This report makes forty four recommendations which, if
adopted, the committee believes would overcome many of the challenges the
construction industry faces in dealing with its unacceptably high rate of
business insolvency. The recommendations seek to deal with the completely
unacceptable culture of non-payment of subcontractors for work completed on
Of these recommendations, two mark a sea change in the
Commonwealth’s role in regulating payment practices in the construction
The first of these is the recommendation that the
Commonwealth enact uniform, national legislation for a security of payment
regime and rapid adjudication process in the commercial construction industry.
The second, related major recommendation is that, commencing
in July 2016, the Commonwealth commence a two year trial of Project Bank
Accounts on 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 the use of a best
practice form of trust account to private sector construction.
Businesses operating in the Australian building and
construction industry face an unacceptably higher risk than any other
stand-alone industry of either entering into insolvency themselves, or becoming
the victim of insolvency further up the contracting chain.
The industry's rate of insolvencies is out of proportion to its
share of national output. Over the past decade the industry has accounted for
between 8 per cent and 10 per cent of annual GDP and roughly the same
proportion of total employment. Over the same period, the construction industry
has accounted for between one-fifth and one-quarter of all insolvencies in
This outcome isn’t, as some have argued, the result of market
forces. While the construction industry is highly competitive and market forces
play a part, there are other powerful factors at play. The structure of the
commercial construction sector, serious imbalances of power in contractual
relationships, harsh, oppressive and unconscionable commercial conduct play a
major role when combined with unlawful and criminal conduct and a growing
culture of sharp business practices all contribute to market distortions. As a
result, the industry is burdened every year by nearly $3 billion in unpaid
debts, including subcontractor payments, employee entitlements and tax debts
averaging around $630 million a year for the past three years
Insolvency and poor payment practices in the industry are not a
new problem. This report is the latest in a long series of inquiries and
reports dating back to at least 1995 that have considered the merits of changes
to the law to regulate the payment of head contractors, subcontractors, workers
and others in the building and construction industry. These inquiries have
provided report after report, recommendation after recommendation, to State and
Commonwealth governments, providing compelling evidence that any participant in
a construction project who holds or receives money on account of the contract
and is under an obligation to pay another participant, should be subject to a
statutory obligation to hold the money as a trustee.
Similarly, a number of inquiries and reports have recommended
the introduction of uniform, national security of payments legislation in the
Yet, little or nothing has been done. To the extent that
regulatory responses have been implemented, Australia now has a fragmented and
disparate legislative regime covering security of payment in the construction
In the view of the committee, the relative inaction that has
characterised most government responses to the completely unacceptable payment
practices in the construction has to end. The continued viability of the
industry in its current structure requires Commonwealth intervention to ensure
that businesses, suppliers and employees that work in the industry’s
subcontracting chain get paid for the work they do.
The construction industry market must be supported so that it
operates in as efficient a manner as possible and distortions of the kind
discussed in this report should be rectified as far as possible.
The structure of the Australian building and construction
industry, as well as the contractual relationships between people working
within it has transformed in the past decade or so.
Typically, the management of major projects is assigned to a
head contractor who is not a direct employer of labour on the project. These
head contractors enter into agreements with the owner/developer on one side and
with major specialist subcontractors who undertake packages of work, on the
other. Depending on the value and scale of the project, the greater proportion
of works is then sub-let to other specialist subcontractors.
This structure has distorted the construction market by
concentrating market power at the top of the contracting chain and inequitably
reallocating risk from the large contracting companies to those who are least
able to bear it, namely subcontractors, suppliers and employees.
This significant structural change has affected the culture of
the industry. A large number of subcontractors that carry the burden of risk
and a concentration of market power in the hands of a relatively small number
of head contractors means that head contractors can often have little regard
for the competitive pressures placed on subcontractors.
One witness who gave evidence to the inquiry likened the
culture to a battlefield, where subcontractors get mowed down and fresh bodies
are just poured in. Evidence to the inquiry demonstrates that head contractors
are often more than willing to abuse their market power to the detriment of
those further down the subcontracting chain. A consistent theme throughout the
evidence provided to this inquiry by sub-contractors and industry specialists
is that the dominant head contractors 'do not play nice'.
The result is a cut-throat industry characterised by serious
problems with non-payment of subcontractors and a deeply troubling record of
insolvency, many of which could be avoided.
The committee believes that the regulatory framework should do
more to protect honest, hard-working subcontractors and others down the
contractual chain whose principal objective of being in business is to be paid
for the work they do.
Phoenix company schemes have been a longstanding concern of
regulatory agencies, parliamentary committees and a more than usual number of
inquiries. However, despite the prevalence of inquiries and recommendations
that followed, illegal phoenix activity remains a significant issue not only in
the construction industry, but throughout the economy.
