Restrictions on a contractor’s right to payments under an operation agreement found to be void on the basis that they were ‘pay when paid’ provisions

Executive summary

It is commonplace for a developer to enter into separate contracts to build (ie an EPC Agreement) and then operate and maintain (ie an O&M Agreement) works.

Following this case, parties will need to be careful when making the right to receive payment under one contract conditional on performance or steps under the other contract. Such conditions may be void as they are captured by prohibition on “pay when paid” provisions within the security of payment legislation.

In Lal Lal Wind Farms Nom Co Pty Ltd as agent for the Lal Lal Wind Farms Partnership v Vestas – Australian Wind Technology Pty Ltd & Max Tonkin [2021] VSC 807, Lal Lal and Vestas entered into an EPC Agreement and an O&M Agreement in relation to a wind generation facility. Under the O&M Agreement, Vestas served a payment claim. Part of Lal Lal’s argument in providing a nil assessment was the milestone of practical completion had not been achieved under the EPC Agreement, which was a requirement before a payment claim could be submitted and therefore, no reference date had accrued and no payment was due.

Her Honour Stynes J held in the Supreme Court of Victoria that despite being related agreements, the entitlement for payment under the O&M Agreement was contingent or dependent on the operation of another contract, being the EPC Agreement. It therefore was captured by section 13(2)(c) of the Building and Construction Industry Security of Payment Act 2002 (Vic) and therefore void as a “pay when paid” provision.

What happened?

The case of Lal Lal Wind Farms Nom Co Pty Ltd as agent for the Lal Lal Wind Farms Partnership v Vestas – Australian Wind Technology Pty Ltd & Max Tonkin [2021] VSC 807 (Lal Lal v Vestas) concerned two construction contracts for a wind generation facility.

Both parties entered into an engineering, procurement and construction contract for the wind generation facility (EPC Agreement) and a contract for the operation and maintenance of the Facility (O&M Agreement), placing Lal Lal as the principal of the EPC and O&M Agreement. Vestas remained a party to the Agreements.

On 28 July 2021, Vestas served a payment claim on Lal Lal under the O&M Agreement claiming approximately $6 million for works and services performed from May 2019 to May 2021. In response, Lal Lal served a payment schedule certifying the amount as nil. Lal Lal relied upon section 7(2)(c) of the Building and Construction Industry Security of Payment Act 2002 (Vic) (SOP Act), indicating it is excluded.

The payment claim was subject to an adjudication, which ultimately determined the amount payable to Vestas was the full $6 million. This was based on:

1. the valuation calculated was in reference to services; and
2. a reference date arose for Vestas to submit a payment claim.

Lal Lal applied for the decision to be declared void in the Supreme Court of Victoria.

Issue in dispute

Relevantly for this article, the issue in dispute related to whether a reference date had arisen under section 9(2)(b) of the SOP Act in respect of the payment claim.

Did a reference date arise under section 9(2)(b)?

As required by section 9(1) of the SOP Act, for Vestas to have served a payment claim there must have been a reference date. The specific issue dealt with by Stynes J is whether or not clause 11.1(c) of the O&M Agreement was a ‘pay when paid’ provision. Clause 11.1(c) of the O&M Agreement states:

Within 5 business days after the last day of each quarter of each Operational Year during the Interim Services (Phase 1) Period and the Term, the O&M Provider is entitled to submit to the Principal a valid tax invoice which states the portion of the Interim Fees or O&M Fees (as applicable) payable by the Principle as set out in Schedule 2.

An “Operational Year” was defined as a twelve month Term commencing on the Commencement Date. The “Commencement Date” in turn was defined as the “Practical Completion Date”, referable to Practical Completion under the EPC Agreement.

Lal Lal argued that as Practical Completion had not been achieved under the EPC Agreement, there was no Commencement Date and so no right for Vestas to submit a payment claim in the O&M Contract.

