Australia: Corrs high vis: Episode 32 – Fiocco Report on security of payment reform in Western Australia

Hi and welcome to Corrs High Vis, I am Michael Barnes a Senior Associate in the Corrs Perth Projects Team.  I am joined today by Partner Chris Ryder, Partner Spencer Flay and Special Counsel Chris Campbell to discuss the Fiocco Report and what it means for security of payment laws in Western Australia.  Business will be aware that every Australian state and territory has legislation which aims to improve security and payment in the building and construction industry by keeping money flowing in the contracting chain. While the primary object of the various acts is the same,  there are some significant differences between the west coast model legislation which applies in WA and the Northern Territory and the east coast model legislation which applies in the rest of the country.

In December of last year the WA government released Barrister John Fiocco's final report on Security of Payment Reform in the WA Building and Construction Industry.  The Fiocco Report is a product of the WA government's pre-election commitment to improve protections for subcontractors.  It makes 44 recommendations, many in harmony with John Murray's National Review of Security of Payment Laws with the aim of addressing ongoing issues of late payment and insolvency.  Significantly, Mr Fiocco recommends that the WA government replace the 2004 Construction Contracts Act with a new Security of Payment Act based on the east coast model.  Mr Fiocco's other recommendations include narrowing the mining exclusion, prohibiting unreasonable time bars, reducing payment timeframes, incorporating express terms regarding the provision of security and introducing a statutory trust scheme for projects exceeding $1 million.  Now I am afraid the abundance of Chris' demands we operate on a first and last name basis, Chris Ryder I would be interested in your general take on the report.  What do people need to know?

Thanks Michael.  For me I think there are three observations, first the key point to remember about the report is the terms of reference, essentially to consider measures to improve security for payment for subcontractors in our building industry here in WA.  Subcontractors comprise about 80% or 85% of the industry and perform about 90 odd percent of the work on construction sites around the state.  So in that context, Mr Fiocco's focus on the current legislative models which promotes security of payment and his recommendations are, in my respectful assessment, reasonably sound.  The second observation is that as we watch developments in this area, and we do watch them with interest, we should all keep in mind that the security for payment legislation in any form it takes is no panacea and the key to success in this industry remains relentless focus on adequate capitalisation, particularly working capital, risk management, business discipline, quality, service, relationships and, commercial and particularly, contractual acuity.  So this legislation isn't going to solve everyone's problems, it's really a piece of legislation that is to facilitate good business practice generally.  And the third and final observation I would have is, that what people need to know about this report, we need to be aware that changes to the security of payment legislation may come not only in WA but particularly in the light of the Murray Report in other jurisdictions.  The tools to be used will be essentially the same but as we will discuss I think in this session, the developments may be significant at a business process level.  If I were managing a contracting business I would be focussed on my internal systems, my processes, my learning and development program so that I could be agile enough to adjust changes in my business to reflect the changes that are likely to come in the legislation.

Great thanks Chris.

As you know Mr Fiocco's call recommendation involves introducing a new Security of Payment Act which would close the divide between east and west while retaining certain aspects of the WA Act.  What are the key differences between the east and west coast models and is one more variation of the east coast model a good thing?

I don't think Mr Fiocco wants to see a further variant of the east coast model.  Effectively, as I understand it, he recommends WA adopting recommendations made by the Murray Report, which as you know is commissioned by the Commonwealth government.  So I think he hopes for all jurisdictions to adopt a consistent approach certainly in my discussions with interested organisations that is universally the desire even though there's a debate about which model is most appropriate.  That said however, it does seem likely that WA legislation will change before the Commonwealth takes its next step and that of course is because the Attorney General has announced very recently that he hopes to introduce legislation into the WA parliament this year and we know there's a federal election coming up so the prospect of uniform legislation being agreed between the states, and I think that it will still need to be state legislation, and then federal legislation coming in on top of that, will take some time.  So there will be a change to the WA Act first.  As to the differences between the east coast model and the west coast model, as it has been described, the key differences I think are these, the east coast model prescribes a statutory process for making claims and responding to claims and that runs in parallel to the contract under which any claims are made and that statutory process may therefore be inconsistent with the contractual requirements between the parties including in relation to timing of various steps. Thus under the current legislation in WA a contracting party will make its claim for payment in accordance with its contract.  If the claim is rejected or if it's not paid within the time required under that contract, then the claimant can commence an adjudication process and under the current legislation it has 90 business days in which to do so.  Now under the East Coast model, which Mr Fiocco recommends be adopted here, the payment claimant may submit a payment claim in the normal course.  Then, no matter what the contract says, the payment respondent must respond to that claim with a payment schedule, as it is called.  And it must do so within a prescribed time which is likely to be shorter than the time allowed under most contracts.  Now that payment schedule must, if it does not accept – if the respondent does not accept the claim in full, set out the amounts accepted and not accepted, and the reasons for any rejections.  Now if the respondent doesn't issue that payment schedule in the time prescribed by the legislation then it must pay the full amount claimed even if it has a legitimate basis for not doing so under the contract and the payment claimant can enforce that payment obligation as a debt, including by suspending work.  So the payment respondent must comply with the timing prescribed by the act – by the legislation that's proposed. If the payment respondent does reject any part of the claim in its payment schedule and that payment schedule has been issued within the prescribed time, then the payment claimant may commence an adjudication process which would be not dissimilar to the process currently prescribed.  But it must do so within a much shorter period of time if Mr Fiocco's recommendations are enacted.

