Yes it can, according to the NSW Court of Appeal. If a contractor assigns an invoice to a debt factor, the contractor may lose its rights under the security of payment legislation in relation to that invoice.
Background - what is debt factoring?
Debt factoring is a form of financing. It allows a contractor to access immediate cash by selling its ‘book debts’ to a third party 'factor', usually a finance company, bank or financial institution.
Once an invoice has been assigned to the debt factor, it will advance money to the contractor. This allows the contractor to receive cash for the invoice before it is paid by the contractor's client. As part of the arrangement, the contractor is usually required to direct its client to pay the invoice direct to the factor.
Debt factoring is relatively common in the construction industry.
How does debt factoring tie in with security of payment?
Under the security of payment legislation, contractors are given statutory rights to receive regular progress payments for works they perform. The legislation entitles contractors to make 'payment claims' to recover their entitlements. In many cases, an invoice issued by a contractor will also operate as a payment claim under the security of payment legislation.
The question then arises - if the contractor has sold the rights attaching to an invoice to a debt factor, and if the contractor's client does not pay that claim in full, can the contractor still make a claim on that invoice under the security of payment legislation?
A recent decision by the NSW Court of Appeal suggests that, in many cases, the answer to this question will be 'no'.
Quickway Constructions v Electrical Energy Pty Ltd
In this case, Electrical Energy (the contractor) issued two invoices to its principal, Quickway Constructions. However the contractor had agreed to assign the invoices to a debt factor. Each invoice contained the followinng statement:
This invoice has been assigned to Scottish Pacific (BFS) Pty Ltd. All payments must be made payable and sent to Scottish Pacific (BFS) Pty Ltd. Locked Bag 2706, Strawberry Hills NSW 2012.
When the principal refused to pay the invoice, the contractor sought to recover payment under the security of payment legislation.
The contractor was initially successful in obtaining adjudication determinations against the principal. The principal then commenced proceedings in the NSW Supreme Court to have the determinations set aside.
Although the contractor was successful at first instance, the principal successfully applied to have the determinations set aside in the Court of Appeal. (Interestingly, the court was divided 2:1. One of the judges agreed with the trial judge and considered that the appeal should have been dismissed.)
Why did the court come to this decision?
Central to the majority's decision was section 13 of the Act, which only allows payment claims to be made by 'a person who is or who claims to be entitled to a progress payment'.
The problem for the contractor was that, according to the majority, the wording on the face of the invoice meant that the contractor could no longer be a person who 'claimed to be entitled to a progress payment'.
The majority said that the 'very document contended to be a payment claim asserted, correctly, that [the contractor] was no longer a creditor'. Its analysis turned on the fact that 'the document asserted to be a payment claim itself denied that any money was owed to [the contractor]'.
The majority was at pains to emphasise that its decision was based on the form of the claim before it, and particularly the annotation giving effect to the factoring arrangement.
Consequently, if you are considering a similar situation, careful attention will need to be paid to the terms of the factoring arrangement and the wording of the invoice itself.
It may well be that if the underlying rights attaching to the invoice have been assigned, and if the invoice effectively requires the recipient to pay a third party debt factor, the person issuing the invoice will no longer have any rights under the security of payment legislation in respect of that invoice. Not only will this include a right to make an adjudication application, but it would also include the right to suspend work if that invoice is unpaid.