Applicable law

Section 13 of the SOP Act prohibits “pay when paid” provisions. It provides:

Effect of pay when paid provisions

1. 1. 1. A pay when paid provision of a construction contract has no effect in relation to any payment for—
         1. construction work carried out or undertaken to be carried out under the contract; or
         2. related goods and services supplied or undertaken to be supplied under the contract.
      2. In this section—
         “money owing”, in relation to a construction contract, means money owing for—
         1. construction work carried out under the contract; or
         2. related goods and services supplied under the contract;

“pay when paid provision” of a construction contract means a provision of the contract—

1. 1. 1. that makes the liability of one party (the first party) to pay money owing to another party (the second party) contingent on payment to the first party by a further party (the third party) of the whole or any part of that money; or
      2. that makes the due date for payment of money owing by the first party to the second party dependent on the date on which payment of the whole or any part of that money is made to the first party by the third party; or
      3. that otherwise makes the liability to pay money owing, or the due date for payment of money owing, contingent or dependent on the operation of another contract.

Therefore, if a provision is deemed a “pay when paid” provision, section 48 operates to void such provision.

This regime was considered by the High Court in the case of Maxcon Constructions v Vadasz¹. In that case it was held that linking a right for a subcontractor to have retention released to achieving an occupancy certificate under the head contract was void as a “pay when paid” provision. The relevant test is whether a provision of a contract makes liability to pay the money contingent or dependent on the operation of another contract.

Arguments

As indicated above, the Adjudicator at first instance determined that the Operational Year will commence on the Commence Date, being the two Practical Completion Dates. As these are governed by the EPC Agreement, this constitutes a payment of money owing dependent on the operation of another contract, falling within section 13(2)(c) of the SOP Act and therefore void under section 48 of the SOP Act².

Lal Lal argued:

1. Clause 11.1(c) does not provide for “money owing”. It merely determines when Vestas may issue an invoice;
2. as both Lal Lal and Vestas are parties to the EPC Agreement, it is not “another contract” for the purpose of section 13(2)(c). This would therefore mean both the EPC Agreement and the O&M Agreement should be considered in tandem with one another; and
3. a finding against this would result in a triumph of form over substance, as contracting parties could easily avoid section 13(2)(c).

Vestas argued that even though both parties are privy to the EPC and O&M Agreements, entitlement to payment is still dependent upon practical completion being achieved under another contract. Therefore, it is a “paid when paid” provision.

Decision

Citing the High Court decision in Maxcon Constructions v Vadasz³, Stynes J agreed with the Adjudicator’s determination. Her Honour applied the test and found that the liability to pay money under the O&M Agreement was contingent or dependent on the operation of the EPC Agreement determining whether Practical Completion had been obtained.

Specifically, Stynes J noted:

1. the parties to the EPC and O&M Agreements are different, as Zenviron are also a party to the EPC Agreement; and
2. the purpose of the Agreements differ⁴.

Her Honour held, ultimately, that the O&M Agreement provided for an entitlement to issue an invoice contingent on the operation of another contract, and therefore is captured by section 13(2)(c).

Why is this important?

This case is important as it correctly implements the current case law regarding “pay when paid” clauses. This is despite clear drafting of contract terms indicating when payment is to accrue.

It further creates difficulty in complex contractual arrangements, where referencing to other contracts may be considered a contingency or dependency, and therefore captured by section 13(2)(c).

HWL Ebsworth Lawyers has expertise in drafting and reviewing construction contracts to protect important business considerations. Please contact Leighton Moon of our Construction and Infrastructure team to discuss any aspects of the above.

This article was written by Leighton Moon, Partner, and Chris Kipouridis, Solicitor.

¹Maxcon Constructions Pty Ltd v Vadasz (2018) 264 CLR 46
²[81].
³Maxcon Constructions Pty Ltd v Vadasz (2018) 264 CLR 46
⁴[87]-[89].