What to do if your builder becomes insolvent?

Australia’s construction industry accounts for about 8% of Australia’s GDP. However, notwithstanding significant growth in the industry, several large builders have become insolvent. In addition, a recent Australian Financial Review article titled ‘Building Insolvencies Surge as Housing Turns’ dated 6 June 2019 suggests that ‘building industry insolvencies have risen to a four-year high in NSW and are approaching historical highs nationally.’

By way of example:

  • In May 2019, Canny Builders entered voluntary administration.
  • In March 2019, SJ Builders appointed a liquidator.
  • Last year, Bayside Construct went into administration with debts of over $20 million (even after winning the national award for the country’s best medium-rise development).
  • In August 2018, Hickory Group put a subsidiary building entity into voluntary administration.

This article details some of the key issues that should be considered by a principal (ie, a party engaging a builder under a building contract) in the event of the insolvency of a builder.

Why do builders become insolvent?

Cashflow issues are often a contributor to the insolvency of construction companies. Evidence suggests that contraction in the property market has negatively impacted developers, builders and subcontractors. Another reason for building companies becoming insolvent is liabilities on projects; for example, if a builder is:

  1. subjected to a liquidated damages claim;
  2. subjected to defective or incomplete works claim(s) (such claims may arise for a significant period of time after completion of the works); or
  3. unable to claim additional costs associated with the completion of works for a project (and therefore incurs losses).
Due diligence

Before appointing a builder, the principal should assess the financial strength and viability of the builder as part of a tender process. The intention is to appoint a builder who is financially robust and who is unlikely to become insolvent during the term of the building contract or subsequently. Clauses exist in construction contracts (which may require amendment and advice from a lawyer) that relate to the principal’s rights in the event of the builder becoming insolvent.

Has the builder become ‘insolvent’ under the building contract?

The question of whether a builder has become ‘insolvent’ and/or has breached the building contract (eg by reason of the appointment of a receiver, administrator or liquidator) can raise difficult legal issues. Advice should be sought in each instance because each building contract is unique and may contain different provisions regarding what constitutes insolvency and the principal’s rights in that event.

Termination of the building contract?

If a builder is subject to an insolvency event, the builder and relevant subcontractors will often stop work. (This reality may have been compounded by the builder falling behind on the program prior to insolvency due to ‘cash flow’ and/or other problems.) The principal may wish to terminate the builder as soon as possible and seek the appointment of another builder to carry on and finish the works. However, care must be exercised before such steps are taken.

The ipso facto provisions in the Corporations Act 2001 (Act) essentially prohibit the termination of a contract (including a building contract) by reason of the insolvency of the builder. Advice should be sought on matters such as the grounds for termination that might be available under the applicable building contract and the appropriate format and content of relevant notices within that contract (eg notice of breach/termination and/or show cause). Principals should seek advice to mitigate the risk that the builder (or an administrator/receiver or liquidator of the builder) will argue that the building contract has been inappropriately terminated and/or repudiated by the principal’s conduct or that the ipso facto provisions of the Act have been contravened. Advice should also be sought on the principal’s entitlement (if any) to call upon bank guarantees, retention funds and/or other security for loss and damage sustained by the principal as a consequence of the builder’s possible breach or repudiation of the building contract.

Correspondence with insolvency practitioners

The liquidator/administrator/receiver of the builder may correspond with the principal to demand moneys allegedly owed by the principal to the builder (in administration, receivership or liquidation). The correspondence needs to be dealt with by the principal, who should seek legal advice on the form and content of a reply. Typically, the principal will deny the builder’s claim and/or argue that by reason of the builder’s breach of the building contract, the principal has suffered loss and damage in excess of the builder’s claim (for example, because of the additional cost to complete the works and the need to rectify incomplete and defective works). The principal should also seek advice on whether it may wish to submit a claim as a creditor of the builder for the cost to rectify defective and/or incomplete works, and/or the additional costs required to complete the works, or delay costs arising from the builder’s abandonment of the works.

Existing and future payment claims?

The principal (and superintendent if there is one appointed under the building contract) should be careful to address payment claims submitted by the builder before its insolvency (with an eye on whether the claim is valid and was not inflated, given the then imminent insolvency event) and those issued by the builder during administration, liquidation or receivership. In particular, the principal should exercise care in dealing with all payment claims by the builder under the relevant state or territory Security of Payment Act (SOP Act). Differences in law exist between each state and territory on issues such as whether an insolvent builder (in administration, liquidation or receivership) is entitled to serve and/or enforce a security of payment claim under the relevant SOP Act. Advice should be sought on this issue and principals should not assume that payment claims cannot be issued and/or enforced by a builder under the SOP Act (or otherwise) simply because the builder is insolvent or in administration, liquidation or receivership.