Chris, it's pretty clear from the report that serious consequences will flow if a respondent fails to serve a payment schedule, serves a payment schedule but fails to pay the scheduled amount, or fails to include in a payment schedule all reasons for disputing a payment claim.  What might that mean for principals and head contractors, and does Mr Fiocco adequately balance the need for prompt payment against the risk of administrative oversight?

So I think there are two – I've just described to you in fairly broad terms the process that will apply if Mr Fiocco's recommendations are legislated. So here's the first:  if the payment respondent fails to serve a payment schedule and fails to pay the amount claimed in time; or serves the payment schedule but fails to pay the scheduled amount within time, the payment claimant can recover the unpaid amount as a debt through the courts or, as I think I mentioned, it can apply some pressure by suspending work.  If the payment claimant elects to recover an unpaid amount as a debt, the payment respondent then can't raise any new defences or bring a cross-claim in defence of that claim for a debt, it's more likely than not has to pay, there will be very limited, if any, circumstances in which it can refuse to do so.  So that is the first critical implication particularly for respondents – they must follow the statutory process and particularly the times prescribed by the statute.  The second implication is this – if the payment schedule is issued on time and the claim is partly or wholly rejected then, as I have mentioned, the claimant can commence an adjudication process.  Now in those circumstances the respondent, if Mr Fiocco's recommendations are legislated, may not in its response to the adjudication application rely on anything other than the matters it raised in its payment schedule.  Now there are two key implications of both of those matters.  The first is that the respondent needs to be acutely aware of the timeframes within which it must act,even if they differ from the timeframes prescribed by their contract and by their internal business processes because otherwise it may find itself liable to pay what it considers to be an unmeritorious claim and then face the difficulty of recovering that overpayment through expensive litigation.  Secondly, the respondent must be ready with all of its arguments in its defence to the adjudication application by the time it provides its payment schedule because it's not allowed to rely on any new arguments if an adjudication application is brought.  So the effect of that as I see it is that a respondent who knows they will be rejecting a claim will have to conduct most of their preparation of their defence to the foreshadowed adjudication application even before they issue their payment schedule.  There will be some considerable pressure on respondents to get their defence right at that point, that is, before a claimant decides to bring an adjudication application and that pressure will be felt particularly where the defences are relatively complex.

Thanks Chris.  Spencer let's talk adjudication.  Mr Fiocco recommends some pretty significant changes to the adjudication process which currently operates under the WA Act.  How would adjudication change if the WA Government adopts Mr Fiocco's recommendations?

As Chris just mentioned, Mr Fiocco recommends changing the adjudication process so that a principal may only include reasons for withholding payment in its adjudication response that were included in its response to the payment schedule.  Now in my mind that is significant because a principal must effectively get its house in order in a much shorter period of time than is currently the case.  Now that may mean speaking to relevant witnesses and obtaining legal or expert advice before issuing the payment schedule.  Now this may be important in the context of delay cost claims.  For example, if a payment schedule contains a claim for delay costs that entitlement would append on the subcontractor having an EOT entitlement.  However, as we all know the assessment of EOT claims is often complex and may require expert evidence.  So it's not clear to me whether adjudicators will have to determine EOT related claims in the current timeframes.  Now in that context I note Mr Fiocco does not recommend adopting the Queensland approach of creating a distinction between standard and complex payment claims.  The distinction guarantees respondents more time to respond to applications involving high value claims.  So Mr Fiocco also recommends some significant changes to the timeframes which apply to adjudications.  Currently an applicant has 90 business days from the date on which a payment dispute arises to commence an adjudication.  Mr Fiocco recommends significantly reducing this time for making an adjudication application to 15 business days.  For my part I think this is a very good suggestion as it removes the advantage applicants currently have where they can be preparing their claim for over three months while a respondent only has 10 business days to prepare its adjudication response.  However, Mr Fiocco recommends that the respondent to an adjudication application must serve its response within the latter of five business days of the application or two business days of the adjudicator's acceptance of his appointment with a potential 10 business days' extension at the discretion of the adjudicator.  Now as Chris points out the work in preparing an adjudication response should be done when preparing the response to the payment schedule.  So even though Mr Fiocco has recommended a reduction of the time to prepare an adjudication response as it currently stands under the Act, I don't think the reduction in that time is that significant.