While the committee appreciates the increasing attention that
regulators are placing on identifying and curbing phoenix activity, progress
has been unacceptably slow. is time the government gave consideration to
closing the legal loopholes that allow the practice to continue to flourish.
This report makes some recommendations in that regard.
The majority of submissions that touched on illegal phoenix
activity contended that the continuing high incidence of phoenixing in the
industry demonstrates that the current legal and regulatory framework is unable
to curb the practice.
The committee considers that the estimates of the incidence of
illegal phoenix activity detailed in this report suggest that construction
industry is being beset by a growing culture among some company directors of
disregard for the corporations law. This view is reinforced by the anecdotal
evidence received by the committee which indicates that phoenixing is
considered by some in the industry as merely the way business is done in order
to make a profit.
The committee is particularly concerned at evidence that a
culture has developed in sections of the industry in which some company
directors consider compliance with the corporations law to be optional, because
the consequences of non-compliance are so mild and the likelihood that unlawful
conduct will be detected is so low.
This culture is reflected in the number of external
administrator reports indicating possible breaches of civil and criminal
misconduct by company directors in the construction industry. Over three
thousand possible cases of civil misconduct and nearly 250 possible criminal
offences under the Corporations Act 2001 were reported in a single year
in the construction industry. This is a matter for serious concern. It suggests
an industry in which company directors' contempt for the rule of law is
becoming all too common.
Recent studies indicate that illegal phoenix activity (across all
industries) may cost between $1.79 billion and $3.19 billion per annum.
Given the over-representation of construction businesses in insolvencies and
phoenixing, the committee believes the construction industry is responsible for
a substantial proportion of this cost.
The committee also heard evidence about an emerging business
model whereby, in the period leading up to a company entering administration,
companies are obtaining pre-insolvency advice on how to restructure their
business prior to the company entering administration, which results in the
company being able to avoid paying it creditors. ASIC noted in its evidence
that this type of advice is often being provided by former insolvency
practitioners who have been previously suspended from practice for misconduct.
ASIC considers this practice to be a significant problem and it is unregulated.
This inquiry received extensive evidence about this type of conduct in relation
to the collapse of Walton Constructions, which the committee believes is a useful
case study of the practice. While corporate restructuring is often a necessary
and beneficial strategy to ensure the ongoing viability of a business or to
provide the greatest value to creditors, it appears that unscrupulous advisors
are, in some cases, facilitating illegal phoenix activity.
Insolvency affects everyone
Insolvency in the construction industry has impacts on
businesses, employees, families and communities. The collapse of a business
places immediate pressure on the management and employees of that business, as
well as its suppliers and contractors. In regional towns, a single insolvency
can affect entire communities.
Evidence from witnesses around the country drew attention to
the troubling health effects and stresses placed on family life caused by the
financial distress stemming from insolvencies. The committee heard evidence of
people being affected by mental health issues, family breakdown, people losing
their houses and becoming homeless and children facing stress and disruption to
their lives. In one tragic case, the committee heard evidence from a man whose
father, a highly respected and successful Perth businessman, took his own life
while fighting for payment for work his company had completed for one of the
biggest construction companies in the country on a major public works project
in Western Australia.
The economic cost of insolvencies in the construction industry
is staggering. In 2013–14 alone, ASIC figures indicate that insolvent
businesses in the construction industry had, at the very least, a total
shortfall of liabilities over assets accessible by their creditors of $1.625
billion. Others who have analysed the data place the amount at $2.7 billion.
The construction industry consistently rates as either the highest or second
highest as against all other industries when it comes to unpaid employee
Insolvency hinders innovation and productivity
Businesses now operate in an environment in which non-payment
for work carried out is commonplace, cash flows are uncertain and businesses
lower down in the subcontracting chain have little power relative to those at
the top of the chain. In this environment, there is very little incentive to
invest the necessary capital to adopt new and innovative construction methods, invest
in new capital equipment or invest in workforce skills development.
The construction industry consistently ranks in the three least
innovative industries in the country. According to latest available ABS
innovation data, only a third of construction businesses could be classed as
'innovation-active' compared with more than half of businesses in the
warehousing, media and telecommunications and retail sector businesses. Less
than fifteen per cent of construction businesses had innovation in development,
compared with over thirty percent of manufacturing businesses and 35 per cent
of media and telecommunications businesses.
As innovation is a key driver of productivity, profitability
and job creation, the lack of innovation in the industry must be addressed.
