I think we are all aware that many domestic builders are struggling at present.  Some will not survive.  For those of us that are not in the middle of building this is interesting and a little sad.  If it’s your builder that is struggling it becomes a real problem.

In this article I want to share how this real problem became a nightmare for one client.

Jim’s Development

The client, let’s call him Jim (because that’s not his real name), was developing a small apartment site.  There were a number of presales in place and the project had encountered various delays including council approvals, issues excavating rocks and contractors that needed to be replaced.

One day the builder, BuildCo Pty Ltd, approached Jim and indicated that there would be some delays to the project.  One of the sub-contractors wanted an up front deposit and BuildCo didn’t have access to the funds until the next progress claim.  Jim didn’t want any more delays – he was worried that further delays would trigger the sunset clauses in his pre-sales and the purchasers would terminate.

Jim therefore agreed to pay the subcontractor’s deposit for BuildCo.  BuildCo promised to pay the money back out of the next progress claim.  BuildCo received the next progress claim from the construction funder and paid the $20,000 back to Jim as agreed.

However, this started to become a pattern.  There were payments to other sub-contractors, payments for the car stacker that the construction funder wouldn’t lend for and other amounts.

The project was all but complete when BuildCo went into liquidation.  BuildCo still owed Jim around $200,000 – even after the last progress claim was forfeited.  Jim thought that was the end of the matter. 

It was 6 months later when the liquidated started asking questions and the nightmare began.

In short, the liquidator claims that $250,000 of the money that was paid back by BuildCo comprises preferential payments and the liquidator is entitled to claim them back.  This claim is in addition to the $200,000 that Jim is still owed by BuildCo.

Preferential Payments

This is a complex area – but put simply, where a creditor has received from a company, in the six months prior to liquidation of the company, more than other creditors the payment may be an unfair preference.  This means that the liquidator may be entitled to ask the creditor to pay the money back and claim as an unsecured creditor.  To be clear, a claim as an unsecured creditor generally results in minimal return after liquidator’s fees and other preferred creditors are paid.

There are a number of potential defences on Jim’s part:

  • Good faith – but Jim will struggle to argue that he wasn’t aware BuildCo had solvency issues;
  • Running Account – this can be difficult with building contracts;
  • Set off – Jim might be able to argue that some of the payments should be set off against other amounts due to Jim; and
  • Retention of Title – Jim didn’t generally transfer any goods he could retain title over – but this could have worked for items like the car stacker?

Jim’s Mistakes

In Jim’s case, there are a number of factors that have compounded his exposure.

The loans were not documented.  Ideally, Jim should have got a signed loan document with security (even if only over the upcoming progress payment) and personal guarantees from directors of BuildCo.

In some cases, as Jim ran short of funds, the loans were made by his family trust.  These were simple loans and repayments – and were a prime target of the liquidator as many of the defences that Jim might have as the developer are harder to make out.

The payments came via Buildco – not directly from the construction funder.  While explaining this could have caused issues with the construction funder it could also have avoided some of the claims.

Best Practice

There are a number of things that Jim could have and should have done to minimise his risks in the situation that he faced:

  1. Get advice – Jim’s first and biggest mistake was not to get advice.  This would have allowed the loans to be structured in such a way as to avoid the worst of the problems.  An outside perspective might have helped point out that what Jim was doing was inherently risky;
  2. Due Diligence – Before you enter into a building contract – satisfy yourself that the builder has the resources and competence to complete the build in a timely fashion. Builders may not like this – but it really is essential;
  3. Documentation – make sure that the loans are documented, structured optimally and secured;
  4. Knowledge – understand what payments might be preferential payments and what might not be.

Would this knowledge have saved Jim?  I believe it would have significantly reduced his losses and reduced his stress.  However, when your builder has solvency issues or is otherwise in default – there is often no easy or good solution.  Even terminating a residential building contract will usually bring delays, cost increases and other complications.

If you have a problem with a building contract – please contact us sooner rather than later.  You can book a no obligation consultation here with Lewis O’Brien.  Get the advice and input that Jim didn’t – and don’t pay the price that Jim has in stress and unnecessary losses.

Lewis O’Brien