30 November 2006
Key Points:
Time bars in construction contracts will not necessarily be unenforceable because of the NSW Security of Payment Act.
Section 34 of the Building and Construction Industry Security of Payment Act 1999 (NSW) is entitled "No contracting out", but since the 2002 amendments to the Act it in fact has the potential to operate far more broadly than this heading suggests. This is because section 34 makes void a provision of any agreement:
Given its breadth, therefore, section 34 is perhaps better described as an anti-avoidance provision rather than as a mere prohibition on or prevention of contracting out.
Adjudications and section 34
Another significant feature of the operation of section 34 is that it has been held that an adjudicator has the power to determine whether contractual provisions relied on by a respondent to defeat a payment claim are void.
This means that if an adjudicator, when reviewing a contract for the purposes of determining an applicant's entitlement to a progress payment, reasonably construes a provision of a contract "as an attempt to deter [the applicant] from taking action under the Act", he or she may disregard it.
Moreover, under the approach currently adopted by NSW courts, an error by an adjudicator as to the application of section 34 to the provisions of a contract will not itself be sufficient to invalidate his or her decision.
The effect of section 34
In addition to observing the broad scope of section 34 and its operation in an adjudicatory context, it is also important to note the seriousness of its effects. At a minimum, where section 34 applies it will mean that in any adjudication or other determination of parties' rights and obligations under the Act, the affected clauses of the contract, including clauses purporting to limit the timing or amount of claims for payment, will be ineffective.
Justice McDougall of the NSW Supreme Court has commented, extra-judicially, that should the question come before him he would take the view that this section renders offending provisions void for all purposes, not merely for the purposes of the Act itself. With respect, however, it is suggested that it is difficult to reconcile this approach to section 34 with the clearly interim character of rights given and determinations made under the Act.
Judicial interpretation of section 34
Given the long reach of section 34 and the significant consequences that may follow from its operation, it is of vital importance that the provisions of a construction contract, and in particular those constituting the payment mechanism, are consistent with the regime set up by the Act.
The achievement of this aim is complicated, however, by the apparent absence of any clear consensus view on what kinds of provisions are likely to fall foul of section 34.
Minister for Commerce v Contrax Plumbing
Until recently, the only major decisions on the anti-avoidance provision of the Act were those of Justice McDougall[1] and the NSW Court of Appeal[2] in Minister for Commerce v Contrax Plumbing . The contract at issue entitled the contractor to make payment claims, but limited the aggregate of the payment claims to the contract price. Any adjustment to the contract price, in the absence of agreement between the parties, was only to be made via a lengthy process of determination by the superintendent's representative, the superintendent, expert determination and then arbitration.
At first instance, Justice McDougall stated that these provisions were void under section 34 because the contractor was not entitled to be paid until the adjustment process had been completed (which the contractor submitted could take, and indeed had taken, six months). As such, the provisions had the effect of deferring entitlement to progress payments beyond the reference date occurring next after the work is done, which he found to be inconsistent with the contractor's right (under section 8(1) of the Act) to a progress payment on and from the reference date.
On appeal, Justice Hodgson (in obiter) went even further by suggesting that contractual provisions which expressly determine "reference dates" for the calculation of "progress payments" may be held to be void if they could possibly operate in a way that would restrict the operation of the Act, even though such contractual provisions are expressly deferred to by sections 8(2) and 9(a) of the Act. He provided two examples of contracts that he considered might be interpreted as restricting the operation of the Act within section 34:
However, Justice Hodgson did not go on to elaborate on the question of what the dividing line might be between contracts that deal with "progress payments" and "reference dates" in an acceptable way and those that would attract the operation of section 34. Furthermore, Justice Bryson and Acting Justice Brownie, the other members of the Court of Appeal, did not express agreement with Justice Hodgson's comment (for more on this decision, see Mathew Stulic's article "To err is adjudicatory, to forgive is judicial: Brodyn considered" in our September 2005 edition).
John Goss Projects v Leighton Contractors
Justice McDougall's reasons in the more recent matter of John Goss Projects v Leighton Contractors [2006] NSWSC 798 indicate that section 34 will not be interpreted as having as extensive a reach as the Contrax cases might suggest.
