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Working group recommendations on construction industry payments

Minister accepts recommendations as basis for bill, with further work yet on some detail

The Law Commission released a study paper entitled Protecting Construction Contractors which recommended the enactment of legislation along the lines of legislation recently introduced in New South Wales to protect construction contractors from non-payment.

This legislation would make “pay-when-paid” and “pay-if-paid” clauses ineffective and provide a fast-track adjudication process for the resolution of disputes.

The Ministry of Economic Development undertook further policy analysis and consultation and the industry working group was established.

The working group rejected alternative options such as compulsory payment bonding, compulsory insurance, compulsory licensing of participants in the construction industry, a scheme of statutory trusts or charges, and covenanting.

Basic scheme

The working group was unanimous on the basic scheme of the legislation, believing that at a general level it had to apply to every part of the contractual chain. A concern was that a proposed solution might apply from the head contractor down, whereas to be effective it must also apply to property developers and other principals at the top of the chain.

As part of this concern, the working group considered that the act should apply to construction contracts with the Crown and should apply to all construction contracts whether they are written or oral.

The key features of the scheme would be:

A: Every contract must provide an adequate mechanism for determining what payments are due under the contract and provide a final date for payment of any sum that comes due.

B: The act would provide default provisions that would apply where the contract was silent on the matters above. These provisions would provide for such matters as payment intervals, amounts to be paid, mechanisms for determining amounts payable, and the final date for those payments. Unless a contract provided otherwise, a contractor would be entitled to claim for and be paid monthly progress payments based on work performed.

C: Every contract must require a payer to give notice to the payee specifying the amount, if any, of the payment proposed to be made, and reasons for non-payment of any part of the amount due, not later than five days after the date on which a payment becomes due.

D: Every contract must contain an obligation that a party may not withhold payment of any amount unless they have given effective notice (in the form contained in paragraph (c) above).

E: Either party would have the right to refer a dispute arising under the contract to a fast-track adjudication process for resolution. A simple example would be if the payee disagreed with the reasons given by the payer for why an amount had been withheld.

F: The adjudicator’s decision would be binding but not final, unless the parties agreed to that in writing, in which case there would be a right of appeal from the adjudicator’s decision.

G: The Act would give a payee the right to suspend work if an amount is not paid when it falls due and the payer has not provided effective notice explaining non-payment, and where there is any non-payment of an adjudicated amount.

H: Any provision making payment under a contract conditional on the payer receiving payment from a third party should be made legally ineffective (this would effectively prohibit “pay if paid” and “pay when paid” clauses).

Detailed design issues

The working group also agreed on several detailed design issues of how the scheme will work in practice, but some issues were not fully explored.

The main items on which there is agreement are:

A: The period for adjudication should be between 10 and 28 days, with the ability for that period to be extended by 14 days with the consent of the referring party. As with all the timing issues, the working group believed further work would need to be done to ensure the timing under the act was consistent with existing general conditions of contract as contained in NZIA SSCI and N7S 3910:1998.

B: The adjudicator should be provided with a power under the proposed legislation to consolidate adjudication proceedings. It is important that the proposed bill creates a nominating authority that will provide adequately and appropriately qualified and experienced adjudicators to ensure parties are not joined in inappropriate situations, such as where the resolution of a relatively small dispute would be unnecessarily delayed by the joinder of a larger dispute.

C: The adjudicator’s decision should be binding but not necessarily final. There should be a right of appeal from an adjudicator’s decision to arbitration (if the contract so provides), or to the court.

D: The adjudication process should be confidential.

E: Retention payments are a necessary part of the construction industry, and performance and maintenance retention payments should be included within the scope of the bill. The bill should include a clause that, where a contract provides for sums to be withheld as retention payments, the sum withheld should not exceed a reasonable assessment of the costs that would arise, should another party be required to undertake that work. NZS 3910:1998 would help determine what is a reasonable assessment.

F: The question of legal representation should be left to the discretion of the adjudicator, with the inclusion of a clause similar to one in section 64(3) of the Commerce Act that the proceeding “shall provide for as little formality and technicality as the requirements of [the] act and a proper consideration of the [matter] permits”. The adjudicator would then determine when it is appropriate for the parties to have representation, while still ensuring the process does not become unnecessarily complicated.

