NSW Supreme Court: Construction companies can collect debts despite insolvency

The NSW Supreme Court recently clarified legislation allowing construction companies to continue debt collection even if they are insolvent.

Insolvency specialist Jirsch Sutherland said that following the decision in KCC v Richard Crookes Construction Pty Ltd [2023] NSWSC 99, construction companies facing cashflow difficulties will now have a far greater chance of pursuing their debtors. The action was brought by Chamberlains on behalf of Jirsch Sutherland to recover debts owed to a subcontractor which had entered voluntary administration.

Richard Crookes is a construction company conducting large-scale projects in NSW, Queensland and the ACT. Kennedy Civil Contracting Pty Ltd (KCC) operated a civil construction business. Richard Crookes engaged KCC to carry out construction work under two subcontracts but failed to pay KCC for valid claims made under the Building and Construction Industry Security of Payment Act 1999 (SOP Act).

KCC became insolvent and entered into a holding dead of company arrangement (DOCA) with its creditors. The DOCA would keep KCC out of liquidation and enable the administrators to continue pursuing KCC's outstanding debts using the mechanism contained in the SOP Act. The DOCA also preserved the "pay now, argue later" principles of the SOP Act. Richard Crookes's rights to seek to recover the amount paid is preserved by the mechanism, which requires the amount paid to be held in trust until the final resolution of any claim. The funds do not become available for distribution among KCC's creditors until any claim made by Richard Crookes has been finally resolved in KCC's favour.

Richard Crookes argued that the holding DOCA was entered into for an improper purpose. It urged the court to override KCC's creditors and terminate the DOCA, placing KCC into liquidation. Richard Crookes also asserted that the legislation ensures that the procedures under the SOP Act were only available to promote cashflow and were not available where the claimant was in liquidation. Richard Crookes said that public policy would be defeated if KCC were permitted to avoid liquidation temporarily by executing a DOCA to enable it to exercise its rights under the SOP Act.

Richard Crookes also pointed to cases in which courts have terminated a DOCA or ended a company's administration in cases where the evident purpose of the DOCA or administration was to postpone the company's liquidation and to prevent an investigation into the company's affairs. Richard Crookes asserted that the DOCA is characterized as a means of circumventing the operation of the SOP Act.

No improper purpose

The NSW Supreme Court disagreed, pointing out that in the cases referred to be Richard Crookes, the administration ended because it was apparent that the purpose of the administration was not to maximize the return to creditors. Instead, the goal was to achieve some ulterior purpose, such as protecting the company's directors.

In this case, the court noted that the purpose of the DOCA is to maximize the return to creditors by permitting the company to exercise the rights conferred by the SOP Act. The court found it was apparent that the DOCA was entered into because the creditors accepted the advice of the administrators that gave them the best chance of maximizing the return to them. In doing so, they reached a reasonable conclusion on a matter that they were properly entitled to consider, which is sufficient to make the purpose of the DOCA a proper one.

A ‘game-changer’

Jirsch Sutherland partner Trent Devine calls the judgement "a game-changer" because it will allow the collection of debts for the benefit of creditors and help protect subcontractors.

"It's a significant development for insolvency in the construction industry, particularly in NSW, but might also have ramifications in other states, as other security of payment regimes is based on the NSW SOP Act," Devine said.

Chamberlain's legal director Michael Terry-Whitall said that the judgement conclusively answers whether the SOP Act can be used on behalf of an insolvent entity. "The decision has far-reaching implications for construction companies as a whole, particularly during the current economic climate, which is placing further cashflow pressures on an already strained industry."