Most in the construction industry now appreciate the importance of complying with the payment claim – payment schedule procedures in sections 20 & 21 of the Construction Contracts Act 2002, and the potentially draconian consequences of a failure to comply under sections 22 & 23. As Asher J observed in Marsden Villas v Wooding Construction [2007] NZLR 897, this can be a “sudden death” regime for owners.
Where in the past, owners have withheld payments or paid part only of a claim as they were unhappy with the quality or progress of the works, or they may genuinely view the payment claim as wildly overstated, that situation changed in 2003 when the Act came into force. Now, provided the contractor’s payment claim complies with the formal requirements of section 20, the only means of disputing the claim, without triggering the default provisions of sections 22 & 23, is to submit a payment schedule which also complies with the formal requirements of section 21, within the prescribed time. A failure to comply with section 21 will result in the entire amount claimed becoming payable as a debt due. At that point, payment cannot be resisted; section 79 expressly provides that a court must not give effect to any counterclaim, set-off or cross-demand, save for undisputed liquidated amounts.
Similarly, where a dispute is referred to adjudication, the adjudicator’s determination must be enforced by the court on the same basis.
The critical point to note at this stage is that the Act does not require the amount claimed by the contractor to be justified in terms of the contract – that is a matter of substance outside the requirements of section 20. Similarly, nor do any deductions under the owner’s payment schedule need to be based in contract – what is required under section 21 is for the contractor to understand what has been deducted, how it was calculated and the reasons for the deductions (see The Fletcher Construction Company v Spotless [2020] NZHC 1942). The core purpose of a payment schedule is, as Harrison J observed in Metalcraft Industries v Christie CIV-2006-488-645, to give the contractor full and unequivocal notice of all areas of difference or dispute to enable it to properly assess its future options.
The merits of any claim or deduction in terms of the contract (the substance of the dispute) must be resolved using the dispute resolution procedures specified in the contract, or adjudication under section 25. Consideration of that claim will follow any interim payment made under the payment-claim/payment-schedule regime under Part 2 of the Construction Contracts Act.
Owners confronted with liability under section 22 (for an unanswered payment claim), or an adverse adjudicator’s determination, often find themselves in an invidious position. Under the Act, they must pay first, leaving the substance of the dispute to be dealt with later.
In response to a summary judgment application by contractors, relying on section 79, owners have tended to claim that there are solvency issues with the contractor, which militate against immediate payment while the substance of the dispute remains unresolved; and where the contractor applies to have an adjudication determination entered as a judgment of the Court in terms of section 73, owners will often seek judicial review of the determination.
The first challenge brings the provisions of section 79 of the Act into perceived conflict with the provisions of section 17(1)(a) of the Insolvency Act 2006, which requires “final judgment” in order to establish an act of bankruptcy, and establishing a company’s “inability to pay its debts” by issuing a statutory demand under section 389 of the Companies Act 1993.
Understandably, when confronted with such issues, the courts have tended to be somewhat cautious. In Concrete Structures v NMHB [2019] NZHC 268, Associate Judge Bell (echoing his earlier comments in Kariiti v Donovan Drainage & Earthmoving CIV-2010-488-000613, 19 November 2010) held that a judgment debtor could raise counterclaims and set-off in bankruptcy proceedings as there would be no opportunity to “argue later”; but it must first convince the court that it had a sound and credible counterclaim or set-off before it would exercise its discretion under section 37 of the Insolvency Act (see also C&R Property Development Ltd v MR Civil Ltd [2020 NZHC 1470 and Hy Tourism Ltd v Three Dukes Home Ltd [2020] NZHC 2051). In other cases, the court has been persuaded not to enforce payment of the debt created by the Construction Contracts Act by the simple expedient of payment into court or into escrow.
The issue is more than esoteric or based on cashflow.
The primary concern is, where solvency is a genuine issue, there may be no opportunity to “argue later”. If the debt established under the Construction Contracts Act is paid, and the contractor is liquidated, any moneys subsequently held to be paid back to the owner on the merits will not be refunded in full out of the moneys paid earlier; the owner will then need to claim against the fund available for distribution to creditors on an equal treatment basis (see the recent decision of the Supreme Court in Debut Homes v Cooper [2020] NZSC 100). In practical terms, the amount paid pursuant to Part 2 of the Construction Contracts Act will be held by the liquidator to be applied in the order of priority in the liquidation. The owner will have no greater entitlement to be paid from the proceeds of the liquidation than any other creditor.
Not paying a disputed amount, notwithstanding the provisions of the Construction Contracts Act, or paying the amount claimed into court or into escrow (see Fletcher Construction v Spotless [2020] NZHC 871), pending resolution of the underlying dispute becomes an attractive option.