G: Where an adjudicator has given a decision in a party’s favour, that party should be entitled to a “security interest” over the land or chattel of the person for whom the work has been carried out if the money is not paid within a prescribed time after the adjudicator’s decision.

This was a response to the concern that the abolition of “pay-when-paid” clauses would require head contractors to pay subcontractors when they themselves had not been paid. The ability for a head contractor to register a security interest or lien over the assets of the principal would help ensure that money is coming in at the top of the contractual chain so it can then filter down to the rest of the chain.

H: The adjudicator’s powers in the British act are preferred over the New South Wales legislation as they are more comprehensive and provide for the adjudicator to be able to appoint experts, assessors and legal advisors, give directions on the timetable for adjudication, for example.

The working group said more work was needed to compare the British adjudication procedures and the British Arbitration Act with the precepts in the New Zealand Arbitration Act to assist in the application of a consistent judicial process.

I: Adjudicators should have the power to appoint experts. The responsibility for notifying other parties should rest with the parties to the proceeding and not the adjudicator.

Detailed design issues not agreed on, and requiring further work by the ministry and industry are:

A: The New South Wales legislation only provides for payment disputes to be referred to adjudication, while the British act refers all matters in dispute to adjudication. The issue of whether the adjudication process should be limited to payment disputes or should apply to any dispute between the parties was not resolved.

Master Builders expressed concerns about the adjudication process dealing with all matters in dispute rather than just payment disputes.

B: The issue of what should be done where the adjudicator’s decision is that a sum of money must be paid and the payer intends to appeal that decision was not resolved.

C: While it was agreed that the registration of a security interest should only be possible after an adjudicator’s decision, the exact detail of the mechanism for achieving this and the property to which such an interest could attach was not resolved.

D: Also not resolved was the issue of whether adjudicators should have the power to opt not to answer questions and instead to allow an expert to answer those questions, in contrast with judges, who are required to answer all questions put to them.

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Construction industry payments bill in Parliament early next year

Consultation over next six weeks before final Cabinet paper

A construction industry payments bill should be before Parliament early next year, Associate Minister of Commerce Laila Harré said on Friday.

Ms Harré (right) outlined progress towards a bill, details of it and the likelihood of early enactment to the annual meeting of the New Zealand Subcontractors Federation.

This story opens with the minister’s address and continues with comments from Geoff Bayley, an arbitrator, quantity surveyor and architectural draughtsman who has been closely involved in formulating the new law; Peter Degerholm, the Subcontractors Federation’s executive officer; Hank Lieshout, president of the Master Builders Federation; and construction industry lawyer Graeme Christie, a partner at Simpson Grierson in Auckland.

A separate story, Working group recommendations on construction industry payments, contains details of the proposed bill.

The minister said the security of payments issue was only one part of a long-overdue review of insolvency legislation. Other parts are issues surrounding phoenix companies, statutory preferences, cross-border insolvency, voidable transactions, bankruptcy administration, the role of the State, voluntary administration, directors’ duties, abuse of trusts and statutory management.

“We want to have this work completed within this term of government. It is a big task, but I am confident that officials will be able to deliver on this tight timetable,” she said.

Legal vacuum “ruthlessly exploited”

Repeal of the Liens Act in 1987 brought about the present insecurity of payments in the construction industry, a legal vacuum which Ms Harré said “has been ruthlessly exploited by some operators.”

Those at the top of the industry pyramid were able to push the risks towards the bottom, “and when others don’t pay their bills on time, or not at all in some cases, subcontractors and their workers are left to pick up a significant portion of the industry’s financing requirement.”

Ms Harré said the activities of the few had weakened the whole industry, which was why there had been so much co-operation on getting legislation and why the industry working party managed to come up with a set of recommendations so quickly.

Master Builders, Contractors shift positions

The Master Builders and Contractors Federations were high on the industry pyramid, representing participants that stood to lose the most from the proposed changes.

“Both these organisations have moved considerably on their previous positions and I would like to thank them for their progressive attitude in helping to build a stronger industry, one which will be better for all participants in the long term.”

The fundamental problem the industry working party identified was that people were not being paid on time. Blockages in the system meant payments could be held up for years, and for no good reason.

