Insolvency in the Building Industry

Building industry insolvencies have risen to a four-year high in NSW and are approaching historical highs nationally, prompting subcontractors to demand protection of unpaid payments in an industry estimated to leave an unpaid $3 billion-worth of bills each year.

Corporate regulator ASIC figures show NSW building industry failures jumped to 64 in March, the highest level since mid-2015, lifting the national total to 153, close to its highs of recent years. Unlike recent years, however, the figures come at a time when housing construction – a mainstay of the sector – is cooling.

Without long-overdue protections for subcontractors, who perform 80 per cent of all building work, many more of these small businesses will hit the wall.

A 2015 Senate report into insolvency in construction estimated the industry suffered $3 billion in unpaid debts, including subcontractor payments, employee entitlements and tax debts averaging about $630 million a year.

JM Kelly Case

Key figures in the multi-million-dollar collapse of a Central Queensland construction group recently faced the Federal Court of Australia in Brisbane ahead of a lengthy public examination into its affairs.

Geoffrey John Joseph Murphy, John Geoffrey Murphy and Noreen Murphy were issued with examination summons to attend the court to produce the books and records of companies in liquidation associated with the JM Kelly Group based in Rockhampton.

A public examination into the affairs of the group of companies has been set down to continue through to August 29.

It comes after the collapse of JM Kelly Builders Pty Ltd in October last year which left unsecured creditors owed nearly $15 million.

The demise of JM Kelly Builders Pty Ltd came a little more than two years after the collapse of JM Kelly Project Builders Pty Ltd, another entity in the JM Kelly Group and triggered the liquidation of a further 12 associated companies.

The State Government announced in late February a Special Joint Taskforce headed by Justice John Byrne and supported by a legal team from the Department of Prosecutions and Fraud Squad detectives.

Mr Murphy was appearing in the Federal Court as part of a public examination by liquidators into the circumstances of the group’s collapse.

The Rockhampton-based builder hit financial trouble in 2016, leaving more than 400 creditors owed an estimated $50 million. The collapse resulted in the loss of 250 jobs and a number of unfinished projects including the Aldi supermarket in Rockhampton and a wing at the Rockhampton Base Hospital.

The founder of the failed JM Kelly Group was entitled to a six-figure salary as a consultant in the three years before the multi-million dollar collapse of the construction company.

Geoffrey John Murphy, 78, was a director of several companies in the group that were put into liquidation in 2016.

But the Federal Court heard yesterday that Mr Murphy continued to be employed as a consultant within the rest of the group that finally collapsed in 2018.

Mr Murphy told the court that he had not taken a salary for several years and some of the funds he received in the final years were payments for loans he had earlier made to the company. He was not certain of the amounts he had been paid in the lead up to the collapse of the group but his annual salary package was approximately $160,000.

Barrister Craig Wilkins, who is appearing for JM Kelly’s liquidators, produced Mr Murphy’s tax returns that showed he had been paid a salary of $167,248 in 2016, $173,812 in 2017 and a partial payment of $66,000 in 2018.

Proposed Solutions

The construction industry in it’s current state essentially forces subcontractors to act as unwilling banks for builders, with no guarantee the debt will be repaid. There have been calls for an overhaul of the industry and protective legislation to be put in place.

A recommended solution to the growing issue of builder insolvencies is the proposed introduction of deemed statutory trusts, which – like trust accounts of real estate agents and lawyers – would ringfence the payments head contractors receive from clients on any project worth more than $1 million, keeping them distinct in the operating funds of the contractor.

A trust system would keep money intended for subcontractors down the chain intact in the event the building contractor went under.

Small Business Ombudsman, Kate Carnell says that while it isn’t a cure all fix for the industry, it would at least preserve the funds owed to subcontractors.

It wouldn’t, however, stop companies from phoenixing. A phoenix company is one that takes on similar or exact actions of a company that has been placed into liquidation. Usually the doors are shut, and the following day re-opened in a new company, without anything having changed. This is a common occurrence in the building industry in Australia and the damage for subcontractors can be devastating.