Thanks Spencer.  A bit of a follow-up question.  So you mentioned that Mr Fiocco contemplates respondents having the opportunity to seek a further amount of time to respond to an adjudication application.  Now as I read the report Mr Fiocco recommends that the decision whether or not to grant the extension rests with the adjudicator in their discretion.  Do you think that Mr Fiocco has, in a sense, missed an opportunity to establish an automatically longer response time where a claim exceeds a particular monetary threshold?

I am not sure that Mr Fiocco has missed an opportunity but it does seem to me to be a conscious decision to grant the discretion in favour of the adjudicator so as I said before under the Queensland Act there is an automatic entitlement to additional time in the case of complex adjudications and complexity is determined by the value of the claim, and it does seem to me that in the usual course the more high value an adjudication application is for generally means that the issues in dispute are more complex which would, in the normal, course justify an extension of time.

Thanks Spencer.  Mr Fiocco also discusses the so-called mining exclusion.  How might Mr Fiocco's recommendations impact the type of work which may be the subject of an adjudication?

So by way of background the mining exclusion which currently exists in section 4(3) of the Act excludes from the definition of construction work, drilling, construction of a shaft, pit or quarry for mining and the assembly and fabrication of plant used for extracting oil, gas and minerals.  The effect being that payment disputes arising from this type of work cannot currently be adjudicated.  Now the first thing to remember is that before it was passed in 2004 the draft Act did not originally include a mining exception.  The addition of the exclusion was a late amendment and on my understanding that is an amendment was driven by some serious lobbying from the mining lobby.  From my part I have never seen the logic in the exclusion particularly where the mining sector constitutes a significant part of the State's construction industry and I am not aware of any suggestion that trades or sub-contractors in the mining sector are less susceptible to security of payment pressures than other sectors of the construction industry.  So for that reason I thought the recommendation in the Evans Report which preceded the 2016 amendments to the Act to abolish the mining exclusion was eminently sensible.  Not least of all because it would have done away with all the appeals arising from arguments about the scope and application of the exclusion.  However, as I currently understand it Mr Fiocco's view is that to remove the mining exception entirely is a step too far at least while it exists in other jurisdictions.  The thinking quite rightly being to work towards harmonisation of the regimes across the country.  So until all the jurisdictions remove the mining exception Mr Fiocco's recommendation is to adopt recommendations 4 - 8 of the Murray Report.  That is, to define construction work, related goods and services and the construction contract in the widest possible terms and to adopt the exclusion in section 5(2) of the New South Wales Act.  Such an amendment would effectively remove section 4(3)(c) from our Act being the section that allows the fabrication or assembly of items of plant used for extraction of minerals, processing oil and natural gas to be excluded.  So to answer your question, if Mr Fiocco's recommendations were to be adopted the work that would no longer be excluded from construction work would be the fabrication and assembly of plant used for processing or extracting oil, natural gas or minerals.  That would mean that the only work which would fall within the exclusion would be the drilling for or extracting oil or natural gas, or the extraction of minerals including tunnelling or boring of construction of underground works for that purpose.

Spencer, a final question for you.  Do you feel Mr Fiocco got everything exactly right or are there recommendations particularly with respect to adjudication which you think are missing from the report?