“While those higher up the chain could carry such liabilities, subcontractors at the bottom of the heap were being forced into bankruptcy. The problem is now at the point where even longstanding, large companies are being affected. Clearly things are way out of kilter and it is time to put things right.

Cabinet agrees with broad thrust

“The working group’s recommendations have now been considered by Cabinet and agreed to as the basis for new legislation. What this means is that the Government agrees to the broad thrust of the proposals, while some more work is still needed on the details.

“This will involve consultation with a wider group of interested parties. It is not envisaged that this consultation will change the basic principles, but it may throw up details that have not yet been considered by the working group or officials.”

The industry working group strongly recommended adopting a fast track adjudication process along the British and New South Wales lines.

“The new legislation will outlaw ‘pay-if-paid’ and ‘pay-when-paid’ clauses. These features prey on the imbalance of power between contracting parties and are at the heart of the current problems in the industry. Pay-if-paid clauses provide incentives to under-tender for projects in order to obtain cashflow and in effect enable subcontractors to be used to partly finance construction projects.

“In recent high-profile collapses of construction businesses in Auckland, non-payment was able to continue for some time. As a result, significant losses were suffered by a large number of small construction subcontracting firms.

Other evasive tactics will be fought

“It is envisaged that adjudicators will have a high level of discretion as to how they can act, and superficial evasive tactics such as ‘pay-when-certified’ provisions will not be condoned.

“Another key feature of the scheme is that the adjudicator’s ruling would be binding but not final. The working group has also recommended that the Government examine the use of security interests over land and chattels and further work will be done on this.

“The ability for a head contractor to register a security interest or lien over the assets of the principal could help to ensure that money is coming in at the top of the contractual chain so that it can filter down to those at a lower level.

“The inappropriate use of liens was the reason they were abolished, therefore it would be necessary to ensure that an effective mechanism is in place to safeguard against this type of activity.

Residential sector included

“A key point of difference between the New South Wales legislation and the working group’s report is for the law to also cover the residential sector. It was felt that this sector was a large part of the industry in New Zealand and that there should be a uniform approach.

“The scheme will allow for subcontractors to stop work if they have not been paid. The fact that this basic right has been legally taken away shows how inequitable the present situation has become.”

Ms Harré said flexibility for the adjudicator would enable fairness. “We do not want this process to turn into just one more round of legal skirmishing. Unless there are compelling reasons it is hoped that the process can be kept as informal as possible. It should also be able to appoint experts in complicated cases. Further work is currently being done on the finer details of the proposals.”

Ms Harré said that because of the complicated nature of the legislation and the crowded legislative program it was hard to give a definite timetable for the changes to come into force. “However, given cross-party support in Parliament, I would hope to have the legislation before the House early next year.”

Not attack on entrepreneurship

She said it was not an attack on entrepreneurship: “We are well aware of the wealth-creating skills of the developers and don’t want to damage that entrepreneurial spirit. We are aware of the difficult job that contractors do in juggling the many different aspects of a large construction project.”

Mr Bayley (right) said it had to be asked, why should the construction industry get any special ? “One reason is to correct the power imbalance.” Results of this were over-competition and under-pricing. Other issues were parasitic tendering, credit spreading and fraudulent contracting.

Under guaranteed maximum price contracts, which developers have adopted over the past two or so years, risk went to those at the bottom of the chain. Current arbitration and litigation procedures “are not quite enough to prevent insolvencies… and are being abused to prevent payment,” Mr Bayley said.

“The legislation would reduce insolvencies. Directors of failed companies confirm that if legislation had been brought in prior to their problems, it would have minimised them [the problems].

Flow-ons from Goodall-ABL

“It would reduce the domino effect of insolvencies. Third-tier labour contractors are now going into insolvency and bankruptcy as a result of Goodall-ABL. It would protect employees at the bottom of the food chain and remove undesirable practices.”

Mr Bayley said 1000 jobs were effectively lost in the Goodall-ABL collapse, “135 million of turnover was lost and the total lost by unsecured creditors was $35 million.

“The protective legislation does not equal security of payment. It reduces the risk of non-payment. The legislation concentrates on keeping business solvent — a fence at the top of the cliff rather than an ambulance at the bottom.”

