Australia: Construction Update - Can Security Of Payment Legislation Operate Down The Contractual Chain?

A question that is frequently asked is whether the Building and Construction Industry Security of Payment Act 1999 (NSW) (the Act) or the Building and Construction Industry Payments Act 2004 (Qld) can operate down the contractual chain.

Can parties who receive the benefit of construction work such as principals under a head contract or contractors under a subcontract utilise security of payment legislation? The advantage of having this ability is obvious. If you can issue payment claims under the Act, then you can take advantage of the rapid and inexpensive adjudication procedure to determine their claims rather than having to seek their entitlement through the courts.

Some commentators have suggested:

• It may be possible to incorporate clauses in contracts so that principals or contractors (i.e. the beneficiaries of work) could make payment claims down the contractual chain (e.g. claims for defective work or liquidated damages).

• Parties could at least make payment claims where they were required to ‘stand in the shoes’ of the contractor to complete work where there had been default by the contractor.

A recent decision of Magistrate J Orchiston in the local court of New South Wales, has answered the question of whether the Act could be turned around to support claims by the beneficiaries of work with an unequivocal no.

Brodyn Pty Ltd -v- Y.A. Welding Pty Ltd [2006] NSWLC 25

Brodyn Pty Ltd (‘Brodyn’) entered into a contract with North Sydney Council to construct a walkway along the foreshore at Kirribilli. Brodyn entered into a subcontract with Y.A. Welding Pty Ltd (‘Welding’) to construct the walkway.

The subcontract was drafted to expressly provide for Brodyn to make a payment claim against Welding under the Act. The relevant provisions in the subcontract were as follows:

• Clause 48 - Sub-Clause 6:

  ‘In the event [Welding] fails to meet its obligations under this Contract or is in default of a provision of this Contract, [Brodyn] undertakes after issuing notice in writing and subject to the terms and conditions of this Contract to execute and complete the Works on behalf of [Welding].’

• Clause 48- Sub-Clause 8:

  ‘[Welding] undertakes to pay [Brodyn] any amount or debt due which may become due and payable under this Contract. [Welding] also acknowledges that [Brodyn] is entitled to submit a payment claim for any works completed on behalf or for [Welding] under this Contract, and in this scenario [Welding] will take the role and liabilities of the Respondent as defined in the Building and Construction Industry Security of Payment Act 1999, as amended from time to time.’

• Clause 48 - Sub-Clause 36:

  ‘Without limiting anything in clause 42, in the event that [Brodyn] exercises its rights under clause 42(c)(i) or clause 42(c)(ii), then [Brodyn] may issue a payment claim under the Building and Construction Industry Security of Payment Act 1999, at any time to [Welding] in respect to works carried out by [Brodyn] in carrying out the whole or any part of the work remaining, and shall be entitled to a progress payment under that Act in the amount of expenses incurred in carrying out that work that, but for the exercise of its rights in clause 42(c)(i) or (ii), [Welding] would have been bound to carry out.’

Welding defaulted in the performance of its obligations under the subcontract. Following a notice to show cause, Brodyn exercised its contractual right to take the work out of Welding’s hands and complete the work using other contractors. Whilst it was agreed that Brodyn would have the contractual ability to claim the difference in the costs incurred for the work performed by a third party under the terms of the contract, the issue was raised as to whether Brodyn could make a payment claim under the Act.

Necessary pre-requisites to make a payment claim

The central issue for determination was whether Brodyn was a person entitled to make a claim for payment against Welding under the Act. This was held to depend on whether Brodyn was a person who had ‘undertaken’ to do ‘construction work’ and thus entitled to ‘progress payments’ under the Act.

Brodyn submitted the intention of the subcontract was that in the event of default by Welding Brodyn would:

• Effectively ‘stand in the shoes of Welding’.

• Be liable to undertake the subcontract work.

• Be entitled to progress payments from Welding under the Act.

• Be exercising its rights and entitlements under the contract and be engaged in an ‘undertaking’ pursuant to the provisions of the Act.