So firstly I think Mr Fiocco and the others involved with preparing the report should be commended.  In my view the report is very carefully considered and its recommendations are sound.  If I had one suggestion I would have liked to have seen Mr Fiocco's report, and for that matter the Murray Report, grapple with the challenge of preventing the abuse of the adjudication regime in my experience usually by the top end of town, as part of a negotiation strategy.  As Mr Fiocco correctly observes the problem of security of payment is most acutely felt by small to medium sized businesses carrying out specialised trade or subcontracting works.  However, over the last 10 years or so it's clear from the appeals to the WA and Northern Territory Supreme Courts that parties have been adjudicating claims in the tens and sometimes hundreds of millions of dollars which appear unrelated to cash flow concerns.  By way of example the JKC v Inpex's appeal to the Northern Territory Supreme and then Court of Appeal concerned a payment claim of some $88 million.  Clearly regardless of the balance sheet of any company a determination of one party pay another party $88 million will have a significant implication on cash flow.  By obtaining a determination of these sort of sums the successful party sets itself up in a negotiation in respect of all claims made under a contract which in my experience almost always involve complex issues of fact and law that should properly be determined by a judicial or arbitral process.  Now adjudications in these sums put enormous pressure not only on the respondent but also on the adjudicator who must currently deliver a determination within 10 business days albeit with the potential to extend that to 20 business days with the parties' consent.  Now I take the point that the current Act allows for adjudicators to dismiss an application for complexity, however, it is my experience that almost never happens which is evidenced by the fact that these type of determinations end up in our Appeals Court.  So I don't actually have an answer to that problem but I would have liked the Fiocco and Murray reports to have considered mechanisms to prevent this sort of abuse of the adjudication regime.

Thanks Spencer.  I will open the floor now to the other Chris in the room, Chris Campbell.  Chris, Mr Fiocco's recommendations extend beyond the realm of adjudication and would if adopted operate to modify certain provisions forming part of construction contracts.  As you know most construction contracts contain provisions requiring the contractor to provide security for the performance of its obligations.  How might the report impact those construction contracts which require the provision of security?

So in a section of the report dealing with contracting practices four recommendations are made in relation to the provision and release of security.  The first recommendation concerns a right for a contractor to substitute the form of security provided under a construction contract at any point during the contract term provided that security of an equivalent value is provided.  To give an example the report suggests that a contractor should have the right to replace a cash retention with a bank guarantee or insurance bond of equivalent value and that this right should override any clause in the contract to the contrary.  If adopted it will be interesting to see how this recommendation is dealt with in legislation with respect to how any replacement security will be treated as being of equivalent value.  From the perspective of a principal or head contractor cash security in the form of retention monies is the best form of security in terms of its availability or accessibility should demand need to be made on it however, if a contractor or subcontractor seeks to replace a $1 million cash retention with a $1 million condition insurance bond there may be certain steps the principal or head contractor would need to take in order to realise the benefit of its security and it is questionable such security would be of equivalent value where it is subject to those kind of conditions.  The second recommendation made in the report concerns the return of security in relation to which Mr Fiocco recommends that the Act be amended to provide an express term in all construction contracts that any security withheld must be returned no later than 12 months after completion.  Again this term would override any term in a construction contract to the contrary, but would not affect the parties' other rights such as security be withheld on rectification works or the length of any defect liability period.  Following on from this the report recommends that Western Australia should adopt Recommendation 18 of the Murray Report which relates to the prohibition of pay when pay clauses.  In the context of security provided under a construction contract, a pay when paid provision is most likely to arise where a subcontractor is not entitled to the return of the security until certain events have occurred under the head contract.  If this recommendation is adopted a provision that links the release of security to a subcontractor to an event under the head contract will be void.  The final recommendation concerning security relates to a requirement for the principal to give 10 business days' notice to a contractor before having recourse on any security that has been provided.  If this recommendation is adopted the principal's notice would need to identify the reasons for drawing down on the security and the rights available to the contractor.  And again, it is proposed that this requirement would override any term of the contract.

Thanks Chris.  I think that neatly covers Mr Fiocco's recommendations with respect to security being a right for a contractor to substitute the form of security, a requirement to return security by no later than 12 months after practical completion.  A doubling down on the existing prohibition of pay when pay clauses and a requirement for 10 business days' notice before recourse to security.  I would be grateful if I could now get your views on the section of the report which deals with time bars.  Time bars, terms which condition certain entitlements by a requirement to give notice, are another common feature of construction contracts which come under fire in the report.  Is it likely that principals and head contractors would still be able to rely on time bars to defeat claims for payment and time.

