Introduction
As I look out the window from my Chambers, the Seascape Apartments are still devoid of any activity (the contractor claiming $33 million, following an adjudication - that claim currently before the High Court) and PwC, the statutory managers of Du Val, have advised that it looks like the valuation of the various companies is well short of the $500 million or so claimed by the Clarkes; and the debts exceed $250 million.
The papers seem to suggest that the money has gone on executive jets, champagne and a fast Instagram lifestyle, reminiscent of George Best who famously said, "I spent my money on booze, birds and fast cars. I squandered the rest!" This rather glib comment should not overlook that the Clarkes have left many investors and subcontractors wondering if they will be paid.
Sadly, the problem isn't new. In the 19th century, Isambard Kingdom Brunel bankrupted many of his financiers with his ambitious projects; JBL shocked the country in the 1970s by going "too far too fast"; the collapses of AB Goodall and Hartner left trails of woe in the 1990s; and Mainzeal was liquidated leaving unsecured creditors $130 million out of pocket in 2010.
The money, it seems, has gone.
This all rather raises the obvious question, how did we get here? or more pertinently, how do we avoid this happening in the future? and how do we preserve the value of half-completed projects?
Only contract with good people
The first piece of advice I received as a young lawyer in the early 1980s, and have given ever since, was to only contract with good people. It is a statement of the bleeding obvious, but it is advice missing from most construction procurement procedures.
For the construction of the Tsing Ma suspension bridge in Hong Kong, the lowest tender, by an implausible margin, was from a large South Korean engineering company. The price was so far adrift from the other bidders that the Government sought an on-demand performance bond for the full amount of the contract price as security. The tender was withdrawn, after much complaining and threats of legal action.
In most cases, you do not need to go so far.
For the Hong Kong projects, tenders were only called from pre-qualified contractors. Pre-qualification required submission of 3 years of audited accounts, evidence of performance on similar projects, current commitments, available resources and expertise, and details of disputes and claims for liquidated damages etc. The Government was then confident that it was only calling for tenders from companies with the financial resources and experience necessary to do the work.
Where construction companies (and consultants) were structured in such a way to separate corporate liabilities from underlying assets, for example tendering using project specific shell companies, parent company guarantees were required. They typically covered:
· a primary obligation to carry out the work, rather than a simple guarantee,
· undertakings to ensure the contracting subsidiary was properly financed and resourced to carry out the work, and
· an undertaking not to do anything which may detract from the subsidiary’s ability to carry out the work.
Assuming that the guarantee was actually given, default was a rare occurrence.
Construction Contracts
Part of the problem rests in the contracting model we have inherited.
The original basis for carrying out building work was under an entire contract, under which there was no entitlement to progress payments, the total contract price being paid in one lump sum once the work was completed. The contractor therefore funded all subcontract works itself, and was reliant on being able to complete the work and the owner's ability to pay.
The entitlement to progress payments was introduced first by contract and then by statute, however the concept of the ultimate entitlement to payment is not established until final completion is achieved - the actual price is only established on the final accounts.
Progress payments, save in exceptional circumstances, are payments only "on account" of the contractor achieving completion and establishing final cost. Subject to contractual provisions to the contrary, if a project is not completed, the contractor's ability to retain payments to date can be questionable.
In the words of Jessel MR in the 1878 case of In re Hall & Barker:
If a man engages to carry a box of cigars from London to Birmingham, it is an entire contract, and he cannot throw the cigars out of the carriage half-way there, and ask for half the money; or if a shoe-maker agrees to make a pair of shoes, he cannot offer you one shoe and ask you to pay one half of the price.
Whether or not a contract is an entire contract will depend largely on its terms, and whether or not performance of all of the contract, or substantially all of it, is a condition precedent to an entitlement to payment. The value of any work completed to date will also be a factor. For example, a process contract or ICT development project, where the incomplete work has no value, would suggest that the entire contract principles apply. Receiving progress payments to meet cashflow is not, it would seem, inconsistent with an entire contract being in place (see Cutter v Powell (1795) 6 TR 320; Hoenig v Isaacs [1952] 2 All ER 176; and Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689 at 699).
More reassuringly, while interim payments are treated generally as advances, both under the common law and under the Construction Contracts Act 2002, whether or not a contract is an entire contract will depend on the contract wording, and its interpretation. Much will depend on how progress payments are calculated, and on what basis they become due.
