Protection of subcontractor payments

Our partners and friends at the Masonry Contractors Association recently wrote a blog on Project Bank Accounts and how they can help subcontractors protect payments - the industry is moving forward in the right direction. Read on below {Source}:

Project Bank Accounts – The Background:

Much has been discussed in recent times about the use of Project Bank Accounts (Trust Accounts) as a means to protect the flow of payments on construction projects from the principals down to the eventual suppliers of the goods and services which form the eventual completed project.

The political, social, and financial consequences of the failure by suppliers and subcontractors to receive payment for works, completed following the all too frequent collapse of development and construction enterprises, was highlighted at every one of the recent hearings into insolvency in construction conducted  by the Senate Estimates Economics Committee.

These consequences included, but were not limited to:

  • Suicides,
  • Stress related depression and mental illness,
  • Accidents as a result of loss of focus,
  • Marriage breakdowns,
  • Loss of homes,
  • Collapse of family businesses,
  • Economic losses to the community,
  • A reduction in industry training investment, and,
  • A general reduction in industry productivity.

Of the 44 recommendations made by the enquiry four (Recommendations 28 to 31 inclusive) relate to the trial, assessment, and investigation of statutory trust and project bank account systems to protect the flow of money within the project supply chain.

The committee’s executive summary expresses the following view:

“Subcontractors have a right to be paid for work completed

In the view of the committee, there is one principle and one principle only that should be observed in relation to security of payment in the construction industry. It is a fundamental right of anyone who performs work in accordance with a contract to be paid without delay for the work they have done.”

The committee’s executive summary quotes:

 “Retention trusts and project bank accounts

Again, submissions and evidence to this inquiry expressed almost universal support for the implementation of a retention trust model or similar mechanism to facilitate the prompt payment of contract payments to subcontractors. Such a mechanism would be in addition to security of payment legislation that provides for rapid adjudication processes in relation to payment disputes. The committee agrees with the evidence and submissions of the many witnesses and submitters who have supported the concept of a trust account model for securing payments to subcontractors and reducing the incidence of insolvency in the industry.

The committee believes that Project Bank Accounts (PBAs) have the very strong potential to resolve the payment problems that have beset the industry and help minimise the great harm that the high level of insolvencies in the industry is inflicting on thousands of businesses and the people who run them and work in them every year.

PBAs would complement a harmonised national security of payments act. Any disputes in relation to payments or the head contractor’s payment instructions to the bank could be resolved through access to the security of payment and rapid adjudication legislation.

The Commonwealth, as a major funder of construction projects, has a responsibility to ensure that it is a best practice participant in the industry. The overwhelming body of the evidence received by the committee in the course of this inquiry indicates that payment practices in the industry are a long way from best practice. The committee accepts the evidence that the introduction of a form of statutory trust account for construction projects which puts payment of subcontractors at arm’s length from head contractors would mark a significant step towards best practice payment system.

For this reason, the committee recommends that, commencing in July 2016, the Commonwealth commence a two year trial of Project Bank Accounts on major construction projects where the Commonwealth’s funding contribution exceeds ten million dollars.

The committee further recommends that, following the successful completion of a trial of Project Bank Accounts on Commonwealth funded projects, the Commonwealth legislate to extend best practice payment systems that protect subcontractors from harsh, unconscionable and unlawful conduct in the construction industry.”

The Current Status:

  • Project Bank Accounts evolved in the UK and have been successfully employed in Scotland England and Wales for many years,
  • Private trials of the concept were conducted in Queensland in the 1980s,
  • The WA government has recently completed several projects trialling the concept, reportedly with success,
  • The NSW government is currently trialling the concept of projects,
  • Private projects in Victoria recovering from head contractor insolvencies using the trust account concept,
  • The NT Government has recently announced its first project trialling Project Bank Accounts, and the ACT, NSW, and Queensland governments have all raised the issue in discussion papers in their respective current legislation reviews, and,
  • There is almost universal support for the concept among subcontractors and general contractors who contract to major organisations.

What then are Project Bank Accounts:

(Acknowledgement is made to the WA Government for material and terms used to provide this brief overview)

In general terms, a PBA (Project Bank account) is an alternative payment mechanism that facilitates the direct and simultaneous payment of a project’s head contractor and PBA participating subcontractors. PBAs also establish a trust arrangement and improve security of payment, subject to certain criteria being met. PBA projects are very similar to conventional projects in that monthly payment claims will still be submitted by the head contractor. These claims will be assessed and certified by a superintendent in the usual way. However, the payment arrangements with the head contractor will be different. The difference is that instead of payments being deposited into the head contractor’s ordinary bank account by the principal, payments will be routed through a dedicated trust account – that is established by a head contractor for the project (i.e. the PBA)(See Standard vs PBA Arrangements below).

The principal will pay money into the PBA and the bank will disburse the funds in accordance with a formal “Project Bank Account Agreement” and a Payment Instruction, determined by the head contractor based on its subcontract and supply arrangements. The head contractor and participating subcontractors will then receive their payments directly and simultaneously from the PBA.

The PBA will also hold any retention moneys arising under the terms of the head contractor’s subcontracts.  Retention amounts will be detailed in the payment instruction and will be released when the head contractor is obligated to return them, or entitled to access the moneys in accordance with the relevant subcontract.