I think the short answer is probably, but the circumstances on which time bar clauses can be relied upon could become more limited depending on if or to what extent the recommendations in the report were adopted.  As you mentioned, time bar clauses are a common feature of construction contracts and a good example of their uses in the context of clauses dealing with extensions of time.  Where a construction contract typically includes a requirement for the contractor to provide notice of a delay event that has arisen the details of its impact on the works.  There might then be a further provision which states that the service of notice in compliance with the requirements of the contract including the time for service of such notice is a condition precedent to the contractor being entitled to claim an extension of time.  Now what the report recommends is an amendment to the Construction Contracts Act which would prohibit time bar clauses where compliance with the requirements to give notice would not be reasonably possible or being reasonably onerous or serve no commercial purpose.

Thanks Chris.  That being the case are there any drafting tips which principals or head contractors should employ now to ensure time bars in their contracts would be enforceable if the WA Government accepts Mr Fiocco's recommendations.

Well at this stage we will need to wait for revised legislation to be brought forward in order to understand exactly how this prohibition might operate.  However the key feature in the wording of the report seems to be reasonableness, so if this recommendation is adopted any contractual regime that requires notice to be served before a claim for an extension of time or variation for example can be assessed  will  need to ensure that the timeframes for service of notice and the level of detail to be included in such notice are reasonable and not onerous in nature.  And what you might also look to include is a short acknowledgement time provision setting out the commercial purpose behind the requirement to provide notice in the manner required by the contract and this is the sort of provision that might be formulated along the lines of clauses that you often see in which parties to a construction contract acknowledge that a contractual rate for liquidated damages is not a penalty.

Yes, okay.  Thanks Chris.  How would Mr Fiocco's recommendations affect payment terms?

In short, the maximum time period for making payment in Western Australia will become shorter.  So currently in WA a party to a construction contract must be paid within 42 days after payment is claimed.  Mr Fiocco recommends that the maximum time for making payments should be reduced to 20 business days in the case of payments from a principal to a head contractor, and 25 business days in the case of payments from head contractor to subcontractor.  And in the absence of any provision dealing with a maximum timeframe for payment in a construction contract, a time period of 10 business days would apply.

Chris, one last question and probably the toughest till last, a very significant section of the report deals with project trusts.  Where does Mr Fiocco land? 

As you say, the report includes a detailed section dealing with project trusts in which Mr Fiocco makes a number of recommendations which, if adopted, the report contemplates being introduced on a phase basis. So the first of these recommendations relates to retention monies and the establishment of a retention trust scheme so that any party that holds retention money pursuant to the terms of the construction contract, which would include principals, is deemed to hold the money on trust, irrespective of the value of the trust money in question.  Following on from this the report also recommends the introduction of a deemed trust scheme under which a party that receives payment under a construction contract on account of work performed, whether in part or whole by another party, then payment is deemed to be held on trust for the benefit of the party who performed the work.  By way of an example, this recommendation would work on the basis that if a head contractor becomes insolvent, the money that each subcontractor has earned but not been paid for at the time of that head contractor's insolvency will be treated by the law as if it were being held on trust for the subcontractors.  The report suggests that these trusts will be just scathing in nature which means that where several tiers of subcontractors sit below an insolvent contractor, each of them will be the beneficiary of trust money held by their respective principal and the trustee for themselves and their own subcontractors have the trust money that they hold or entitled to be paid.  The report recommends that initially this scheme would apply to construction contracts where the value of the head contract is a million dollars or more and suggests that the government might consider reducing or removing this threshold after five years.

So what happens next?  Shortly after releasing the report in December, the WA Government announced it would carefully consider each of Mr Fiocco's recommendations with a view to introducing legislative reforms in the first half of 2019.  WA Attorney General John Quigley provided a more telling insight into the WA Government's thinking at a construction industry breakfast in mid-February.  Mr Quigley indicated to a large room of keen observers that the WA Government intends to broadly adopt Mr Fiocco's recommendations and to embrace the East Coast model with the aim of achieving nationally consistent security of payment laws.  In terms of timing, Mr Quigley said that he was quietly determined to bring in both security of payment and the cascading trusts which Mr Fiocco describes, before the end of 2019.  We will of course follow any legislative developments with interest. For now, thank you to Chris Ryder, Spencer Flay and Chris Campbell from the Corrs Perth projects team for distilling the key takeaways from Mr Fiocco's report.  And thank you also to our listeners for tuning in.  My name is Michael Barnes. Until our next Corrs High Vis podcast, goodbye.

This podcast is for reference purposes only.  It does not constitute legal advice and should not be relied upon as such.  You should always obtain legal advice about your specific circumstances.

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