The legal niceties of entire contracts aside, most contracts will provide for the consequences of termination. NZS3910:2023 provides that, upon resuming possession of the site, the contractor is not entitled to further payment (see clause 14.2.3), and on completion of the works, the contractor is to reimburse the additional cost of completing the works together with any damages payable (see clauses 14.2.4 & 14.2.5). Where the contract is cancelled under either section 36 or 37 of the Contract and Commercial Law Act 2017, no further payment is required and no payments to be returned under section 42, pending the grant of relief under section 43.
In most cases, therefore, the question of whether or not a contract is entire will rest on the court's power to grant relief, which may include reimbursement of all progress payments made to date.
The residual, and problematic, issue is the assumption within the industry that progress payments are the head contractor's to disburse as it thinks fit; or more critically to the subcontractor or supplier most pressing for payment.
Buildability
Entire contracts also remain relevant when considering a contractor’s entitlement to variations.
There seems to be an assumption that work which is not detailed in the drawings or specifications, or which the contractor the contractor has not priced, when detailed, is a variation. Nothing could be further from the case.
The pertinent question when assessing variations is whether or not the work is within the scope of the contract. In the famous anecdote, where a housing is to be build, but the foundations not detailed, if the contractor has agreed a price, the cost of forming the foundations in accordance with accepted standards is within that price. This has been the accepted position since the case of Thorn v Mayor and Commonality of the City of London (1875-1876) L.R. 1 App. Cas. 120 HL.
This position is confirmed in clause 2.7.4 of NZS3910, under which the contractor is entitled to have such omissions treated as a variation only where the omission was not reasonably foreseeable.
Subcontractors and Suppliers
In Lord Denning's famous aphorism in Dawnay's case, "cashflow is the very lifeblood of the [construction] enterprise." Sadly, that cashflow does not attach to the project for which it is paid.
The cash "flows" from the owner and its financiers, neither with any obligation to ensure that the payments are applied to the work for which the contractor establishes its entitlement. Interim payments are claimed, typically on the basis of achievement of work carried out under the head contract. Subcontractors and suppliers must then establish their entitlement to share in the payments under their respective subcontracts. The two don't always match.[1]
For the contractor, the further flow of funds down the contract chain will depend on the most pressing demand - while payment by the owner should cover the full entitlement of all participants in the project for work to date, that is not reflected in any legal obligation on the contractor to pay. Without a clear statement of trust, and the funds being set aside, there is no legal or equitable claim available to subcontractors or suppliers to access those funds (save for retentions in terms of sections 18A to 18Q of the Construction Contracts Act, if the funds are actually set aside).
The subcontractor has to enforce its rights to payment against the contractor, with no recourse to the owner or its financiers.
This unhappy state of affairs is compounded by the payment cycles in most projects, with the head contractor claiming payment at the end of the month (for work undertaken to date), and the owner typically making payment on the 20th of the month following the claim (17 working days under clause 12.2.7 of NZS3910:2023 and 20 working days under section 22 of the Construction Contracts Act). That payment will typically be subject to deduction for retentions (up to 5% in. most cases, and a sliding scale under section 12.3.1 of NZS3910:2023 up to a cap of $200,000).
Payments to subcontractors will typically be up to 90 days following payment claim (to allow that claim to be included in the next head contract claim and for the payment to then be received), with retentions being 10% or more. So, while the head contractor's payment claim may be based on its obligations to its subcontractors and suppliers, there is frequently a sizeable cashflow imbalance in the contractor's favour, with no direct obligation on the owner and its financier to ensure that the funds reach their intended destinations.
Head Contractor Insolvency
Like most Ponzi schemes, when the music stops, the money has gone - and not to the project for which payment was made, but to other projects with more pressing demand.
The owner will typically terminate the head contract, and get the project completed, retaining the benefit of work carried out by subcontractors, most of whom will not have been paid. Procuring another contractor to complete the work will depend on the market conditions (almost never at the discount speculated by Venning J in the Rau Paenga case). Inevitably, some work will need to be redone, and the cost to complete will be more than the original contract price, with no fixed price, liquidated damages for delay or warranties from the new contractor.
