Construction Contracts Act 2002 – development funding

The Constructions Contracts Act 2002 came into force on 1 April 2003 and has a number of important implications for financiers and borrowers. It affects commercial construction contracts (and, to a limited extent, construction contracts for residential – i.e. owner-occupied – developments).

The Act provides for certain statutory rights and obligations intended to supplement any construction contract entered into after 1 April, and specifically:

• facilitates cash flow through the industry by regulating payments and providing remedies for unpaid contractors; and
• establishes a supposedly quick and inexpensive adjudication process to help resolve disputes arising from construction contracts.

Implications for lenders and borrowers

"Pay when paid" and "pay if paid" clauses are now unenforceable. These clauses have been used by head contractors to make sure that subcontractors will not get paid for their work until the head contractor has been paid. Lenders will need to take this into account when financing head contractors and sub contractors as cashflows may be affected significantly.

The payment and adjudication processes prescribed in the Act introduce risks for the borrower and its lender.

A borrower, as the principal under the construction contract, may have to pay a greater sum than the costs of the works. This will arise where the contractor has made a payment claim and the borrower has not responded within the specified timeframe under the Act and in default has to pay the full amount claimed.

If the borrower does respond in time but disputes part of the claim, the dispute can be referred to adjudication under the Act and there is the risk of the adjudicator determining an amount beyond what the borrower can pay. This will then become an issue for the financier.

An example of the dramatic results that can arise from an adjudicator's decision has been demonstrated in an English case, where an adjudicator overlooked a provision entitling the owner to retain moneys and awarded the contractor £207,741, rather than the £141,254 to which the owner would have been entitled had the retentions been taken into account.

The adjudicator's award was binding and so the amount was required to be paid across to the owner to the contractor. The contractor went into liquidation, and so the amount was not recoverable, even though the adjudicator's mistake was subsequently rectified in a separate court decision.

In a similar scenario, principals and financiers are likely to seek an amount and coverage of any contractor's bond to extend to cover payments due by a contractor to a principal.

Payment processes and rights of suspension now available to a contractor under the Act could cause delays to the project. These could cause problems where there are sunset clauses or other time constraints in other project documents such as on-sale contracts or leases.

Charging orders

A remedy now available to contractors under the Act, pursuant to adjudication, is a charging order. A charging order is a remedy to enforce a judgment debt, and once registered, it is a charge over the land but ranks behind prior registered charges, according to normal priority rules.

The lodging of a charging order would usually constitute a breach of a borrower's covenants under standard loan documentation. Financiers should ensure that their loan documents provide that the lodging of a charging order against the title to the land constitutes an event of default.

Bell Gully has prepared a guide to the Act and has also prepared "Act-compliant" revisions to the most commonly used New Zealand conditions of construction contracts.

Click to download a copy of the guide in PDF format and for further information.

Enquiries and information

For more information on any of the cases, articles and features in Financial Services Quarterly, please email Rachel Gowing or call on 64 9 916 8825.