Navigating security of payment claims - adjudication or court?

What you need to know?

• In Victoria, a contractor pursuing a security of payment claim who chooses to go to court to recover unpaid claimed amounts after a principal fails to serve a payment schedule bears the risk that judgment will be refused in its entirety if the claim incorporates any "excluded amount".
• In assessing whether a payment claim incorporates any excluded amount and is otherwise valid, the court will consider the claim document on its face, and will not have regard to extrinsic evidence of surrounding circumstances, even if doing so might in fact demonstrate that an item of work has been inappropriately described or is an excluded amount.
• If a contractor's application to court is refused because the claimed amount incorporates an excluded amount, it may still be open to the contractor to include the same work (less any excluded amount) in a fresh payment claim.

What you need to do

• Contractors should take care to avoid incorporating any excluded amounts in their payment claims, and should think carefully before heading to court (rather than adjudication) to enforce a claim even if the principal did not serve a payment schedule objecting to any excluded amounts.
• To best protect their interests, principals should promptly serve a payment schedule in response to any payment claim to dispute claimed amounts, including on the basis that work is incorrectly or insufficiently described.

The Victorian Building and Construction Industry Security of Payment Act 2002 is intended to promote a 'pay now, argue later' scheme, similar to equivalent legislation across Australia. Theoretically, this means that those who engage in construction work, or who supply goods and services under construction contracts, are paid in a timely and cost-effective manner. However, differences between the legislation in each State and Territory, as well as nuances within each jurisdiction, has meant that security of payment claims are often far more complex than intended.

Under the Victorian Act, if a principal fails to pay an amount set out in a contractor's payment claim, and does not submit a payment schedule objecting to that amount, the contractor can either:

• recover the unpaid amount in court as a debt due and payable; or
• make an adjudication application in relation to the payment claim.

The Act expressly prohibits certain amounts – referred to as "excluded amounts" and covering such things as time related costs and damages for breach of contract – from being claimed in a payment claim. As a consequence, an adjudicator is unable to take into account excluded amounts when determining the amount payable by a principal, and the court is unable to enter judgment unless it is satisfied that the claimed amount "does not include any excluded amount".

While the Act's provisions on excluded amounts may paint a complex picture, the Victorian Supreme Court of Appeal has attempted to return to basics in the recent case of Yuanda Vic Pty Ltd v Façade Designs International Pty Ltd [2021] VSCA 44. In overturning the trial judgment (see our previous publication for background), the Court of Appeal held that the relevant provisions of the Act mean what they say: if the original payment claim includes claims for excluded amounts then the court is unable to give judgment in favour of the contractor – the court has no power to ignore excluded amounts and enter judgment for a lesser sum.

Although the concept of excluded amounts is unique to Victoria, some of the Court of Appeal's views as to the function of the court in security of payment regimes have broader relevance. In this regard, the appeal also considered the common law doctrine of severance and the degree to which the court is able to consider material beyond the face of a payment claim.

What if "excluded amounts" appear in payment claims?

On appeal, the principal successfully contended that the trial judge should have dismissed the original proceeding on the basis that the claimed amount included interest, which is an excluded amount, and that it was not open to the court to adjust or sever the claimed amount by this excluded amount.

The majority (McLeish JA and Niall JA) held that:

• a claimed amount is the amount set out in a payment claim at the time of issuance in accordance with the Act; and
• the court is unable to enter judgment for an amount less than the claimed amount where that amount includes an excluded amount.

The majority's position was heavily influenced by their view that the Act preferences adjudication over litigation as a quicker and more informal means of resolving security of payment disputes. They held that the Act clearly establishes the contents of a payment claim as a matter for adjudication, and were accordingly eager to confine the court's role to identifying and enforcing statutory liabilities incurred as debts under the Act. Any broader role would sit "uncomfortably" with the Act's delineation between the court and the adjudicator, and would open the way for the court to determine complex factual disputes about claimed amounts. The majority also considered that denying direct judicial enforcement without prior adjudication would promote compliance with the Act's prohibitions against contractors incorporating excluded amounts in a payment claim.

The consequence of the majority's approach is that a contractor who chooses to seek enforcement through the court, as opposed to through adjudication, bears the risk that the court will identify an excluded amount and therefore not enter judgment at all.

