Australia: Set off in a construction agreement - use it or lose it!


The concepts of set off and back charges are fairly common in construction and engineering circles, however, the correct application of these types of provisions can often be confusing.

In the recent case of PPK Willoughby v Eighty Eight Construction, the Supreme Court considered (amongst other things) whether an adjudicator had failed to fulfil his statutory obligations in determining that there was no retrospective right to set off for the cost of rectifying defects.

The facts

PPK (as Principal) and Eighty Eight Construction (as Contractor) entered into a "Construction Agreement" for the construction of luxury homes on Sydney's lower north shore.

As part of the payment process the Contractor would email a spread sheet to the Superintendent every month containing a claim for interim payment. Shortly thereafter, the Superintendent would meet on site with the financier's quantity surveyor and the Contractor to walk through the site and determine what work had been completed that month.

After undertaking a site inspection, the Superintendent would then issue a certificate of payment identifying what the Principal should pay to the Contractor. Sometime shortly after issuing the certificate, the Contractor would then submit a tax invoice stating the amount certified as being payable. Not surprisingly, the Superintendent would then approve the tax invoices for payment. This process was working reasonably well until unlucky payment claim #13 landed on the Principal's desk.

In payment claim #13, the Contractor had claimed payment for an agreed amount of approx. $450,000. The payment claim was made under the Building and Construction Industry Security of Payment Act 1999 and was approved for payment by the Superintendent. The Superintendent approved payment in full knowledge of minor and major defects in the works. Somewhat unsurprisingly, the Principal refused to pay the claim, claiming that the work was 'riddled with defects'. The Contractor sought to have the matter adjudicated.

The adjudicator concluded that the defects report provided for the purposes of the adjudication post-dated the agreed payment claim and that there should be no set off for the cost of rectification of defects, as the contract did not permit "the retrospective application of deductions". In light of this, the adjudicator concluded that the Contractor was entitled to payment of $450,000. The dispute headed to court.

The arguments

The Principal claimed that the adjudicator had merely adopted the Superintendent's valuation and had not turned his mind to the statutory powers given to him. That is, the adjudicator had not himself determined the amount of the progress payment (if any) to be paid to the Contractor and merely adopted the Superintendent's valuation of the amount due.

The Principal also submitted that the adjudicator knew there were substantial defects in the work done by the Contractor but had made no allowance for this in his determination. The Principal then alleged it had been deprived of its entitlement to have the cost of defect rectification set off against any amount otherwise due.

The Contractor submitted that the adjudicator had followed due process. The Contractor further submitted that the real dispute, as identified by the adjudicator, wasn't the valuation of the work but, rather, the amount (if any) which should be allowed as a set off, which the adjudicator had determined as nil.

The decision

The court stated that whilst the adjudicator may have been right or he may have been wrong in his interpretation of the set off provision, he turned his mind to the relevant statutory and contractual provisions, to the relevant reasons for non-payment and to the submissions and material in support of those reasons and rejected the Principal's set off argument.

Having dealt with the real issue in dispute, the adjudicator sought to complete the statutory functions of determining an adjudicated amount. The Principal's challenge to the adjudicator's determination therefore failed and the Principal was obliged to pay the Contractor the whole of payment claim #13.

The lesson

If a party seeks to claim set off then the amounts to be set off should be included in any certificate of payment or payment schedule. In addition, if parties seek to claim retrospective application of deductions then this should be reflected in the construction contract.

For further information please contact:

Paul Brennan, Projects Partner
Phone: +61 2 9233 5544

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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