Justice McDougall stated that a clause that had the effect of barring claims by the contractor for any sums over and above the pre-agreed "contract amount" unless the contractor gave written notice of its intention to claim, and submitted the claim within ten days of becoming aware of the circumstances on which the claim was based, did not fall foul of section 34. He found that such a clause did not restrict the plaintiff's statutory entitlement to make a payment claim within 12 months after its work under the contract ceased; rather, it simply limited "entitlement to work that might be comprised in a payment claim, whenever the payment claim is made".
Payment clauses and section 34
What kind of payment provisions, then, are likely to survive a challenge brought on the basis of section 34?
Clauses withholding payment until conclusion of dispute resolution
The clause impugned in the Contrax decisions was of this type, but it does not necessarily follow that all clauses that defer entitlement to progress payments until the outcome of a dispute resolution process will fall foul of section 34. On the basis of Justice McDougall's reasoning, it appears that so long as such a process (which might take the form of an expedited expert determination) is to be concluded by the next "reference date" under section 8(1) of the Act, this type of provision is acceptable. However, if the dispute resolution process continues after that time, the clause is at risk of being struck down on basis of the decisions in Contrax .
Clauses setting yearly or half-yearly dates for payment
As noted above, Justice Hodgson observed in Contrax that clauses that provide for yearly reference dates may attract the operation of section 34.
With respect, it is difficult to see why this is so, especially as sections 8(2) and 11(1)(a) of the Act clearly provide for reference dates and dates on which progress payments are to be made to be set under the contract. Thus, there is nothing to prevent the parties setting reference or payment dates on such periods as they may agree and include in the contractual terms (and in respect of which the contract will no doubt provide for an additional financing charge to be paid to the contractor).
Clauses requiring contractor to finance some or all of the works
Some projects are undertaken on the basis that the contractor is required to finance either a part or the whole of the works. In effect, the provisions imposing this restriction will:
and thus on Justice Hodgson's view in Contrax , be rendered void by section 34.
Again, however, the better view appears to be that there is nothing in either the express provisions of the Act, or policy behind it, that would prevent the parties from determining (in the contract) the dates on which progress payments are to be made or the way in which they are to be calculated.
As mentioned above, the contractor on a project being undertaken on this basis will also generally require that a financing charge be included in the contract sum payable for the work, thereby further negating any rationale for striking down such payment structures. Therefore, there should be no obstacle under the Act to such a "self-financing" arrangement being put in place.
Clauses imposing finance drawdown limitations
Another type of clause not directly considered in the Contrax decisions but that also has the effect of limiting the amount of progress payments is a finance drawdown limitation. Under these provisions, the amounts which the contractor is entitled to claim at any time during the project is capped, so as to ensure that the owner's financing arrangements will be sufficient to cover the contractor's claims. In these circumstances, as in those considered above, the contract sum will normally also include a fee to be paid to the contractor in order to cover the costs of any temporary "bridging" financing it is likely to require in the interim.
Again, it appears that there is no reason why such a clause should attract the operation of section 34, as under the Act the parties are entitled to set methods for determining the timing and amount of progress payments to be made under the contract.
Nor should a properly drafted finance drawdown limitation provision offend the section 12 prohibition on "pay when paid" clauses, as the caps it imposes on the amounts of any progress payments are periodic rather than absolute, and will be agreed by the parties and set out in the contract rather than being contingent on the sums actually drawn down by the owner.
Conclusion
Despite the broad approach to section 34 taken by some judges in the Contrax decisions, the better view is that contractual provisions that have the effect of imposing limits on the amounts to be included in or times for submission of payment claims do not necessarily offend the scheme set up by the Act.
Thus, where the appropriate drafting and structures are employed, parties to construction contracts should continue to enjoy considerable freedom in determining the payment and financing regimes they wish to include in their contracts.
[1] Minister for Commerce (formerly Public Works & Services) v Contrax Plumbing (NSW) Pty Limited [2004] NSWSC 823.
Thanks to James Shirbin for his help in writing this article.
For further information, please contact Sergio Capelli.
