Construction & Infrastructure Update – March 2018

“Pay when Paid” clauses and the Tasmanian SOP Act 2009


By David Palser and Alastair Oxbrough

Overview

The recent decision in Maxcon Constructions Pty Ltd v Vadasz [2018] HCA 5 (Maxcon) provided the first High Court guidance on the application of the “pay-when-paid” provisions in the security of payment legislation.  In this case, it was the South Australian legislation, which is the same, for current purposes, as the Building and Construction Industry Security of Payment Act 2009 (Tas) (SOP Act).

Whilst most participants in the construction industry were aware that traditional “pay when paid” and “pay if pay” clauses had been prohibited by the SOP Act, many were surprised by the conclusion in Maxcon that the provisions dealing with the withholding of retention monies in a subcontract were unenforceable provisions because the trigger for return of those monies was the issue of the certificate of occupancy for the whole building works.

“Pay-when-paid” and “Pay-if-paid” provisions

It is common in the construction industry for a head contractor or Project Co (in a PPP project) to be in a situation where a subcontractor’s potential right to payment (eg. progress payments, claims and release of retention) arises in circumstances where the head contractor or Project Co has equivalent rights in the head contract.  The participant in the middle is exposed to risk if it must pay the amount to the subcontractors before its entitlement is determined or it has received the funds under the head contract.

Prior to the enactment of the SOP Act, the usual solution for the head contractor or Project Co was to insert provisions into the subcontracts to the effect that:

  • the timing of payment under the subcontract was determined by when payment was received under the head contract (“pay-when-paid”); and/or
  • the entitlement to payment under the subcontract was dependent on payment being received under the head contract (“pay-if-paid”).

Tasmanian SOP Act

The Tasmanian SOP Act came into force in 2009. The SOP Act is largely based on the Building and Construction Industry Security of Payment Act 1999 (NSW), and is generally consistent with the equivalent legislation in Victoria, ACT, Queensland and South Australia.

The object of the SOP Act is to ensure that any person who undertakes to carry out building work or construction work (or who undertakes to supply building or construction-related goods and services) within Tasmania under a building or construction contract, including such a contract that relates to a residential structure, is entitled to receive, and is able to recover, progress payments in relation to the work or goods and services (sections 3 and 7).

Prohibition of “pay-when-paid provisions”

Section 16 of the SOP Act prohibits both “pay when paid” and “pay if paid” clauses referred to above, but more importantly for current purposes, also prohibits a third category of provision which “otherwise makes the liability to pay money owing, or the due date for payment of money owing, contingent or dependent on the operation of another contract.” (our emphasis)

Most participants in the construction industry understood the application of the SOP Act in relation to the types of “pay when paid” and “pay if paid” clauses referred to above, but until the recent High Court of Australia decision in Maxcon, few understood the potentially far-reaching impacts of the third category on common provisions in construction contracts.

Maxcon Constructions Pty Ltd v Vadasz

In Maxcon, the subcontract for piling work included a standard retention clause permitting the head contractor to retain, by way of security, 10% of each progress payment due to the subcontractor, up to a total of 5% of the contract sum.  The release of the retention money was contingent upon the issue of a certificate of occupancy for the entire project, not merely completion of the work under the piling subcontract.

The High Court held that the retention clause in the subcontract was unenforceable as a “pay when paid provision” because the release of the retention money (ie. payment of money owing) was “contingent or dependent on the operation of another contract”.  This was because the dates for release of the retention money under the subcontract were dependent on the issue of a certificate of occupancy, and such a certificate could not be issued until completion of the whole project in accordance with the head contract.

The conclusion of the High Court was that the whole of the retention monies clause was unenforceable, meaning that the head contractor was not permitted to retain any retention monies from the progress payments.

Implications

Maxcon was surprising in two key respects.

The first is that the prohibition extends to provisions for “money owing” which are indirectly contingent or dependent on other contracts, not simply those which are directly contingent or dependent.  That is, even if the condition for payment in the subcontract makes no mention of another contract, it may be prohibited if satisfaction of that condition itself is dependent upon something else occurring under another contract.  The High Court in Maxcon specifically rejected the argument that the issue of a certificate of occupancy was an “independent event” because it depended “not upon any contract that may have been entered into between owner and builder” but upon the completion of the building in accordance with the plans and specifications in the relevant development approval.

The second respect is that the consequences of the prohibition may be wider than first thought, and in some cases, may be difficult to predict.  For example, at first blush, it appears that the “pay-when-paid” provision in Maxcon was the provision dealing with the return of the retention monies, however, the High Court concluded that the whole retention monies clause was unenforceable, thereby preventing the head contractor from withholding the retention monies in the first place.

The High Court decision in Maxcon is likely to mean that a number of common contractual provisions in downstream contracts in the construction industry are not enforceable, such as:

  • a retention monies clause which provides that it will be returned upon completion of the defects liability period under the subcontract will be unenforceable if the defects liability period is linked to the defects liability period under the head contract;
  • provisions which attempt to “pass through” determinations and decisions of the superintendent, principal, or independent certifier under the head contract to the subcontractor, to the extent that they are conditional on the subcontractor being paid any amount under the subcontract (eg. where a payment under the subcontract is triggered on achieving practical completion, but that a condition of practical completion under the subcontract is the issue of the certificate of practical completion under the head contract);
  • payment of progress payments under the head contract conditional upon the certification by the funders under a property finance facility agreement; and
  • “linked claims and linked disputes” provisions (eg. the standard AS 4903 subcontract and in the main subcontracts in most PPP projects) which requires a subcontractor to be bound by the outcome of the dispute process under the head contract in relation to subcontract disputes for “money owing” which relate to the head contract.

Finally, it should be reinforced that the prohibition only applies to provisions relating to “money owing”, and thus, is unlikely to affect provisions dealing with performance bonds or guarantees or claims for extension of time.

Key takeaway

All head contractors and Project Co’s should review their subcontracts and ensure that all provisions associated with payments of “money owing” in those agreements are not directly or indirectly conditional on other contracts.

If you have any queries or would like further information regarding this article, please contact:

Alastair Oxbrough
Partner
M: 0400 818 636
E: aoxbrough@pageseager.com.au

Published: 28 March 2018

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