In the second of our series of articles, we set out some risks and opportunities for contractors to be mindful of when completing a project in the age of the coronavirus.

Security of Payment

The onset of COVID-19 has already started to lead to an uptick in disputed progress claims. With cashflow drying up, assessors are now looking much more closely at claims from contractors, and raising any and all reasons available to them in order to withhold payment.

This is a timely reminder that there exists ‘security of payment’ legislation in each State and Territory. That legislation provides contractors with a quick and inexpensive statutory right to obtain interim cashflow on their construction projects. When used at the right time, the legislation is a powerful tool for contractors to secure prompt payment in relation to a disputed progress claim.

With this in mind, contractors should:

(a) be vigilant about receipt of payment claims from their subcontractors under security of payment legislation, and adhere to the requirements and formalities of the legislation by ensuring that valid payment schedules are issued to subcontractors within the relevant timeframe

(b) consider their ‘upstream’ rights under the security of payment legislation, where cashflow is becoming a significant issue as a result of clients unreasonably assessing contractors’ payment claims.

Managing the risk of subcontractor insolvency

The economic downturn is likely to see an increase in subcontractor insolvency. Managing this issue can be difficult. On the one hand it is in the contractor’s interest to see its subcontractors stay afloat and complete their scope of work, as insolvency is likely to lead to delay (and likely exposure of the contractor to liquidated damages) and increased costs in completing the project. However, on the other hand assisting a subcontractor in financial distress (for example, by making advance payments for cashflow purposes) is risky because the subcontractor may nevertheless still become insolvent.

We set out below some of the ways in which contractors might monitor their subcontractor’s financial position on an existing project, where the subcontractor is likely to go into administration.

1. Statutory declarations: Most construction contracts require subcontractors to provide the contractor with a statutory declaration and other documentary evidence when it submits a payment claim to demonstrate that all workers and subcontractors have been paid all monies due and payable to them as at the date of the relevant claim. Usually, the contract also permits the contractor to withhold payment of moneys certified until satisfactory evidence of payment has been provided.
   
   If the subcontractor is highly likely to become insolvent, it is important that the contractor does not pay the subcontractor until it receives a statutory declaration that complies with the requirements of the contract, and is signed by someone sufficiently senior.
   
   
2. Auditing Records: Construction contracts often give the contractor broad rights to inspect and copy any records required to be kept by the subcontractor in relation to the project. Where such a right exists, contractors could conduct such an audit if in any doubt whether the subcontractor’s employees or sub-subcontractors have been paid.
   
   
3. Advance Payment: It is not uncommon for subcontractors experiencing financial difficulty to request an alteration to the agreed contractual payment mechanism by way of advanced payments.
   
   Care should be taken before agreeing to payment in advance. Whilst this may seem appealing as a catalyst to enable the subcontractor to progress the work, contractors should consider the risk of subcontractors becoming insolvent after any payment in advance is made, but the work has not been progressed commensurately.
   
   If contractors are to entertain any form of advanced payment, one way to mitigate this risk is to request additional security from the subcontractor in return for the advance payment.
   
   
4. Inventory of materials / unfixed plant and materials: A contractor experiencing financial difficulty may seek to remove plant, equipment and materials from the site. To minimise the risk of this happening, it would be prudent for contractors to:
   
   (a) avoid paying for any unfixed plant and materials (to the extent possible under the terms of the relevant subcontract)
   
   (b) keep a detailed inventory of what materials are on site and off site and which, if any, have been paid for by the contractor
   
   (c) periodically take photographs of materials installed and those in storage (on and off site).

This is the second article in this series – click here to read the first, which discusses the steps contractors can take during these unprecedented times to protect their cash flow.

Maddocks has produced guides to a range of legal issues raised by COVID-19. You can access these guides here.