The PBA may also hold any disputed claimed amounts pending the resolution of issues in relation to those claims.

Standard vs PBA Arrangements:

Standard Project using AS2124 / AS400 Series Contracts:

PBA Project Using the same head contract documents with minor amendments to the general conditions in conjunction with a “Project Bank Account Trust Deed” and a “Project bank Account Agreement”:

On a PBA project, the contractor makes its monthly payment claim and the SR (Superintendent’s Representative) certifies this claim in the usual manner. Following certification, however, the contractor is required to provide a breakdown of how this amount is to be allocated to the supply chain, known as the Progress Payment Instruction (PPI) (See Attachment A).  This instruction is lodged with the bank and a copy is provided to the SR.  The SR then, after examining the Statutory Declaration, Progress Payment Instruction, and Monthly Report provided by the contractor, confirms through the client system that they are not aware of any information that suggests the Statutory Declaration is false.  The contractor and subcontractors then simultaneously receive payment from the PBA in accordance with the instruction. (Adapted from WA Government documentation)

The Progress Payment Instruction generated by the Head Contractor and countersigned by the principal before being on-forwarded to the PBA Bank is very important and fulfils a number of functions, as it:

  • triggers the obligation of the principal to pay the amount certified by the superintendent into the PBA,
  • identifies the relevant subcontractors, their payment allocation and their account details (to allow the bank to disburse funds out of the PBA),
  • specifies retention amounts (as retention amounts between the head contractor and participating subcontractors will also be held on trust in the PBA),
  • specifies amounts, included in the certified claim by the head contractor, claimed by subcontractors but disputed by the head contractor, and, subject to further issue resolution, and,
  • provides to the bank (that holds the trust account) an irrevocable direction to the bank, to simultaneously pay, to the head contractor and the subcontractors into the designated accounts and in accordance with the PPI, the monies held in the PBA.

The works contract will acknowledge that payment out of the PBA is a ‘good discharge’ of the payment obligation of the principal to the head contractor (The Principal therefore incurs no further liability in relation to payments under the head contract or associated supply or subcontract arrangements).

This structure maintains the debtor/creditor relationship that exists under the works contract (and the subcontracts) and provides for a payment mechanism only. The PBA is not intended to affect turnover reporting or interfere with ordinary contractual relationships.

Who will establish the bank account?

The head contractor is responsible for establishing the PBA. For the purpose of a trial, some pre-agreed PBA documentation has been prepared with a Major Bank in Australia (Discussions are under way with most of the major banks). The bank account will be established by virtue of the principal, the head contractor and the bank entering into the PBA Agreement (Project Bank Account Agreement). The PBA Agreement requires the bank to acknowledge that the account is a trust account and therefore it must act on the payment instructions (as received from the head contractor) and give effect to them.

A “Priority Deed” is also available in cases where the head contractor’s bank has a general lien over the contractor’s assets or their work in progress in order to protect the interests of subcontractors and suppliers on a particular project. This is a legal process which does not affect the cost control and administration systems generally operated by the company.

In the majority of cases, it is likely that payments out of the PBA will be made within a few days of the principal depositing money into the PBA. The effect of this will be to enhance certainty of payment timeframes for parties that participate in the PBA.

What Changes are likely to the way we operate?

The head contractor or will need to open one additional bank account for the purpose of processing all project related expenses other than the contractor’s own general overheads or preliminaries expenses. Most companies or businesses, just like individuals, operate more than one bank account / loan agreement.

The PBA “Trust” account must be operated as per the (Project Bank Account Agreement) to avoid the contractor losing the right to operate the account. This account can be on the basis of one account per project or one account for all projects with the only stipulation being that cash from one project cannot be used to fund payments on another.

The Principal, the head contractor, and, initially engaged subcontractors execute a simple “Project Bank Account Trust Deed” in a designated format with subsequent subcontractors required to, or, in the case of lower tier suppliers and subcontractors, having the option of entering the arrangement via an “Accession Deed”.

As described earlier the Progress Payment Instruction (PPI) (See Attachment ‘A’) is one of the key documents in the system. This is usually raised in ABA format just like our standard internet electronic payment requests only the instruction is for the disbursement of 100% of the progress claim on the day, or immediately thereafter, the principal’s deposit has cleared.

Flowcharts and internal administration procedures not unlike those currently used on construction projects have already been developed as an aid to the implementation of the PBA concept in commercial projects. These procedures and processes have already been used on a number of projects in Australia.

Implementation of the system would involve modifying the current systems to that similar to a dual business accounting system where charges were being applied across two or more subsidiary enterprises

Benefits of these Modifications:

Apart from the more obvious marketing advantage to a software company which adapted proactively to these impending legislation of these supply chain and procurement management changes, such as having a product ready for release as these changes occur, early involvement in trials would provide a perfect opportunity for the company to appropriately ‘field test’ the system on live projects.

The additional benefits to the industry would be that:

  • Those who undertook work on a project could reasonably rest assured that, apart from ‘force majeure’ events, their payments for work undertaken would be protected in an honest, transparent manner.
  • Consumers and principles who engage builders and head contractors would be able to ensure that trade contractors who contributed to the project get compensated for their inputs.