property Securities Register. While a sub-contractor may lose their priority when the goods become affixed to the building, a well crafted clause may allow the sub-contractor to trace the money to the proceeds of sale.
Review of the Act
It has been recognised that the Act is not flawless and a review was commenced in 2010.
A Bill is currently before Parliament which will result in the following the three main changes:
- removing the distinction between residential and commercial construction contracts;
- extending the definition of construction work to include design, engineering, and quantity surveying work so that they can use the progress payment procedure; and
- amending the enforcement of adjudicators’ determinations.
Following the financial collapse of Mainzeal many in the industry will be calling for further changes to provide sub-contractors with a higher level of protection in relation to unpaid work, progress and retention payments when the head contractor goes into receivership or liquidation.
The moral of the story is that history does seem to repeat in the construction industry. Accordingly, it is important to understand the terms and conditions contained in a construction contract and how they impact on a sub-contractor’s rights and obligations when the head contractor goes into receivership or liquidation.
If we can help you with any query regarding this article please contact Kirsten Murfitt or Mike Newdick.