The Hidden Danger of Preference Payments

Many businesses are not aware of how their assets could be caught up in someone else’s liquidation or administration. For subcontractors, one of the hidden dangers when dealing with builders is the potential to be hit with a preferential payment demand if the builder enters into liquidation.

Claims can be made years later, meaning that subcontractors who have just scraped by in surviving the collapse of a major contractor can then be hit with a demand notice that could potentially destroy their business.

An example of these laws at play is the case of a subcontractor who was pursued by Cullen Group for preferential payments made in the lead up to their 2016 collapse.

According to construction industry news site Subbies United, a business that had barely survived the collapse of Cullen Group was forced out of business due to a $75k repayment of preferential payments. The subcontractor had also lost more than $200k in unpaid material left on Cullen sites. The subcontractor was then forced to terminate 35+ staff and wind up his business.

The Cullen Group Liquidator had found that for the 11 months prior to their liquidation, from January 2016, Cullen Group were trading insolvent.

The preferential payment demand was made based on the assertion that a reasonable person should have realised the company was trading insolvent at the time of the payment.

Subbies United goes on to highlight the unjust nature of the situation, pointing out that it would have been difficult for the subcontractor to have been aware of the insolvency, given that the industry regulator, QBCC had investigated Cullen Group and not been aware.

The QBCC had access to the financial records of Cullen Group and according to the Commissioner, sometime after March 2016 they did an audit of Cullen.

• Cullen Group passed that audit and their Category 4 QBCC License (30-60 million) remained intact.
• This means the QBCC deemed Cullen to be solvent.
• The Commissioner said when questioned about the default judgement awarded against Cullen in March 2016 “one debt does not mean a company is trading insolvent”.
• The Commissioner also said “there was not at that point in time an immediate risk in our view that there would be a significant risk to a larger group of people”.

Regulators allowed the company at the centre of one of Queensland’s biggest building industry collapses to keep trading for nine months after it defaulted on debt. Nov 2018

If the QBCC,  who had access to Cullen Groups financial records were not aware that Cullen was trading insolvent, how were subcontractors and suppliers be reasonably expected to know that Cullen Group was trading insolvent?

What is Deemed A Preferential Payment?

In order for a liquidator to successfully prove a preference claim, they must establish the following (section 588FA):

• The company (in Liquidation) and the creditor were parties to the transaction.
• The creditor receiving the payment is an unsecured creditor.
• The transaction took place within six months before the commencement of the winding up (this is extended to four years for payments to related parties).
• The company made the payment when it was insolvent, or the company became insolvent as a result of the transaction.
• The payment resulted in the creditor receiving more than they would in a liquidation scenario.
• the creditor suspected, or had reason to suspect, that the company was insolvent.

Subcontractors can be sued for preferential payments if they tick certain boxes such as;

• Making written demands for overdue payments
• Stop production or work on jobs
• Send emails asking or begging for payments.

This is evidence that can be used by a liquidator to assert that a subcontractor was aware that the builder was trading insolvent at the time of payment.

If a subcontractor is paid late (out of terms) in the last 6 months prior to the Builder’s collapse and made demands on the builder to pay their progress claims, the subcontractor is assumed to have known the builder was insolvent, therefore the payment received is deemed a preference claim.

This disturbing facet of the law means that public registers shaming builders for late payments can be used as evidence by liquidators that subcontractors should have been aware that a builder was trading whilst insolvent. In this respect, unfortunately even the act of looking out for your fellow subcontractors can do more harm than good.

So, what can you do to avoid these unfair laws? There have been calls for changes to legislation, but even the proposed changes won’t entirely solve the issue. Essentially, the only way to protect your business is to be vigilant and do your research before taking on a contract. If you find yourself in the position that a client has gone into liquidation, get advice immediately and don’t speak to anyone until you’ve received the specialist advice required to navigate these incredibly complex situations. If you or one of your clients have received a demand from a liquidator, then you should obtain appropriate legal advice before seeking to defend any such claim yourself.

If you’re concerned about the primary builder because you’re seeing the signs or starting to get paid late, we’re here to help. The C&D team can start putting strategies in place to mitigate instances of preference claims, and if you do receive unfair preference claims, we can help you through the complex process. To schedule a complimentary, obligation-free consultation, call 1300 023 782 or book via the link below.