Tripartite agreements/financing issues

The fact of the builder becoming insolvent or being subject to an insolvency event may trigger provisions of tripartite or funding agreement(s) in place between the principal, builder and financiers. These provisions should be considered and advice should be sought on issues such as whether the principal must consult with and/or obtain the consent of the financier before issuing default/show cause notices and/or terminating the builder. This will mitigate the risk of a breach of finance agreements, which could jeopardise the ability of the principal to complete the project.

Who will be appointed as the replacement builder?

If the builder enters into administration/liquidation/receivership and if:

    1. there are defective and/or incomplete works; and/or 1
    2. practical completion of the works has not yet been achieved,

the principal must consider which builder should be appointed to take over the works (Incoming Builder) to ensure they are completed in a satisfactory and legally compliant way. The selection of an Incoming Builder is often a difficult task because builders may be reluctant to ‘take over’ the existing works and may propose a contract price that exceeds the balance of the contract sum (to ‘price in’ the risk associated with taking over the works and issuing certificates of compliance for such work). In addition, there may be some delay in appointing an Incoming Builder due to the need to obtain quotes, run tenders, negotiate and finalise contracts, and deal with financing issues associated with the original builder’s insolvency.
The Incoming Builder should be appointed under an appropriate building contract and there should be discussion with the Incoming Builder about its liability for existing works and any exclusions regarding those works as well. The principal should document the works ‘as at’ the cessation of works by the old builder (and before the Incoming Builder commences works).

What if an Incoming Builder is not appointed?

The principal may be tempted to not appoint an Incoming Builder and instead seek to manage or complete the works themselves by directly engaging the subcontractors (particularly if the works appear close to completion). If so, the principal (and, in some cases, its directors, officers and personnel) may incur legal liabilities, including:

    1. if the principal is not appropriately licensed as a builder at law) for breaches of the Building Act and associated regulations by acting as the ‘builder’ and carrying out, procuring, managing or arranging unlicensed works. Liability includes potential criminal prosecution of individuals concerned with such conduct and then imprisonment and/or significant fines;
    2. liability of the principal and/or its personnel as the ‘builder’ of works. As the builder, the principal and/or its personnel may be liable to the owners corporation(s), purchasers of dwellings and subsequent purchasers. Liability may exist if the Domestic Building Contract Act’s implied warranties apply and may be deemed to be given by the principal and/or by the principal’s personnel to the extent that they have carried out or otherwise acted as the ‘builder’ of such works at law; and
    3. liability for misleading and deceptive conduct to the owners corporation and to owners – it may be argued that the principal and/or its personnel have engaged in misleading and deceptive conduct by failing to appoint a new builder to take over and complete the works.
Domestic building insurance

Domestic building insurance (DBI) must be obtained by a builder (for the benefit of owners and subsequent owners) if the cost of domestic building work is over $16,000 and no exclusions apply (the key exclusion being for works of three (3) storeys and above). A claim against the DBI policy can only be made if a builder has become insolvent, died or ‘disappeared’.

In the event of an insolvency of the builder, the principal may have a claim against the DBI. As soon as possible, the principal should seek advice on the merits of making a claim on a DBI policy (or policies). The claim should be submitted with all due expedition because strict limitations apply under policy wording.

The principal should also seek legal advice on how to obtain a comprehensive building defects report(s) (and contemporaneous evidence) setting out the details of any and all incomplete and defective works (including a possible distinction between structural and non-structural defective works), and the details of all associated rectification works. (Victorian ‘developers’ under DBI policies generally cannot claim for the cost to complete the works due to an exclusion). If a principal fails to obtain an appropriate expert report(s), their ability to claim on DBI insurance may be prejudiced.

Disclaimer
This article is general commentary on a topical issue and does not constitute legal advice. If you are concerned about any topics covered in this article, we recommend that you seek legal advice.

Queries

For further information please contact the author or any member of our Building and Construction team.

The Authors

Richard Hutchings

PARTNER, MELBOURNE

John Hutchings

PARTNER, MELBOURNE