The solvency of contractors is likely to become a real issue, particularly in a booming construction market which is, at best, under-capitalised.
For an owner, missing the time limit for provision of a payment schedule, or providing a schedule which does not meet the requirements of section 21 (see the merits decision of van Bohemen J in Fletcher Construction v Spotless [2020] NZHC 1942) can be catastrophic. The owner must first seek either the agreement of the liquidator or leave of the court under section 248(1)(c) of the Companies Act to commence the merits proceedings in the hope of recovering any overpayment in terms of the contract (see R v Decmil Construction [2020] NZHC 2976). Even if successful, such merits proceedings only get the owner part way to recovery of any overpayment.
Resisting enforcement of the initial debt due then becomes very attractive; and it has achieved some sympathy from the courts, notwithstanding the clear expectations of section 79.
This issue was considered at some length by the Court of Appeal in Laywood & Rees v Holmes Construction [2009] NZCA 35. In that case, the contractor sought the enforcement of an adjudicator’s determination. The owners resisted enforcement on the basis, among others, that the provisions of section 19 of the Insolvency Act 1967 could not be used to enforce payment under a determination as it was not a “final judgment”. The Court of Appeal initially acknowledged that an adjudicator’s determination is not intended to be a final determination of the dispute; however, it went on to determine that the prohibition in section 79 effectively took precedence over section 19(1)(d) of the Insolvency Act.
Noting that bankruptcy notices and statutory demands are important enforcement mechanisms, Justice Glazebrook commented at paras [63 & [64]:
[63] If the contrary view were to be adopted, the efficacy of the s 73 process would, in our view, be undermined. Parties to construction contracts could refuse to pay an amount ordered by an adjudicator, and resist bankruptcy notices or statutory demands in relation to the debt, on the basis that they had a counterclaim, set-off or cross-demand. The effect of this would simply be to recreate similar problems to those which led to the enactment of the CCA, albeit in a different context.
[64] We acknowledge that this approach may produce hardship. A party may have a meritorious counterclaim, set-off or cross-demand and may not raise it in the context of the CCA or by means of separate proceedings. Yet that party may be precluded from raising it in an application to set aside a bankruptcy notice or statutory demand that follows an unsatisfactory judgment issued under s 74. This seems hard. But while the adoption of the alternative view would alleviate this hardship, it would, as we have said, create another hardship – it would keep the party in whose favour the adjudicator rules from its entitlement under the CCA, and thereby frustrate its purpose.
Following the reasoning of the Court of Appeal in Laywood & Rees, there would seem to be little justification for the approach outlined in Concrete Structures. The best approach for owners disputing payment claims is to issue a payment schedule in terms of section 21, and failing that there seems to be little legal justification for not paying the amount claimed and raising proceedings, either in arbitration or adjudication, on the merits as a matter of urgency.
On the issue of the use of bankruptcy notices and statutory demands to force payment by recalcitrant judgment debtors, while common, the position is perhaps not as blanket as Justice Glazebrook suggested. Section 79 certainly proscribes raising cross-demands, counterclaims and set-off to defend summary judgment and other enforcement proceedings, the position in relation to bankruptcy and winding up proceedings is somewhat different. Both sections 17(7)(b) of the Insolvency Act and 290(4)(b) of the Companies Act 1993 recognise that having a counterclaim, cross-demand or set-off which could not be raised earlier can be valid grounds for setting aside a bankruptcy or statutory demand (see Robertson v ASB [2014] NZCA 597).
That said, the decision of the Court of Appeal in Laywood & Rees is binding authority, and until the apparent ambiguity (at best) between the Construction Contracts Act and the Insolvency Act is resolved by the legislature, or the approach taken by the Court of Appeal revised the Supreme Court, the approach outlined in Concrete Structures would seem to be incorrect.
That is not to say that bankruptcy and statutory demand proceedings should not be used as enforcement mechanisms, as Justice Glazebrook observed; there are, however, defences to bankruptcy and winding up which are more complex than the Court of Appeal needed to consider in Laywood & Rees. There are also other enforcement mechanisms available, for example charging orders and the like.
The alternative to resisting enforcement of an adjudicator’s determination is to challenge the determination by way of judicial review. In what was the last of the Willis Trust cases, Laywood & Rees disposing of the issue of enforcement, the Court of Appeal was asked to set aside the adjudicator’s determination in Rees v Firth [2011] NZCA 668. On the question of the approach to be taken to judicial review, Justice Arnold noted that a person who does not accept an adjudicator’s determination should litigate, arbitrate or mediate the underlying dispute, rather than seeking relief by way of judicial review of the determination. Judicial review should be available, in the Court of Appeal’s view, only rarely.