For most projects, as payments are in arrears and there is no obligation to make further payment on termination, the owners are able to move on. In rare cases (a number of the Du Val projects), the insolvent contractor may be kept on to complete the project - that has potential liability for the receiver/liquidator, so this will occur only when those projects are near completion and there is considerable cashflow to be released on completion.
In the majority of cases, the contractor is removed from the site and the owner then needs to find others to complete the work.
Subcontractor Warranties
With some exceptions, most construction companies are project managers, relying on subcontractors to carry out most of the work, with significant plant hired and labour sourced from workforce companies. Following termination, keeping subcontractors on site to complete their works becomes a priority.
For subcontractors, there is also an incentive to complete the work, subject to being satisfied that their retentions, arrears of payment and future payments are secured. Direct subcontractor warranties have been the norm in major construction projects for many years.
Typically, they cover:
· notice by the subcontractor to the owner in the event of default by the contractor;
· the ability by the owner to take a novation of the subcontract in the event of termination of the head contract;
· direct warranty for the subcontract works and an obligation directly to the owner to rectify defects;
· in some cases, the right of direct payment; and
· consolidation of any disputes.
The form of subcontractor warranty in Schedule 13 of NZS3910:2023 falls well short in many respects.
Under the ideal forms of warranty, the owner has a direct right of contract with the key subcontractors, and has the ability to bring in another head contractor/project manager, if needed, to complete the work. Argument over liability for outstanding payment is common in such circumstances, and hard to resist.
For such arrangements to work effectively, some amendment to the terms of the head contract is required, notably:
· registration of subcontractors as a condition of approval;
· proof of payment of subcontractors as a condition of continued progress payment;
· provision of subcontractor warranties, covering not only warranty of work carried out, liability in the event of default and also novation of the subcontract at the owner's option; and
· direct payment of subcontractors by the owner, also at the owner's option.
The last issue, direct payment, comes with a number of risks for owners.
Where a contractor becomes insolvent, the equal treatment of unsecured creditors, ie subcontractors, becomes an issue. If an owner pays a subcontractor its arrears in order to get the works completed, then under the pari passu principle which applies in liquidations, the owner may remain liable to the contractor for those arrears - and so have to pay those arrears twice; once to the subcontractor to stay on site and then again to the liquidator of the insolvent company.
Short of legislative intervention (for example in Singapore and Malaysia under their respective security of payment legislation, which provides for owners to be jointly and severally liable with head contractors to subcontractors for amounts determined in adjudication), the only way around this risk is by (1) express trust, with all its complications; (2) a direct payment agreement in place before the insolvency; or (3) conditioning payment by proof of payment of subcontractors, with provision that direct payment by the owner discharges any obligations to the head contractor.[2]
The difficulty with direct payment is that, under the insolvency legislation, any such payment will not discharge the liability on the part of the owner to the head contractor. It is accepted law that a contractual arrangement cannot not override the equal treatment provisions of sections 292 to 301 of the Companies Act 1993.[3]
In the UK decision of Mullan v Ross[4], a direct payment clause in a contract was held to be void. That case should be contrasted with the case of Glow Heating v Eastern Health Board[5] where such a clause was held to be effective as against a liquidator on the basis that direct payment was held to be mandatory, rather than permissive. Commentary on that case is not supportive of that approach.[6]
Part of the confusion over the issue is that the cases focus on the direct payment to the subcontractor, rather than the impact of such a payment on liability of the owner to the head contractor. The concern is twofold – (1) whether or not the provision in the head contract allowing direct payment discharges the owner’s liability to the head contractor; and (2) whether or not the payment received by the subcontractor gives a preference to the subcontractor which is voidable.
On the first issue, mist direct payment provisions in head contracts will provide first that the owner may pay subcontractors directly, and second that such payment will be deducted from the head contractor’s next payment claim. It is the latter part which provides effectively for a discharge of the owner’s liability.
Applying Bathurst principles of contract interpretation it is at least arguable that a term will be implied that the owner is released from liability to the head contractor for payment of the amount paid directly to a subcontractor.
On the second point, the pari passu principle is one of equal participation by unsecured creditors in the assets of a company on liquidation. The provisions of the Companies Act gives liquidators the right to set aside payments or arrangements which prefer one creditor over another.
