Australia: Forging a path to protecting subcontractor payments in insolvency

Last Updated: 12 November 2018
Article by Daniel Morris

Introduction

On 11 February 2014, voluntary administrators were appointed to a large construction enterprise known as the Forge Group which had become insolvent. At the time of its insolvency, Forge was engaged on two mining construct projects, one in West Angelas and one in Cape Lambert.

Shortly before the administrators had been appointed:

  1. Forge had made, and Hamersley had certified, a progress payment claim on account of works carried out under Forge's construction contracts with Hamersley; and
  2. Hamersley had claimed liquidated damages on account of delays in Forge's works. After the appointment of administrators to Forge, which resulted in the termination of its construction contracts with Hamersley, Forge's lender, the ANZ Bank, appointed receivers to Forge and asserted a right to have its loans repaid out of Forge's certified progress payments. Hamersley's liquidated damages claim and ANZ's claim against Forge's certified progress payments were determined by the WA Supreme Court in Hamersley Iron Pty Ltd v Forge Group Power Pty Ltd (In Liquidation) (Receivers and Managers Appointed) [2017] WASC 152 ("Forge 1"). The decision in Forge 1 has important implications for subcontracting civil contractors seeking to be paid for their work by insolvent head contractors. The decision on appeal from Forge 1 has equally important implications.

Understanding those implications for subcontractors requires consideration of how the Court in Forge 1, and later on appeal from Forge 1, dealt with a contest between the ANZ as Forge's lender and Hammersley Iron Pty Ltd as Forge's principal and owner of Forge's construction site.

Forge 1: ANZ Bank gets the account receivable, Hammersley Iron does not

In Forge 1, the Court found that by registering a Personal Property Security Interest ("PPSI") against all the insolvent head contractor's (Forge's) assets (other than land), the ANZ Bank got to recover loan repayments plus interest ahead of all others whom Forge owed money. There was only one such asset up for grabs. This was the progress payment that, at the time of appointment of administrators to Forge in its insolvency, Hammersley had certified as payable, but had not yet paid, to Forge, on account of its construction work.

In Forge 1, the Court found that Hamersley's obligation to make a progress payment was an asset, in the form of an "account" to which ANZ's PPSI had attached. According to Forge 1, this meant that the "account" itself had become collateral for payment of Forge's debts to ANZ.
The Court went a step further, saying that ANZ's security interest in this "account" meant it had the same kind of ownership of the account as a beneficiary of a trust has in the assets of the trust, even though they don't have control over those assets (that belongs to the trustee).

This finding knocked out of the running, ANZ's only contender for the account, being Hamersley. At the time, Hamersley was seeking to enforce its claim to liquidated damages against Forge.

Hamersley was held to have lost its contest with ANZ to recover the account, because the account consisted of nothing more than Hammersley's debt to Forge. To avoid having to pay that debt to Forge, Hamersley had to show that it could set off its obligation to pay that account against Forge's obligation to pay liquidated damages to Hamersley. The objective was for the two obligations to cancel each other out.

Hamersley argued that this right of set-off existed under both the Corporations Act 2001, section 553C, and the contract between Forge and Hammersley.

However, the Court in Forge 1 found Hamersley had no such right of set-off because:

  1. The kind of ownership of the account that ANZ got from its PPSI meant that Forge's obligations to Hammersley, and Hammersley's obligations to Forge, were no longer "mutual" in the way that the Corporations Act, s.553C, required, in order for a set-off to occur.
  2. Where there is an insolvency, s.553C of the Corporations Act is the only law that can govern rights of set-off, leaving no room for Hamersley to claim a set-off under the contract.

This meant that:

  1. Hamersley had to pay the entire account over to Forge's liquidators; and
  2. Forge's liquidators had to pay the entire account over to ANZ.
  3. Unsurprisingly, Hamersley was dissatisfied and appealed against the decision in Forge 1. The appeal against Forge 1: Hammersley gets a set-off, ANZ gets what's left

The decision on appeal from Forge 1 is Hamersley Iron Pty Ltd v Forge Group Power Pty Ltd (in liquidation) (receivers and managers appointed) [2018] WASCA 163. That decision overturned the findings in Forge 1 that we have mentioned, and found instead:

  1. ANZ's PPSI did not make ANZ an owner of the account in the same way as a beneficiary is the owner of a trust fund.
  2. Therefore, Hamersley's and Forge's debts to each other were mutual in a way that did require them to be set off against each other under section 553C of the Corporations Act.
  3. Even if section 553C did not apply, it was incorrect to say, as the Court had done in Forge 1, that the section 553C left no room for any set-off to apply under the contract between Forge and Hamersley.
  4. How the Forge decisions affect payments to subcontractors when head contractors become insolvent

    There were no subcontractors involved in the Forge cases. However, the reasoning in those cases has important implications for subcontractors' payment rights in cases of head contractor insolvency.

    This is because of law reforms that have, to varying degrees, been implemented, debated and reported on around the country, whereby:

    1. trusts can be used to allow subcontractors to be paid ahead of the owner/principal that engaged an insolvent head contractor (like Hamersley Iron in the Forge cases); and
    2. the Personal Property Securities Act can be used to allow subcontractors to be paid ahead of the lenders and other third party creditors of the insolvent head contractor (like ANZ in the Forge case).

    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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Daniel Morris
 
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