Will the NSW Security of Payment Act still apply to a company which is ‘hopelessly insolvent’?

This article analyses the decision of Ball J in Kennedy Civil Contracting Pty Ltd (Administrators Appointed) (KCC) v Richard Crookes Construction Pty Ltd (RCC); in the matter of Kennedy Civil Contracting Pty Ltd [2023] NSWSC 99 and considers the ramifications for the scope of section 32B of the Building and Construction Industry Security of Payment Act 1999 (NSW) (SOP Act).

This article combines and reproduces various content originally prepared for articles authored by Michael Terry-Whitall appearing on Chamberlains Law Firm’s website. Michael is a Partner at Chamberlains Law Firm (who represented KCC in the above case) and heads their Building and Construction Division nationally. Michael is also an Adjudicate Today Adjudicator.

Issues before the Court

There were two issues associated with this case:

1. Is a Deed of Company Arrangement (DOCA) entered into for the dominant purpose of avoiding the operation of section 32B of the SOP Act a DOCA that has been entered into for an “improper” purpose pursuant to section 445(D)(1) of the Corporations Act 2001 (Cth) (Corporations Act)? (Question 1)
2. In the event that the answer to question [1] above is “No”, is a DOCA entered into for the dominant purpose of avoiding the operation of section 32B of the SOP Act amount to an abuse of process? (Question 2)

Section 32B of the SOP Act provides that:

(1) A corporation in liquidation cannot serve a payment claim on a person under this Part or take action under this Part to enforce a payment claim (including by making an application for adjudication of the claim) or an adjudication determination.

(2) If a corporation in liquidation has made an adjudication application that is not finally determined immediately before the day on which it commenced to be in liquidation, the application is taken to have been withdrawn on that day.

The Facts

On 1 November 2021, RCC engaged KCC to carry out civil, stormwater and associated construction works under two separate subcontracts. During the performance of the works, KCC served several payment claims under the SOP Act. RCC responded to some of the payment claims with payment schedules and failed to respond to others.

On 1 August 2022, joint and several voluntary administrators were appointed to KCC pursuant to Section 436A of the Corporations Act. During the administration, the administrators formed the view that KCC was “hopelessly insolvent”.

On 29 September 2022, KCC commenced proceedings seeking to recover monies under the SOP Act arising from RCC failing to make payment in accordance with previously issued payment schedules or failing to issue payment schedules at all.

On 9 November 2022, RCC filed a Notice of Motion, seeking that the proceedings commenced by KCC be dismissed as an abuse of process. Separately, RCC filed proceedings in the Federal Court seeking the DOCA be terminated pursuant to section 445D of the Corporations Act.

On 10 November 2022, at a meeting of KCC’s creditors, the creditors voted in favour of entering into a “holding DOCA” (Holding DOCA) for the dominant purpose of pursuing RCC (among other debtors) under the SOP Act.

The meeting minutes reflected that in the administrators view KCC was “hopelessly insolvent” and it would inevitably need to be placed into liquidation, however the Holding DOCA was proposed to allow proceedings under the SOP Act to continue as otherwise section 32B of the SOP Act would mean the case against RCC (among others) must be abandoned.

The matter (including RCC’s Federal Court proceedings which were joined to KCC’s proceedings) was heard together by Ball J in the Supreme Court of NSW on 2 February 2023.

Question 1 – was the DOCA entered into for an improper purpose?

RCC first submitted that entering into a DOCA for the dominant purpose of avoiding section 32B of the SOP Act was an “improper purpose”

RCC then submitted that the public policy or purpose behind section 32B of the SOP Act was to ensure the SOP regime was only made available to entities which were solvent and required cashflow. RCC made reference to the parliamentary readings introducing the amendment and also the Murray Review and argued that by reference to that extrinsic material, section 32B should be read in a manner that gives effect to that public policy.

Ultimately, RCC argued that permitting KCC to avoid liquidation “temporarily” by executing the DOCA would be contrary to that public policy and would also render section 32B ineffective as entities which were insolvent and would otherwise be placed into liquidation would now simply execute a holding DOCA.

In considering RCC’s first submission, the Court held:

“In the present case, however, it is apparent that the purpose of the DOCA is to maximise the return to creditors by permitting the company to exercise the rights conferred by the SOP Act. The effect of Richard Crookes’s submission is that greater weight should be placed on achieving what are said to be the goals of the SOP Act than achieving the aims of Part 5.3A of the CA in deciding whether the power conferred by s 445D(1)(g) should be exercised.”¹

and

“The question whether Part 5.3A of the CA is being used for an improper purpose is not to be resolved by a careful analysis of whether creditors and the company will be in a better position if the DOCA remains on foot than if it does not. In the present case, it is apparent that the DOCA was entered into because the creditors accepted the advice of the administrators that gave them the best chance of maximising the return to them. In doing so, they reached what appears to be a reasonable conclusion on a matter that they were properly entitled to consider. That is a sufficient to make the purpose of the DOCA a proper one.”²

In considering RCC’s second submission, the Court held:

“It is also plain from the terms of s 32B of the SOP Act that the purpose of the section is to deny the benefits of the legislation to companies in liquidation, not more generally. The fact that the report that led to the amendments which included s 32B and the Second Reading Speech suggested that the policy of the SOP Act “is to maintain cash flow while a construction company remains solvent” (to quote from the report at 118) is irrelevant and cannot be reconciled with the provisions of the statute itself.”³

and

“it is difficult to see how it could be said that the DOCA was designed to avoid the operation of the SOP Act. It would be more accurate to say that it was designed to take advantage of the limited operation of s 32B. The evident purpose of s 32B is to prevent a situation from arising where an interim payment made under the Act becomes permanent because, on liquidation, the payment is no longer available to be returned to the payer if the payer is successful in its claim under the construction contract. But the DOCA in this case specifically preserves Richard Crookes’s rights to recover the amount it pays under the construction contract.⁴ On the other hand, if Richard Crookes is correct, it will be entitled to avoid the operation of the SOP Act, and the obligation to make interim payments, simply because it refused to pay amounts that the Act obliges it to pay. If any party has sought to avoid its obligations under the Act, it is Richard Crookes.”⁵

Question 2 – did entering into the DOCA amount to an abuse of process?

In rejecting RCC’s arguments as to an abuse of process, the Court held:

“it is not correct to characterise KCC’s claim as an attempt to avoid the operation of s 32B. Rather, it has organised its affairs so that it falls outside the scope of s 32B. That does not involve an abuse of process. Moreover, again for the reasons already given, it could not be said that the DOCA undermines any policy of the SOP Act.”⁶

Key take-aways from the case

The scope of section 32B of the SOP Act is limited to the express wording of the legislation, namely that a party in liquidation cannot avail itself of the procedures under the Act.

¹ [29] per Ball J.
² [31] per Ball J.
³ [34] per Ball J.
⁴ The terms of the Holding DOCA included that any monies recovered would be held on trust, pending the finalization of any proof of debt proceedings, thus was consistent with the SOP Act’s “pay now argue later” regime. It was put to the Court that the Court should have made this finding even if the DOCA did not so provide, but Ball J declined to make a finding on that point at [36].
⁵ [35] per Ball J.
⁶ [42] per Ball J.