The difficulty in the construction context is, on the insolvency of the head contractor, owners will wish to keep subcontractors on site in order to complete the contract works; they will only do so if arrears are paid.
The issue was considered by the High Court in Sanson v Ebert Construction,[7] however in that case the payment was made to the subcontractor by a third party financier. The issue was whether or not that payment was voidable (which the Court held it was not). The parties accepted that the payment by the funders did not affect the owner’s liability to make the payment under the head contract.
It would appear that direct payment by owners to subcontractors, at least in the event of insolvency, it not without its difficulties. The legislative alternative is discussed further below.
Umbrella Agreements
For more complex projects, involving the rights in the event of default by an owner/promoter, financier, contractor and beneficial off-take purchaser or leaseholder, such issues can be legislated by entering into agreements which govern how the parties exercise their respective rights while retaining the ultimate value of the project.
The issue is one of regulating how those parties exercise their respective rights in the event of default, particularly as the events of default, and resulting rights, will differ from contract to contract.
Under such arrangements, in the event of a failure by the owner/promoter - the financier, contractor and off-take purchaser each gives the other notice of default before terminating their respective agreements.
Similarly, if the contractor fails, the owner/promoter, financier and off-take purchaser each defer exercising their rights pending finding a replacement contractor.
In each case, the parties work together to try to keep the project on track and avoid the inevitable delay, uncertainty and loss in value if the contractual arrangements fall apart. Much of this should happen in any event, however having the discussion in advance, and regulating how the parties exercise their respective rights, and negotiating their contracts in that context, can be beneficial in practice.
Statutory Reform
The final piece of the jigsaw, aside from a significant shift in how contracts are structured, is statutory reform.
The first, and simplest amendment is to the Construction Contracts Act 2002 to make owners liable for amounts due from head contractors to subcontractors, either under the default payment provisions of sections 22 to 24 or as a result of an adjudicator's determination under section 58. This extension is similar in many respects to extending the application of a charging order to “associates” owning property not owned by a respondent under section 50.
This would fly in the face of most basic rules of contract enforcement, with perhaps the exception of the rights of third parties under the Contracts (Privity) Act 1982, now part of the Contract and Commercial Law Act 2017. The immediate impact of such a change will be for owners and their financiers to ensure that payments made for a project are properly applied down the contract chain.
The second is to establish a statutory scheme, similar to that for retentions under sections 18A-18Q of the Act, to provide as follows:
· payment claims under section 20 to identify amounts due to subcontractors, and any deductions from such payments and the reasons for them;
· separate accounts to be maintained by head contractors for payments due to subcontractors;
· the ability for owners to pay subcontractors directly, and to be discharged from any obligation to pay such amounts to head contractors; and
· the registration of all subcontractors with owners as a condition of approval.
While this may seem, at first glance, to be overkill, the construction industry has a problem with payment and cashflow, built on the assumption that contractors have the capital and resources to be liable for the value of the work they undertake. This is far from the case, and disruptive and damaging failures will continue until these issues are properly addressed.
The reality is that such amendments would not be necessary if we didn’t have a problem. The amendments are also not without precedent, as similar provisions have been enacted in the security of payments legislation in Singapore and Malaysia.[8]
Conclusion
Sadly, in the rush to get projects started, most owners and project managers are reluctant to engage in a productive discussion about default, and contractors are nervous about starting on the wrong foot and potentially losing the job by being overly cautious.
Until we properly address these issues, we will be left with little more than prognostications from politicians, and we will continue to see corporate failures across the industry.
John Walton
Bankside Chambers
6 February 2025
(revised 7 March 2025)
[1] See Julian Bailey Construction Law London Publishing Partnership 3rd Edition, 2020 at paragraph 20.39
[2] See Julian Bailey Construction Law at paragraphs 20.42 et seq
[3] See Allied Concrete v Meltzer [2015] NZSC 7
[4] Mullan & Sons Contractors v Ross [1996] N.I. 618
[5] Glow Heating Ltd v Eastern Health Board (1992) 8 Const L.J. 56
[6] See Keating on Construction Contracts 11th Edition at 16-075
[7] Sanson v Ebert Construction Ltd [2015] NZHC 2402
[8] See s24 Building and Construction Industry Security of Payment Act 2004 (Singapore) and s30 Construction Industry Payment and Adjudication Act 2012 (Malaysia)