Changes to Security of Payment legislation to affect building & construction contracts

Key points to note

• When acting as principal under construction contracts, certain payments must be withheld from head contractors.

• There are adverse consequences for principals if they fail to comply with the obligation, or mistakenly comply when the obligation does not exist.

No doubt most owners and developers have regularly received payment claims and adjudication applications from building contractors since the Building & Construction Industry Security of Payment Act 1999 (NSW) was introduced in March 2000.

Since February last year principals have begun to receive another type of notice under the Act. Titled a \"payment withholding request\", the notice is issued by a subcontractor and obliges the principal that receives it to withhold certain amounts from its head contractor. A principal which does not meet these obligations maybe required to assume the debts of its head contractor.

It has been our experience that many subcontractors misinterpret the Act and issue invalid payment withholding requests. If a principal withholds payment in response to an invalid notice, the local council will be in breach of its contractual obligations to the head contractor.

About the Act

The intention of the Act is to ensure that any party that contracts to carry out construction work (or supply related goods or services) on commercial developments in NSW is entitled to promptly receive progress payments as they become due. The Act does this by establishing a summary procedure involving the making of a payment claim by the contractor, provision of a response by the principal, and adjudication of any dispute by an independent third party.

The Act also applies between head contractors and subcontractors.

If a subcontractor has obtained a favourable determination of their claim, the subcontractor is entitled to a debt certificate under the Contractors Debts Act 1997 (NSW). The debt certificate directs the principal to pay the amount of the determination from any money that may be due by the principal to the head contractor.

In practice, this manner of securing payment of the debt is often frustrated where the head contractor is insolvent or the principal has fully paid the head contractor (who does not pass on the payment to the subcontractor) by the time the adjudication process is concluded and before receipt of the debt certificate under the Contractors Debts Act 1997 (NSW).

To try to reduce the frequency of such outcomes, amendments to the Act were introduced on 28 February this year.

In essence, the amendments allow a subcontractor who has made an adjudication application to serve a \"payment withholding request\" on the principal. A payment withholding request requires the principal to retain sufficient money to cover the claim out of money that has (or will become) payable by the principal to the head contractor in respect of work undertaken by the subcontractor until:

• the adjudication application is withdrawn;

• the head contractor pays the subcontractor the amount claimed to be due under the  claim;

• the subcontractor serves a notice of claim on the principal under the Contractors Debts 1997 (NSW); or

• 20 business days elapse after a copy of the adjudicator's determination of the adjudication application is served on the principal.

If the principal fails to comply with the payment withholding request, the principal becomes jointly and severally liable with the head contractor for the debt owed by the head contractor to the subcontractor.

Of course, the principal may not owe the head contractor any money because the head contractor has already been paid, or is in default of the head contract. In that event notice must be given to the subcontractor within 10 business days after receiving the payment withholding request that the principal is not (or is no longer) a principal for the purpose of the request. Failure to give the notice is an offence for which the former principal can be fined.

The Act does provide protection for the principal against the head contractor as:

• The obligation to retain money on receipt of a payment holding request is a defence against recovery of the money by the head contractor from the principal;

• The period during which the principal retains money after receiving a payment withholding request is not to be taken into account when determining a period for which the principal owes money to the head contractor, such as when calculating interest;

• A subcontractor is subject to a penalty if it does not notify the principal within five business days of the withdrawal of its adjudication application; and

• The principal is entitled to rely in good faith on statements made in the form of a statutory declaration by the head contractor that the amount claimed in the adjudication application has been paid or that the adjudication application has been withdrawn.

Although the amendments commenced on 28 February last year, they apply to contracts entered into before that date.

Action Required

What should an owner or developer do if it receives a notice purporting to be a payment withholding request?

1. Check that the request is in the approved form and attaches a statutory declaration that complies with the Act.

2. Check whether any money is payable or might become payable to the head contractor in respect of work undertaken by the subcontractor.

3. Either inform the subcontractor within 10 business days that no relevant amounts are (or will become) payable to the head contractor or take internal steps to ensure that no relevant payment is made to the head contractor.

4. If an amount is retained from the head contractor, inform the head contractor.

5. Await receipt of either notice of withdrawal of the adjudication application, a notice of claim under the Contractors Debts Act, a statutory declaration from the head contractor that the amount claimed in the adjudication application has been paid, or the expiration of 20 business days from receipt of a copy of the adjudicator's determination.

Author: David Creais