In his dissent, Sifris JA disagreed with the "all or nothing" approach adopted by the majority. Instead, his Honour held that the procedure for judgment under the Act is not intended to be inflexible nor to punish a contractor for adding an obviously excluded amount in a payment claim where the principal has failed to serve a payment schedule disputing that amount. Notably, his Honour questioned "why should so simple a case – where nothing is disputed – go to an adjudicator?" in circumstances where the Act allows claimed amounts to be adjusted in other instances, such as to address arithmetical errors. In this context, Sifris JA considered that such obvious adjustments are not only necessary and permissible, but "entirely in tune with the aim and purpose of the Act".

Severance of excluded amounts from payment claims

The contractor also argued that the trial judge was entitled to sever the excluded amount from the claimed amount, to the extent such amounts were included in the payment schedule. The Court of Appeal, however, held that the common law doctrine of severance was of no assistance here on the basis that it only applies where part of an instrument is invalid. There was no question as to the validity of the Act nor of the payment claim. Payment claims which incorporate an excluded amount remain valid. This is evident in the requirement that the principal's payment schedule must identify alleged excluded amounts. Accordingly, there was no instrument for the doctrine of severance to apply to. In contrast, the Victorian Supreme Court has previously held that the common law doctrine of severance could apply to allow adjudicators to assess only valid parts of a payment claim and provide a determination for that part of the claim: see Gantley Pty Ltd v Phoenix International Group Pty Ltd [2010] VSC 106.

Where part of an adjudication determination is infected by jurisdictional error, only the Western Australian Act clearly provides for severance of those parts of the determination that are invalid. Recent case law, however, suggests that severance of part of a determination affected by error is now also the preferred position in NSW: see YTO Construction Pty Ltd v Innovative Civil Pty Ltd [2019] NSWCA 110.

The level of inquiry required to identify excluded amounts

The principal submitted that the trial judge erred in only considering the payment claim on its face when determining whether his Honour could be satisfied that no excluded amount had been claimed. The principal argued that such an approach was impractical, as a contractor is unlikely to characterise any part of its claim as an excluded amount. The Court of Appeal disagreed and held that no full investigation or "digging exercise" was contemplated by the Act. In the Court's view, while a contractor may not explicitly disclose an excluded amount for what it is, it will be possible to see from the payment claim what amounts have been taken into account in calculating the claimed amount, and the work, goods or services to which they relate.

In this case, the Court made no further inquiries to ascertain whether described work constituted an excluded amount, despite the principal alleging that a number of excluded amounts had been wrongly described as "variations". Rather, in considering the face of the payment claim and relevant invoices, the Court deemed these amounts to be variations for the purposes of judgment under the Act as they were referred to solely as variations in those documents. Ultimately, this did not assist the contractor given that the interest component of the claimed amount was clearly an excluded amount, and on the majority view judgment could not be entered for a lesser amount.

This limited level of inquiry is consistent with the legislative intent for courts to have a narrow role in security of payment disputes. To this end, the Court of Appeal held that the Act merely sets out a "relatively quick summary procedure for allocation of risk pending any final determination". The majority reasoned that this construction does not unfairly disadvantage a principal, as the principal has the opportunity to identify any amounts alleged to be excluded amounts when providing a payment schedule in response to a payment claim. It is ultimately up to the principal to undertake a full investigation during the adjudication process. Should the principal fail to do so, it is not able to later seek a full investigation by a court to interrogate an alleged deficiency in the payment claim that the principal should have raised earlier.

Where this leaves us

At times, a contractor will be faced with a situation in which their principal has failed to serve a payment schedule in response to a security of payment claim within the required time period, and the contractor will face a choice between going to court or adjudication to recover any unpaid amounts. In those circumstances, the majority judgment in Yuanda Vic Pty Ltd v Façade Designs International Pty Ltd indicates that a contractor should refrain from seeking judgment in court unless confident that their claim is entirety free of excluded amounts. Where a contractor instead decides to refer the matter to adjudication, it should be mindful that the Victorian and NSW Acts require the principal to be given another opportunity to provide a payment schedule before adjudication is commenced.

For a principal, serving a comprehensive payment schedule in a timely manner is critical in disputing claimed amounts whilst preserving the ability to participate fully in any adjudication process.

This case also shows that while there may be common ground about the policy objectives of security of payment regimes, there remains different judicial opinions as to how the legislation should be interpreted to best give effect to these objectives. It may be that the clarification given by the majority judgment here of the court's role compared with that of the adjudicator will assist parties to more effectively engage with the adjudication and court processes prescribed by the Victorian Act but the challenges caused by varying State and Territory regimes are set to remain and require all parties to pay careful attention to their rights and obligations.

Authors: James Clarke, Partner; and Amelia Barrow, Lawyer.