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 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 fast cars, fine wine and beautiful women; I blew 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?
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 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 (seeCutter 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.
Subcontractors and Suppliers
In Lord Denning's famous aphorism in Dawnay's case, in construction "cashflow is the very lifeblood of the 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. Subcontractor's and suppliers must then establish their entitlement to share in the payments under their respective subcontracts. The two don't always match.
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. 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).
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 balance 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.
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 Palmer 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 management companies, 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; and
- in some cases, the right of direct payment.
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.
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, 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 under its security of payment legislation, which provides for direct payment of subcontractors discharging obligations to head contractors), 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 (see Julian Bailey Construction Law 3rd edition at paragraph 20.42 et seq).
The legislative alternative is discussed further below.
Umbrella Agreements
For more complex projects, involving an owner/promoter, financier, contractor and beneficial off-take purchaser or leaseholder in such issues by entering into agreements which govern how the parties exercise their respective rights, while retaining the ultimate value of the project, has become increasingly common.
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 recognising the rights of all contract participants, is statutory reform.
The first, and simplest amendment is to the Construction Contracts Act 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 over a property not owned by a respondent under section 50.
The immediate impact of such a change will be for owners and their financiers to ensure that payments made for a project are 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.