Deemed Statutory Trusts Proposal to Protect Subcontractors

PROPOSED NEW STATUTORY TRUST ACCOUNT 

In our recent article, Amendments to the Security of Payment Act are commencing 21 October 2019,¹ we outlined some of the changes to the Security for Payment Act 1999 which will commence on 21 October 2019. The Government is also considering introducing a new Statutory Trust account to further protect subcontractors and suppliers. This will have an enormous impact on the construction industry and the entire contracting chain.

August 2018 Consultation Paper

In August 2018, the Government released a Consultation Paper entitled “Securing payments in the building and construction industry – a proposal for ‘deemed’ statutory trusts”² (Consultation Paper).

The deemed statutory trust proposal would require a contractor to place expected subcontractor payments in a trust account separate from other business funds to guarantee subcontractor payment.

This Consultation Paper arose as a result of the recommendations of the Commonwealth commissioned review into building and construction insolvency by Mr John Murray AM in December 2017³ (Murray Review), which recommended the implementation of a cascading statutory trust as a means of providing a fair and cost-effective method of dealing with a party’s entitlement to be paid.

The Consultation Paper provided an opportunity for industry and other stakeholders to submit feedback on a proposal to give effect to this recommendation through introducing deemed statutory trusts into the Building and Construction Industry Security of Payment Act 1999 (NSW) (SOP Act).

Key to the Consultation Paper was the suggestion that by implementing the deemed statutory trust system via the SOP Act, it would strike a balance between providing greater protection for vulnerable parties within the building and construction industry and ensuring that additional regulatory and administrative costs to business are minimised.

Kreisson made a submission to that Consultation Paper which can be accessed here. It was our view that the statutory trust system was unworkable.

The statutory trust proposal has not been included in the Amendments to the SOP Act being introduced on 21 October 2019 and is still in the consultation stage.

In April 2019, the NSW Government commissioned a paper entitled “Financial Impacts of Statutory Trusts in the Building and Construction Industry” which was prepared by Houston Kemp Economists⁴ (Financial Impacts Paper).

The Murray Review

The Murray Review found that:

“…the most effective way that payments can be secured from misuse and the risk of head contractor insolvency is by implementing a cascading statutory trust. Only such a statutory trust would secure the payments of all subcontractors, including the most vulnerable at the base of the contractual chain.^{” 5}

In November 2018 the Commonwealth Government issued a Working Paper from the office of the Australian Small Business and Enterprise Ombudsmen entitled “Cascading Deemed Trusts in the Construction Sector”⁶ (Federal Working Paper).

That working paper stated:-

“That there is a systemic issue, which is supported by the increase in insolvencies in the construction sector. Disproportionally this impacts the small businesses – the subcontractors at the end of the chain. Of all insolvencies, 64 per cent of insolvencies are businesses with less than five employees.

We have considered the various arguments for and against cascading deemed statutory trusts and, on balance, support their implementation in the construction sector. Our research has shown that the benefits of implementation outweigh the potential costs and impacts on working capital.”

Insolvency in the construction industry

Due to the hierarchical nature of contracting in the construction industry, it is well accepted that insolvency by a single entity often impacts a range of other parties in the contractual chain.

Subcontractors at the base of the contractual chain are particularly vulnerable to harm as they are likely to be small businesses with a reduced ability to withstand unplanned financial losses and less bargaining power in relation to payment terms and time frames.

What are Deemed Statutory Trusts?

A deemed statutory trust would mean that all amounts received by a head contractor or subcontractor (the ‘trustee’) as payment for work completed under a construction contract are deemed as trust funds for the benefit of its subcontractors, workers and suppliers (the ‘beneficiaries’).

Essentially under a deemed statutory trust, a fiduciary relationship is statutorily imposed on the parties in a contractual relationship.

Some of the key details of the proposed statutory trusts set out in the August 2018 Consultation Paper includes the following:-

• that deemed statutory trusts would ‘cascade’ and apply to all subcontractors linked to the head contractor;
• the deemed statutory trust would apply to all construction projects of $1 million or more;
• the requirement to establish a ‘deemed’ statutory trust will arise immediately when the contract monies are received by the head contractor or subcontractor (trustee);
• responsibility for managing the ‘deemed’ statutory trust will belong to the participants in the construction project. In particular, it will be the responsibility on the entity that is the ‘trustee’ in the relationship;
• A trustee who is required to hold trust monies on multiple construction projects could use one consolidated trust account (rather than separate trust accounts for each project), separate from the contractor’s other accounts;
• subcontractors and suppliers will be provided with a wider range of remedies in the event of a failure to pay through breach of trust such as:-

1. proceedings to compel the trustee to perform its duty or protect the beneficial interest in the trust property;
2. proceedings to remove a trustee and appoint a new trustee in its place;
3. an order that trust monies be paid into court;
4. an injunction restraining a breach of trust;
5. the appointment of a receiver of the trust property;
6. a personal action against a third party who has received trust property; and
7. tracing or following the trust property into the hands of the person who received it, in certain circumstances.