He said security of payments would only be guaranteed by systems which at the moment were not viable, such as statutory guaranteed payment bonds and insolvency insurance.

The primary document on which all this legislation is based, internationally, is Britain’s Latham report, produced in 1994. The New South Wales state government adopted the British legislation only to the extent of addressing payment disputes.

Adjudication very fast-track

Mr Bayley said the NSW process was “very fast track” — an adjudicator is appointed within three days of a dispute being registered and a decision will be produced within 10 days. “Adjudication is not arbitration, mediation, conciliation or expert determination, and it does not require agreement [between the parties that they should follow this course] to start. The adjudication is binding, not final, so it could be appealed.”

Under the British law, the party found liable must pay the money found to be owed before lodging its appeal, but appeals have been heard quickly. There have been 35 of them since the first one, where an adjudicator reached a decision on 14 January 1999. That decision was upheld by the court, on appeal, on 12 February 1999.

“It would reduce disputes to a manageable size and keep cashflow going. Very often the reason for large disputes is they weren’t resolved early. It would reduce, if not eliminate, fictitious and fraudulent claims. It would eliminate ‘enthusiastic litigators’. It would reduce creditors’ exposure to cost at an early stage. It would reduce risk in construction contracts and reduce the cost of buildings.”

Peter Degerholm (left), Chubb NZ’s commercial manager, was instrumental in forming the Subcontractors Federation three years ago and in highlighting the inequality of subcontractors’ positions, where their work or product had been used or installed and they had no redress for non-payment.

Legislation the start to culture change

“We see legislation as the start. Fifty-three recommendations came out of the Latham report — the last one was legislation and that was to start a culture change.”

Mr Degerholm said the move to new legislation meant the federation also had to strengthen its organisation to bring force to the law change, and to raise support for other insolvency law changes. “We represent 13 organisations. We would like to see that grow.

“We realise that security of payments is something elusive and so heavily tied in with insolvency legislation.”

Mr Degerholm said the consequences were “not policeman-type, but actual commercial consequences at work. At the moment, if you have a difference of opinion people don’t want to talk about it. Here, in 10 days you’re going to go to adjudication. It’s risk management, it’s not risk elimination.”

Again, the Goodall-ABL debacle arises: “Goodalls’ retentions were just under $1 million, according to the liquidator’s report. In fact, $6-7 million may have been retained. It smacks of abuse, to me. They were using the pay-when-paid clause as an excuse — 12% of creditors were owed $1 million on pay-when-paid clauses.”

Mr Degerholm said the act would be a catalyst for improved contract documentation, “so we can get good practice, work on conditions of contract we haven’t been happy to talk about.”

Master Builders’ head ensures antagonism remains

Mr Lieshout got a politely antagonistic reception, given the Master Builders’ rejection of the Subcontractors’ position over many years, but set himself up to be pilloried with one question: “Why are all these people [subcontractors] seeing the main contractor as the cashcow?”

The answer to that, of course, comes not simply through a legislative change but through time-honoured commercial practice, that you don’t get a job done unless you’re prepared to pay for it, irrespective of commitments to you.

He made the Master Builders’ position more curious, by saying “This is perhaps a good opportunity to put some acid on the developers to provide proof of ability to pay.”

Pay-when-paid clauses allow main contractors to be sloppy

Mr Christie, citing the 1997 case of RH Page Ltd v Hitex Plastering Ltd (Ian Holyoake) over non-payment for work done on the Blue Harbour Apartments in Auckland, said “Hitex fended off subcontractors with a pay-if-paid clause. Pay-if-paid clauses allow main contractors to be sloppy.”

He said contractors should require a bond from the project principal, but “it doesn’t happen.” Main contractors took incredible risks and subcontractors were not all lily-white: “That’s mainly because you keep working for the abusers. You keep them in business.”

Tongue in cheek, Mr Christie said: “I see this new legislation as providing great opportunities for lawyers and would like to thank the minister for that.” Then seriously, he added: “No, keep the lawyers out of the process. There are some very capable people within the construction industry , sufficiently capable to know the real issues.”

Two suggestions Mr Christie raised were, that the new law should give the adjudicator the ability to subpoena people to appear at hearings, a power which arbitrators possess; and that the adjudicator should have the power to join the developer to proceedings, “to try and get the cashflow flowing.”

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