Early detection is critical to curbing illegal phoenix activity and preventing
smaller scale insolvencies from becoming more significant
Industry participants are generally the first to become aware
that a company may be entering financial distress; as such more effort needs to
be expended in regularising information flows between industry participants and
regulators. If industry participants are reluctant to inform the regulators as
a result of intimidation and fear of commercial consequences, confidential
tip-off lines, or equivalent measures, should be developed.
Failure to pay employee entitlements is often a sign of
cash-flow problems that may be a precursor to insolvency. Early detection and
intervention is crucial to preventing companies in financial distress from
either entering insolvency, or continuing to raise debts before eventually
collapsing. The committee was pleased to hear that a range of
whole-of-government responses, led by the ATO and ASIC, have been established
to share information between regulators. More resources should be directed to
these measures and, where necessary, legislative frameworks should be amended
to promote greater information sharing.
The committee also welcomes reports that the ATO and ASIC are
engaged in information sharing activities with superannuation funds. The
committee encourages the regulators to increase cooperation with superannuation
funds aimed at early detection of non-payment.
More needs to be done to protect honest industry participants from unscrupulous
The construction industry accounts for an unacceptably high
proportion of total alleged criminal and civil contraventions of the Corporations
Act. This is indicative of a culture that has developed in sections of the
industry in which some company directors consider compliance with the Corporations
Act to be optional.
This culture highlights the importance of a reform to
legislative and regulatory framework so that it better protects law abiding
industry participants from unscrupulous business practices.
Disqualification of directors
ASIC has the power to disqualify a person from holding a
directorship under section 206F of the Corporations Act, where evidence
indicates that insolvencies are connected to criminal or civil misconduct. Despite
the considerable number of breaches within the construction industry, has been
used as the exception rather than the rule, with an average of only 69
directors, across all industries, disqualified per financial year.
These low numbers have contributed to a feeling among
insolvency practitioners, academics and participants within the
industry—including potentially unscrupulous directors, that ASIC fails to take
enforcement seriously. The committee does not agree with this view. However the
committee is mindful that effective enforcement of the law requires resources,
particularly in circumstances where non-compliance is the result of concerted
effort on the part of those who desire to flout the law. For these reasons, the
committee recommends that the government ensure ASIC is adequately resourced to
enforce the law in each and every case where breaches are detected.
Director Penalty Regime
Disqualification is not the only response available. The
Director Penalty Regime originally introduced as part of the Insolvency (Tax
Priorities) Legislation Amendment Act 1993 but substantially amended in
2012, aims to ensure that directors cause their companies to comply with
certain taxation and superannuation obligations. The regime has been an
important legislative reform in extending the ability of ATO to ensure that
directors comply with their obligations to pay employee entitlements.
Nevertheless, the committee appreciates that the regime could
be utilised more broadly, and has failed to recover a significant amount of
outstanding liabilities. Of more concern, however, is the fact that the regime
does not cover GST liabilities, allowing unscrupulous property developers to
avoid their GST obligations intentionally. The committee believes that further
consideration on this point should be conducted by the Legislative and
Governance Forum for Corporations, the body with oversight of corporate and
financial services regulation
Transactions entered into in order
to avoid employee entitlements
Section 596AB of the Corporations Act prohibits
transactions entered into with the intention of preventing the recovery of
employee entitlements or depriving employees of their entitlements and imposes
a criminal sanction for breach. Yet, despite clear evidence of this occurrence,
no prosecution under section 596AB has ever been initiated. The provision needs
to be amended to make it fit for purpose.
In an industry characterised by low barriers to entry, small
profit margins and inequitable allocation of risk, an effective licensing
regime is necessary to protect participants from both unscrupulous and hapless
The committee considers that three elements of a licensing
regime are critical in reducing insolvency within the construction industry:
evidence of adequate capital backing; financial skills training; and a fit and
proper test. The committee notes further that a critical element of any fit and
proper person test is the regularity and responsiveness of the test to a change
in circumstance. Random financial health spot-checks should be conducted by the
Transfer of jurisdiction of
The Federal Circuit Court of Australia has a substantial
jurisdiction in personal bankruptcy but not corporate insolvency. The committee
considers that strong arguments exist for the extension of the jurisdiction of
the Federal Circuit Court of Australia's to include corporate insolvency
matters under the Corporations Act 2001. In particular, it will promote
expeditious resolution of matters at a lower cost.
Valuing debt assignments fairly
The Corporations Act and the Bankruptcy Act 1966
diverge over the value of debt assignments at creditors meetings. Under section
64ZB(8) of the Bankruptcy Act the voting power of a person who buys a
debt is the amount assigned for that debt, not the original value of the debt.
