Insolvency and bankruptcy in construction

Insolvency or bankruptcy of a party in a construction project can have serious implications and raise difficult legal issues.

Estimated reading time: 5 minutes

What is insolvency?

Insolvency is the inability to pay outstanding debts as and when they fall due.

The Corporations Act 2001 (Cth) provides mechanisms for a company to handle cash flow difficulties, such as voluntary administration or liquidation.

If a liquidator or administrator is appointed, consequences include the cancellation of the company’s Queensland Building and Construction Commission (QBCC) licence, the immediate termination of employees, the seizure of assets by secured creditors, and the appointment of replacement building contractor.

What is bankruptcy?

Bankruptcy is a legal process where a person relinquishes control of their financial affairs to a third party as a result of becoming insolvent.

The role of the third party, usually a trustee, is to ensure the bankrupt’s assets are distributed appropriately to creditors. The process is governed by the Bankruptcy Act 1966 (Cth).

Managing risk in construction projects

Some of the ways the Australian construction industry allows parties in a building contract to manage their risk, include:

Contract clauses

A building contract should manage risks of insolvency and bankruptcy by being carefully drafted.

This can include clarifying the right to terminate in the event of insolvency or bankruptcy.

For example, the QBCC’s standard form contract for new home construction states that if a party to the contract is made bankrupt or goes into liquidation, the other party may terminate the contract by giving written notice.

Under this contract, if the building contractor terminates the contract, they may remove all their equipment and supplies from the project site and recover all damages, loss, cost or expense caused by the termination.

If the owner terminates the contract, they may complete the work or employ another party to do the work and may take possession of any unfixed materials and goods left at the site by the building contractor to do the work.

The Housing Industry Association (Queensland)’s equivalent contract states that if a party becomes insolvent, goes bankrupt or becomes subject to a winding-up order made by a court, the other party may terminate the contract by giving written notice.

However, the Corporations Act 2001 (Cth) contains “ipso facto” provisions which prevent the termination of a contract for the sole reason of insolvency, so legal advice should be sought to avoid contravening these provisions.

Financial protections

An owner may consider actions such as registering an interest on the Personal Property Securities Register, to gain priority if a building contractor becomes insolvent or bankrupt; and incorporating proof of payments to sub-contractors as a condition for payment to the building contractor.

A building contractor may consider actions to prevent insolvency, such as using specialist constriction accountants, understanding QBCC requirements, and performing due diligence on developers and subcontractors.

Statutory protections

Subcontractors charges

The Building Industry Fairness (Security of Payment) Act 2017 (Qld) allows a subcontractor to recover outstanding payments from an entity higher in the contractual chain than the contractor, via a “subcontractor’s charge”, in events such as liquidation.

Money owed to the contractor can be held while the claim is being decided by a court, and subsequently directed to the subcontractor once a decision is made.

If the contractor accepts liability to pay all or part of the amount claimed, the higher entity must pay that amount to the subcontractor.

The subcontractor has a right to apply to a court for a judgment debt if such a payment is not made.

Subcontractors can minimise the impact of insolvency by taking precautions such as conducting licence checks and credit checks on a building contractor; and obtaining references from subcontractors who have worked for the potential client.

Excluded individuals

Bankruptcy or insolvency of a person or company can lead to an industry ban under the Queensland Building and Construction Commission Act 1991 (Qld).

The Act states a person becomes an “excluded individual” if they:

  • take advantage of bankruptcy laws or become bankrupt, and not more than three years have passed since they did; or
  • were a director, secretary or influential person for a building company within two years before that company went into liquidation or became subject to a winding-up order, and that liquidation or order happened not more than three years ago.

This status means the person’s QBCC licence is cancelled, and they cannot hold another QBCC licence, or another position of control or influence in a QBCC-licensed company, for three years from the date of the “insolvency event”. A person involved in two insolvency events faces life exclusion.

Queensland Home Warranty Scheme

This scheme involves claiming home warranty insurance, which must be taken out by a building contractor for residential work valued at more than $3300 in Queensland.

It offers several protections for the owner when the building contractor fails to complete the contracted work, including when the building contractor goes bankrupt or into liquidation.

Phoenixing

Phoenixing activity involves forming a company to continue the business of a company that has been liquidated, in a bid to avoid paying liabilities, and to continue to make profits.

The process is named after the phoenix, an immortal bird from Greek mythology that cyclically regenerates from the ashes of its predecessor.

In 2020, the Corporations Act 2001 (Cth) was amended to create phoenixing offences and to grant stronger powers to federal authorities to tackle the activity.

How Gibbs Wright Litigation Lawyers can help

Insolvency and bankruptcy in the building is a complex area of law. If you’re involved in a building contract matter or dispute, we recommend that you seek legal advice.

Call Gibbs Wright Lawyers today about any building contract matter with our construction litigation team in a no-obligation, confidential consultation.