• The trust system would use the existing dispute resolution mechanism provided under the SOP Act’s adjudication scheme for an expeditious interim decision. Parties would also be able to have disputes determined finally and conclusively in accordance with a court separately.
• On receipt of a progress payment from the principal, the head contractor will be entitled to invest that money and retain the proceeds of that investment. The proceeds of the investment would only be available to the trustee once all the beneficiaries are paid what is due and owing to them in full. If a trustee makes a loss from any investment of trust money, the trustee would need to compensate for the loss from their own assets.
• Beneficiaries would be provided with a statutory right to inspect trust account records.
• Executive liability will apply to a director and any other individual involved in the management of the corporation who can influence its conduct. The director or other individual will be held liable for a breach of the corporations’ duties as a trustee if the person had knowledge of the breach and failed to take reasonable steps to prevent or stop the breach.
• Trusts can result in a speedier resolution of disputes because, generally, the head contractor cannot withdraw money from the trust fund until all the claims of the fund’s beneficiaries have been met. This will result in speedier payment of subcontractors and avoid any unnecessary disputes to avoid payment and therefore delay the final payment.

The Consultation Paper also identified various drawbacks of the proposal which included:-

• ‘Deemed’ statutory trusts can reduce the ability of businesses to manage cash flow;
• Statutory trusts may not be effective at achieving their objectives;
• Statutory trusts interfere with insolvency laws because trust funds do not form part of the debtor’s estate for distribution. Such interference is considered justified, as otherwise creditors would obtain a benefit from the work and materials supplied by participants in the project who have not been paid;
• Statutory trusts may impose administrative and regulatory burdens;
• Statutory trusts may make it difficult for businesses to obtain finance.

Industry Response

The closing date for the submissions in response to the NSW Consultation Paper was 18 September 2018.  Those submissions were published on the Fair Trading web site.

Even though the Consultation Paper was released at the same time as other proposed amendments to the SOP Act it was not included in the suite of changes the subject of the Building and Construction Security Amendment Act 1999 (NSW) which is due to commence on 21 October 2019.

Kreisson made Submissions which opposed the proposal to establish deemed statutory trusts in the SOP Act in response to the Consultation Paper and those Submissions are published online.⁷

Financial Impacts Houston Kemp Report Model

The April 2019 Financial Impacts Report was prepared by Houston Kemp Accountants for the NSW Department of Finance, Services and Innovation to consider the financial impact of establishing statutory trusts to guarantee subcontractor payments.

The Paper acknowledges that the high rate of insolvencies in the building and construction industry is attributable to the pyramidal contracting chain.

The Report made a number of findings and observations with respect to the impact of the statutory trust proposal which included:

• The imposition of additional administration costs on construction businesses (such as bank fees and additional bookkeeping);
• Financing costs to businesses in the industry overall would be lower (due to prompt payment smaller contractors will not need to raise as much working capital by financing);
• Direct and indirect insolvency costs being avoided as well as reduced exposure to the consequences of upstream insolvencies;
• That competition within the building and construction industry would be affected by changing the costs of both contractors and subcontractors;
• That small and medium sized construction businesses would principally benefit the most;
• That construction businesses with turnover of under $5 million will most likely be financially better off due to the lower financing costs and reduced cascading insolvencies, which will likely outweigh the associated compliance costs;
• larger businesses (that is, with an annual turnover of over $5 million) are expected to incur more compliance costs than the expected benefits;
• recommendations applying a minimum contract value threshold or excluding residential construction work from the statutory trust obligation has a similar effect to applying a contract threshold;
• that the proposal be implemented on a staged basis to assist the industry with preparing for compliance.

The Financial Impacts Report also recommended further consultation with industry. We are aware that the industry has recently been targeted with a variety of surveys in respect of the proposal.  We will keep you informed on the progress of the proposal developments.

Conclusion

It appears that the wheels are in motion for a deemed statutory trust scheme to be imposed within the SOP Act legislation to protect payments to subcontractors.

Although a lot of the details are still yet to be finalised, the Financial Impacts Report and industry wide consultation indicate that NSW intends to follow the recommendations of the Murray Review and implement a statutory trust scheme to help secure payments down the contractual chain and thereby reduce cases of insolvency in the building and construction industry.

Contact us

David Glinatsis (Director, Kreisson) and Catherine Lucas (Solicitor).

For more information, contact us at excellence@kreisson.com.au or on 02 8239 6500.

This communication is sent by Kreisson Legal Pty Limited (ACN 113 986 824). This communication has been prepared for the general information of clients and professional associates of Kreisson Legal. You should not rely on the contents. It is not legal advice and should not be regarded as a substitute for legal advice. The contents may contain copyright.