Construction sub-contracts will sometimes include a provision allowing a head contractor to retain a portion of the monies due to a subcontractor until a date after the subcontractor’s works have been complete – for example, at practical completion of the head contract or when the defects liability under the head contract has expired. This delay in payment can cause real unfairness to the subcontractor – especially when there is a large time lag between the works performed by the subcontractor and the completion of the overall build. It also raises the risk of a subcontractor never receiving full payment for its works if the contingent event never occurs or if the head contractor becomes insolvent in the meantime.
Building and Construction Industry Security of Payment Act 1999 (NSW) (the Act)
Recognising the unfairness caused to sub-contractors, the Act when introduced in 1999, included a “pay when paid” provision (section 12) which mandated that any provision in a construction contract which sought to make payment to the subcontractor contingent on the head contractor being paid by a third party, or payment to the subcontractor being made contingent on the operation of another contract, was of “no effect”. The scope of this section has previously received little judicial attention.
High Court rejects a narrow operation of the “pay when paid” provision
In Maxcon Constructions Pty Ltd v Vadasz  HCA 5 the High Court upheld the finding of the adjudicator that the “retention” provisions in the subcontract fell within the operation of the Act’s “pay when paid” provision. In doing so, the High Court rejected a narrow approach to this provision which had been adopted by the South Australian Supreme Court.
In Maxcon’s Case, the building contractor (Maxcon), and Mr Vadasz, a piling subcontractor, were parties to a subcontract under which Mr Vadasz had agreed to design and construct piling for a strata development in Adelaide. The subcontract required Mr Vadasz to provide a “cash retention” equivalent to 5% cent of the overall contract sum with the retention funds to be released in tranches as follows:
- 50% within 90 days of the occupation certificate being obtained;
- the remaining 50% within 365 days of the occupation certificate being obtained.
Under this clause of the subcontract, Mr Vadasz would be denied a large amount owed for works performed by him at the initial construction stage until one year after the entire building was complete – lengthy period of time.
On 25 February 2016, Mr Vadasz served on Maxcon a payment claim under the Act stating that a progress payment of $204,864.55 was due (this amount included the retention monies). On 8 March 2016, Maxcon provided a payment schedule pursuant under the Act stating that it would pay only $141,163.55, ie it deducted a retention sum and administration charges. Mr Vadasz then applied for adjudication of his payment claim under the Act.
The adjudicator accepted Mr Vadasz’s submission that Maxcon was not entitled to deduct the retention sum and determined the adjudicated amount to be equal to the total amount claimed by Mr Vadasz. In relation to the retention sum, the adjudicator concluded that the retention provisions of the subcontract did constitute “pay when paid” provisions and were thereby ineffective – meaning that Maxcon had no right to withhold the retention sum.
Maxcon appealed to the South Australian Supreme Court which found in favour of Maxcon. The Court considered that the retention provisions did not fall within the “pay when paid” provision of the Act on the basis that the date when occupation is achieved is not contingent on Maxcon either being paid or on the operation of the head contract.
The High Court rejected the approach of the South Australian Supreme Court. It held that the “pay when paid” provision of the Act meant that Maxcon could not withhold the retention monies from Mr Vadasz because, ultimately, the release of the retention monies to Mr Vadasz was dependent on the operation of another contract (ie the issue of an occupation certificate for the building was dependent on Maxcon performing the building works as required under the head contract).
Lessons from the Case
The High Court favoured an expansive interpretation to the “pay when paid” provision of the Act. In practice, the effect of the decision is that head contractors need to ensure that their subcontracts do not contain retention provisions which infringe the “pay when paid” provision of the Act, as interpreted by the High Court.
It is important to note that the decision does not affect the provision of “security” under a subcontract such as a bank guarantee or an insurance bond. In light of the High Court’s decision, we recommend that head contractors review their subcontractors to ensure that they are legally compliant and to consider other amendments to provide adequate protections for defective subcontractor works.
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