In contrast, under the Corporations Act, the value of the voting power
is the original value of the debt. The committee believes that the voting value
of debt assignments at creditors meetings under the Corporations Act should
be aligned with those applicable under the Bankruptcy Act 1966.
This anomaly was identified in the Walton Construction's
case study, where a company connected to Walton's bought $18.5 million of
Walton's debt for $30,000. The committee believes that there is no cogent
reason why debt assignments should be valued differently for the purposes of
the Corporations Act and Bankruptcy Act.
The committee considers further those businesses that
provide restructuring advice should not be permitted to buy into the companies
they are advising via debt acquisitions.
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
This is not a new or radical principle and State and Territory
parliaments across Australia have introduced security of payments legislation
in an attempt to ensure that money owed to subcontractors is paid. The
enactment of this legislation has been a positive development. However, the
committee has heard evidence that while well intentioned, the often vastly
different laws operating in each jurisdiction are not working as well as they
were intended and there are significant barriers to access. Indeed, the
disparate nature of the various regimes and the relatively poor take up of
parties enforcement rights under the State and Territory regimes, as well as
other significant problems, provides a strong indication that national
harmonisation is necessary.
The construction industry is a national industry. Its
participants, large and small, routinely operate across state borders. It is
absurd that in this day and age there are eight separate security of payments
regimes which differ markedly from one other. Some of the differences are small
and some are large and significant, but what they all do is present manifold
difficulties for construction industry businesses that routinely operate in
more than one state. This has resulted in a great deal of wasteful litigation
in which parallel points of law are raised in the different jurisdictions.
Witnesses and submitters to the inquiry expressed almost
universal support for a single set of rules applying around the country for
security of payment and related matters in the construction industry. The most
effective way of achieving this would be for the Commonwealth to legislate
based on the Commonwealth's various heads of legislative power, especially the
corporations' power. This approach was adopted by both the Cole Royal
Commission and the more recent Society of Construction Law Report on Security
of Payment and Adjudication in the Australian Construction Industry.
As both these reports pointed out, there may not be completely
universal coverage achieved by Commonwealth legislation. However it would be
near enough to universal provided at least one party to a contract is
incorporated, such that any marginal loss of coverage relative to State
legislation would be an acceptable price to pay for this long-overdue reform.
For these reasons, the committee recommends that the Commonwealth enact
uniform, national legislation for a security of payment regime and rapid
adjudication process in the commercial construction industry.
Retention trusts and project bank
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
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
Economists recognise the importance of overcoming information
asymmetries to ensure the proper functioning of markets. This understanding
underpins the requirement that public companies lodge their financial reports
with ASIC each year. Asymmetries of information naturally create power
imbalances. During the course of this inquiry the committee's attention was
drawn to a number of information asymmetries that negatively affect subcontractors.
Proposals to rectify these asymmetries are discussed in the report.
A legal obligation to warn of
Information is critical in inhibiting illegal phoenix activity
and preventing small-scale insolvencies turning into larger collapses.
Financial institutions are privy to more information about the financial status
of companies they are involved with than subcontractors engaged in specified
projects. This came to a head in the case of Walton Construction's, which
collapsed on 3 October 2013.
The committee notes that in this case, an information asymmetry
existed between the National Australia Bank (NAB) and subcontractors engaged
with Walton's, which allowed NAB time to protect their interests. Removing the
asymmetry by imposing a duty on those with more information to inform other
participants in the market will reduce power imbalances and lead to a more
effective market overall.
The committee is supportive in principle of requiring financial
institutions to warn respective regulators if they have reasonable grounds to
suspect that a business is in financial distress and may be, or may be about
to, trade insolvent.
However, the committee accepts that imposing a legal obligation
on financial institutions to do so could in many circumstances be
counterproductive and may force companies into administration that could
otherwise survive. The committee suggests that in order to protect their own
interests, participants in the industry who provide goods or services on credit
should seek as much information about the financial situation of their trading
partners as possible.
A beneficial owners' register and a
Director Identification Number
To register a company a person must lodge an application with
ASIC. Under section 117(2) of the Corporations Act, the
application must include the name and address of each director of the company.
However, little is done to verify that information and consequently there is a
lack of transparency surrounding the identity of company directors.
The inability of regulators and participants in the building
and construction industry to identify and track individuals suspected of
illegal activity is a significant cause of the incidence of illegal phoenix
A lack of transparency around company directors means that
regulators are slower in clamping down on illegal phoenix operators and
therefore more innocent participants are caught up in schemes, suffering
significant economic and social effects. A comprehensive and verified
beneficial owners' register would save regulators time in drawing links between
The committee believes that the recommendations in this report
must be implemented as soon as practicable to ensure a productive, properly
functioning construction market in which people are paid for the work they do.
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