We frequently hear of situations where contractors enter into home-build agreements without taking extra steps to protect themselves in the event that the other party can no longer pay their bills.

As many will know, the building industry can be vulnerable to financial trouble. If a contractor is not a “secured creditor” and the other side goes bust before paying them, then the contractor is unlikely to recover much of the money owed (if any).

Contractors that become “secured creditors” significantly improve their chances of recovering moneys owed to them in insolvency situations.

A secured creditor is a person (or entity) who is owed money by another and has rights to their assets if the other party falls behind on their payments.

Secured creditors also have priority over unsecured creditors for moneys owed by a person/entity that is insolvent and managed by a liquidator or administrator. Unsecured creditors can only be paid once all of the secured creditors have been paid.

It is best to create a security interest at the point of entering into the agreement or as soon as possible afterwards, rather than when the other party is already in financial trouble. If it is created when the other party is already struggling financially then the security interest may not be enforceable as it attempts to give priority over other creditors.

How do you become a “secured creditor”?

In circumstances where the other party owns land (for example a land-owner contracting for a home-build), contractors can become secured creditors by negotiating in their building work agreements the right to register a mortgage over the land to secure payment of their fees (and then registering such a mortgage or a caveat).

In circumstances where the other party does not own land (for example subcontracting arrangements), contractors can become secured creditors by negotiating in their building work agreements security interests over the other party’s personal property (like their tools, materials and vehicles) to secure payment of fees. Where this is agreed, the contractor should register the security interest on the Personal Property Securities Register (PPSR) as soon they can. This prioritises the security interest over other secured creditors who register later.

Having said this, there are circumstances (for example where a contractor is tendering for work in competition with others) where it may not be possible to negotiate becoming a secured creditor. Even in these “take it or leave it” situations the contractor can protect themselves by ensuring that their invoices are “Payment Claims” and by using the mandatory dispute resolution procedures to encourage moneys owed to flow through to them.

What about ‘retention of title’ agreements?

 Many contractors and suppliers in the building industry supply building materials as part of their building work. Often contractors will rely on ‘retention of title’ type agreements to protect their interests in the materials until they have been fully paid.

While ‘retention of title’ agreements in most cases create security interests in the materials, this alone will not guarantee that the materials are protected against claims by third party secured creditors, for example banks. In these circumstances, contractors should take the next important step of registering this security interest over the materials on the PPSR as soon as possible. As above, this will increase the priority of the contractor’s security over the materials compared to other secured creditors who register later.

While this area can be complex, participants in the building industry can greatly improve their chances of recovering moneys owed in insolvency situations if they take steps to become secured creditors. In “take it or leave it” situations, obtaining professional advice early on can assist in increasing protections and/or reducing risk.

Jason Klapproth
Commercial Lawyer
Wellington