Welding argued that:

• A right to a progress payment under the Act required the relevant party to have ‘undertaken’ to carry out ‘construction work’ under a ‘construction contract’.

• The objective of the Act is to provide for the protection and timely payment of a subcontractor from a contractor and a builder from a principal.

• The relevant provisions of the contract were conditional and provided for a self-help remedy which could not be characterised as an undertaking.

• Brodyn had made no promise to carry out work, but rather it was an election to carry out work upon default by Welding.

• The definition of ‘undertaking’ refers to the obligation of one party undertaking to carry out construction work for another party, not the contemplation of one party undertaking to carry out construction work for itself as a self-help remedy.

The Magistrate concluded that any person who undertakes to carry out construction work under a construction contract is entitled to receive, and is able to recover, progress payments in relation to the carrying out of that work.

The Magistrate found that the term ‘undertaken’ was not defined but that ‘undertaken’ for the purposes of the Act involved a person entering into an obligation with another person to do something. It was also found that the special conditions attempted to bind Brodyn to perform and accept an obligation by direct reference to the Act and incorporating the language of the Act. However, the Magistrate found that the use of these words in the contract, and in particular the use of the word ‘undertakes’, was not enough to establish that for the purposes of the Act Brodyn had undertaken to carry out construction work.

The Magistrate found that:

• In the context of the Act, the word ‘undertake’ did not extend to a right or a unilateral discretion to do something without an element of obligation being involved.

• The reference to Brodyn having a contractual right or rights accurately describes the legal nature of the relevant terms of the contract.

• The subcontract did not provide for the giving of any contractual undertaking by Brodyn to Welding to do the construction work in the event of default by Welding. Upon default by Welding, Brodyn had the right to take over the construction work, with additional remedies against Welding to recover the various costs that might be incurred by Brodyn. It was, in essence, a self-help remedy.

• Brodyn was not contractually bound to Welding to complete the work merely by virtue of the use of the word ‘undertakes’ in the subcontract conditions.

• Welding had no rights or remedies under the contract if Brodyn failed to complete the works following default by Welding. This was contrary to there being an undertaking by Brodyn to carry out the works.

The Magistrate was satisfied that Brodyn was not a person who fell within the Act as being a person who has undertaken to carry out construction work under the contract. As a result, Brodyn was not entitled to make a claim for payment against Welding under the Act.

Is the Act limited to an upward operation?

The conclusion of the court highlights the importance that should be placed on considering the precise obligations of parties to a contract. While at first it appears that the decision rejects the downward operation of the Act, this possibility should not yet be dismissed out of hand. It may be possible that careful drafting can yet overcome the barriers of this decision to principals wishing to orchestrate a downward operation of the Act.

If a contract was to contain a separate regime for ‘other works’, it may be possible to frame the obligations of the principal not as a consequence of an election and a self-help remedy, but rather as an enforceable undertaking to the contractor. The clause would need to provide an undertaking by the principal to carry out construction work that was enforceable by the contractor. The trick for the principal would be to control and orchestrate the conditions and method of that enforcement so as to retain control of these circumstances. Such a clause would require careful consideration and drafting to have effect, and even so, may still fall foul of the legislature’s upward intention of the Act.

In conclusion, despite the possible avenue for deft contractual manipulation, at present the Act is likely to be limited to reflect an upward operation. It would however be timely to review contracts in relation to provisions for the principal to take over the works and claim costs back from the contractor. Further, it is important to remember that even if the process in place is not enforceable under the Act, it is still enforceable under the contract and can be pursued in the usual manner.

Phillips Fox has changed its name to DLA Phillips Fox because the firm entered into an exclusive alliance with DLA Piper, one of the largest legal services organisations in the world. We will retain our offices in every major commercial centre in Australia and New Zealand, with no operational change to your relationship with the firm. DLA Phillips Fox can now take your business one step further − by connecting you to a global network of legal experience, talent and knowledge.

This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.