You’re a subcontractor engaged by a head contractor, who is engaged by a principal. You’ve just secured an adjudication in your favour for work performed on the project for $1,000,000.
The day after receiving the decision, the head contractor goes under.
Normally, this would place you in a long line of unsecured creditors, petitioning for pennies from an insolvent company. It’s doubtful you will see any of the outstanding $1,000,000.
The subcontractor’s debt regimes provide a way to circumvent this difficult but common scenario.
Subcontractor’s debt regimes enable a subcontractor to bypass the upstream contractor
A subcontractor’s debt regime allows the subcontractor, such as in the example above, to leapfrog the head contractor and request payment directly from the principal. The same applies to a sub-subcontractor circumventing a subcontractor to request payment from the head contractor, and so on.
However, the usefulness of such regimes will be limited to whether the party up the chain (e.g. the principal) has any money owing to the contractor below it. Where a principal has paid all amounts owing to the head contractor, a subcontractor cannot expect any payment directly from the principal.
Queensland has a subcontractor’s charges regime, which we have written about in a separate article. In this article, we address the New South Wales regime, which is narrower and focuses strictly on certified debts.
While the NSW subcontractor debt payment regime is not quite as useful as its Queensland counterpart, the regime can still be leveraged in certain circumstances to enable a subcontractor to request payment from the principal where the head contractor cannot or will not come to the table.
What is the subcontractors’ debt regime in NSW?
In NSW, the process of bypassing a contractor to claim payment directly from the principal is regulated by the Contractors Debt Act 1997 (NSW) (CDA).
Unlike the Queensland subcontractor’s charges regime, the New South Wales CDA requires subcontractors to obtain a debt certificate prior to seeking payment from the principal.
This essentially means that (in most cases) a subcontractor will have to make a successful adjudication application against the defaulting contractor before the debt can be pursued via the principal.
While this may diminish the usefulness of the regime, it is important to note that using the CDA to recover your debt does not exclude a subcontractor from also using other means to recover its debt (provided it does not double recover, of course).
What is a subcontractor’s entitlement to recover money from a principal under the CDA?
If a defaulting contractor owes a subcontractor money for work carried out or materials supplied, the subcontractor can obtain this money from the principal, provided that there is still money payable or owing to the contractor.
Importantly, the CDA refers to the Building and Construction Industry Security of Payment Act 1999 for its definition of construction work and supply of materials. While this is a broad definition, it excludes:
- drilling or extracting oil or natural gas; and
- extracting minerals, including tunneling or boring, or constructing underground works, for that purpose.
A precondition of claiming this outstanding money from the principal is obtaining a debt certificate. There are limited circumstances that allow a subcontractor to obtain a debt certificate, including:
- having an adjudicator find in your favour which leads to you filing the adjudication certificate as a judgment for a debt; or
- a judgment is given against the defaulting contractor.
This is, of course, easier said than done.
What are the timing requirements?
A claim under the CDA must be brought within 12 months of the debt becoming payable. Failure to do so may result in you losing your entitlement to bring a claim against the principal.
You must bring the claim against the principal by serving a notice of claim (with a copy of the debt certificate) in the approved form under the CDA.
So, I’ve brought my claim against the principal. How do I get paid?
After the principal receives the notice of claim and the debt certificate as outlined above, the CDA operates to assign to the subcontractor the principal’s obligation to pay the money owed to the defaulting contractor.
This effectively means that where the defaulting contractor would normally have rights and entitlements to payment from the principal, the subcontractor gains those rights instead and can now request payment directly from the principal.
This does mean, however, that if there is no money owing to the defaulting contractor from the principal, the principal has no obligation to pay the subcontractor. This highlights the importance of acting quickly as a subcontractor to secure your right to payment.
It is also important to consider what rights the principal may have in that scenario too – often in the insolvency scenario we described above, the principal is left in the lurch too, and could well be considering its rights to pursue the contractor or set-off against monies owing to them.
