Building And Construction Update

• Security of Payment Act also affects financiers

• Security of Payment changes in Victoria

A recent decision of the Supreme Court of NSW (Over Fifty Mutual Friendly Society Ltd & Anor v Smithies & Ors [2007] NSWSC 291) (OFM decision) demonstrates that financiers who exercise their step-in rights, contained in project finance documents and (acting as the borrower) issue directions to contractors, will not escape the implications of the Building and Construction Industry Security of Payment Act 1999 (NSW) (Act).

Section 7(2) of the Act provides that the Act does not apply to a construction contract that forms part of a loan agreement, a contract of guarantee or a contract of insurance under which a recognised financial institution undertakes to lend money or guarantee payment of money or provide an indemnity with respect to construction work.

The OFM decision demonstrates that financiers have to date been falsely comforted by the provisions of section 7(2) of the Act. In this case, Over Fifty Mutual Friendly Society (OFM) was a financier and entered into a series of loan agreements with the principal (borrower) for the purpose of funding a construction project.

The project costs started to exceed the budget and the borrower requested additional funds to complete the project. OFM was naturally concerned about the financial status of the project and the borrower's ability to repay the loan. It therefore exercised its step-in rights under the loan agreements and entered into project management and accounting arrangements in order to save the project. As part of the new arrangements, OFM agreed to make payments directly to the subcontractors engaged on the project.

The borrower was unable to complete the project and the subcontractors issued payment claims under the Act on OFM and went to adjudication. OFM tried to hide behind the provisions of section 7(2) of the Act. However, the adjudicator found that the role of OFM had changed (as a result of the subsequent arrangements to manage the project and make payments) from financier to a principal role in the completion of the work to which the Act applied.

The law on whether such arrangements constitute construction contracts for the purpose of the Act or whether they are part of a loan agreement is largely unsettled and untested. What is certain is that the Courts will not (except in very limited circumstances) review an adjudicator's determination. Even a manifest error of law or fact by an adjudicator is not sufficient for judicial review. The financier's only redress is to pay the adjudicated amount (on an interim basis) and commence separate proceedings to recover the amount paid.

Therefore, financiers must tread very cautiously when entering into loan agreements for construction projects and closely consider their options in a distressed project. In some cases, it may be better to wind up the project rather than to exercise the step-in rights. The problem can also be managed (although, not eliminated) at the loan agreement documentation stage by expressly communicating that all conduct, when exercising step-in rights, is done as part of the loan agreement between the financier and the borrower.

However, no matter what precautions a financier may take, it cannot completely avoid the operation of the Act. A provision of any agreement (including loan agreements) which attempts to modify or which may have the affect of deterring someone from taking steps under the Act will be declared void pursuant to section 34 of the Act.

Financiers should strongly consider seeking specialist legal advice when entering into loan agreements for construction projects and when faced with a distressed project.
by Ranjan Rajagopal

Recent amendments to the Building and Construction Industry Security of Payment Act (Vic) will have a substantial affect on how statutory adjudications are undertaken in the Victorian construction industry.

The amendments came into force on 30 March 2007. Some of the changes are very different to the operation of the equivalent legislation in other jurisdictions. Most significantly, the amendments introduce the concept of claimable variations which limit the types and quantum of disputed variation claims that can be submitted to the adjudication process.

Disputed variations can only be adjudicated up to a prescribed cap. The amendments have created the following regime:

• where the contract sum for a construction contract is not more than $150,000, the claimant will be able to refer a disputed variation to adjudication

• where the contract sum for a construction contract is between $150,000 and $5 million the claimant will be able to refer a disputed variation to adjudication up to the value of claims for disputed variations reaching 10% of the initial contract sum

• where the contract sum for a construction contract exceeds $5 million, the claimant is not able to seek adjudication of a disputed variation claim at all (except to the extent that the contract made no provision for resolving disputes about variations).

The amendments are obviously to address the concern that the legislation should not be used to determine disputed variations on large contracts. The legislation elsewhere (particularly NSW) has been criticised in many quarters for not capping the quantum of claims that can be submitted to the process.

The Victorian Act has also excluded claims relating to:

• latent conditions

• time related costs

• changes in law

• damages.

The other big change in Victoria is that disgruntled respondents will no longer be able to provide security in satisfaction of an adverse adjudication determination but will now have to pay cash. This brings it into line with NSW. It was this particular amendment in NSW which changed the legislation from being something of a "toothless tiger" into a very powerful mechanism for contractors and sub-contractors to secure payment to ensure cash flow on the project as the legislators intended.

One gets the feeling that there will be far greater activity in the adjudication sector in Victoria (albeit on a smaller scale than has been experienced in NSW) subsequent to the amendments coming into force.
by Scott Laycock