After assignment, the principal is then liable to pay the money owed to the defaulting contractor to the subcontractor. Once the principal has paid the debt to the subcontractor (or the debt certificate is set aside by a court), the assignment ceases to operate, and the subcontractor no longer has any right to claim payments from the principal where the defaulting contractor would normally be entitled.
However, the principal is not liable to make any payments to the subcontractor until 7 days after the subcontractor serves the notice of claim. This allows other subcontractors to make claims against the same defaulting contractor, as will be discussed in the next section of this article.
What if multiple subcontractors have brought claims with respect to the same defaulting contractor? Which subcontractor does the principal pay first?
Generally speaking, where there are multiple debts against the same defaulting contractor, priority will be determined by the order of service of notices of claim on the principal.
In essence, the CDA operates on a ‘first come, first served’ basis.
However, as discussed above, there is a 7-day period after the service of the notice of claim during which the principal is not liable to make any payments to the subcontractor. This is important because if other subcontractors also serve a notice of claim during this 7-day period, all of those claims will have equal priority.
Let’s have a look at an example of this below:
- Head Contractor Pty Ltd (Head Contractor) has been engaged by Principal Pty Ltd (Principal) to construct a hospital in Sydney.
- Head Contractor then engages Plumbing Pty Ltd (Plumbing) to perform the plumbing and draining works for a fixed sum $1 million.
- Plumbing performs $500k in works on the project, but Head Contractor has encountered financial issues and is failing to make payments to Plumbing.
- Electrical Pty Ltd (Electrical) and Formwork Pty Ltd (Formwork) are also subcontractors engaged by Head Contractor and are similarly not receiving payments from Head Contractor for works performed.
- Plumbing, Electrical, and Formwork all make successful adjudication applications against Head Contractor and each file their adjudication certificates as a judgement for debt.
- On 1 August 2022, Plumbing serves a notice of claim on Principal with a copy of the debt certificate for its debt of $500k.
- Because Plumbing served the notice of claim on 1 August 2022, Principal is not liable to make payments until 8 August 2022, to allow other subcontractors to also make claims.
- On 5 August 2022, Electrical serves the notice of claim for its debt of $250k.
- Formwork, however, is a bit slow out of the gates and doesn’t get around to serving its notice of claim until 15 August 2022, for its debt of $750k.
- Principal only has $800k left to pay the Head Contractor for the work performed. This means that there is not enough money to pay all three subcontractors, and how much each gets will be determined by priority.
- Because both Plumbing and Electrical submitted their claims within the 7-day period that started with Plumbing submitting the first claim, Plumbing will get paid its $500k and Electrical will get paid its $250k first, because both subcontractors have equal priority.
- However, because Formwork submitted its claim after the 7-day period, it does not have equal priority with the other subcontractors. Therefore, despite having a larger debt owing than the other subcontracts ($750k), it takes last priority and is paid the remaining amount of the $800k, being only $50k.
But what if all subcontractors had submitted claims within the 7-day period?
In that case, all subcontractors would take equal priority, and Principal would be required to make pro rata payments to the subcontractors in proportion to the amount of the respective certified debts.
Based on the example scenario given above, this means that Plumbing would receive $266.640, Electrical would receive $133,360, and Formwork would receive $400,000 from the $800k owing to the Head Contractor. This illustrates the importance of acting quickly to protect your right to seek payment from a principal.
What if the principal doesn’t pay?
In short, if the principal fails to pay, a subcontractor can sue the principal in the NSW Local Court.
The principal’s defences are limited to any defences the principal would have had against the defaulting contractor for the debt, except for a defence based on something the principal did after receiving the notice of claim.
This means that it is not a defence that the principal has already paid the debt to the defaulting contractor instead of the subcontractor where the subcontractor served the notice of claim to the principal and the principal effectively ignored it.
If a principal is sued, it can apply to the court to have its liability reverted back to the defaulting contractor.
Subcontractors need to be aware of the strict process and timing requirements of recovering debt under the CDA.
In light of this, we recommend getting in touch with us if you need help preparing or responding to a claim under the CDA.