Building contract deposits

The ABIC SW H Contract is frequently administered by architects for residential projects and anecdotal evidence suggests there has been an increase in the requirement for the owner to provide a deposit when completing the ABIC SW H Contract.

Deposits have been a longstanding feature in Master Builders Australia (MBA) and Housing Industry Association (HIA) contracts, where, typically, the deposit is effectively applied to progress claims by the contractor as the contractor progressively completes the works. However, the treatment of the deposit is different under the drafting of the ABIC SW H Contract whereby under clause N17 the deposit is not applied until after the works achieve practical completion. This position may be adjusted by the amendments discussed under Alternative management of a building contract deposit.

In 2018 amendments were made to the ABIC SW H Contract that introduced a mechanism allowing the owner to pay a deposit to the contractor subject to mutual agreement of the owner and contractor (See ABIC SW H Contract information – Schedule 1 Item 31 'Deposit provided by owner’). The deposit must comply with any applicable legislation including as set out in any checklist included in the ABIC SW H Contract. For example, in Victoria the deposit cannot exceed the maximum percentage in the Domestic Building Contracts Act 1995 (Vic) being 10% of the contract price if the contract price is less than $20,000, or 10% if the contract price is $20,000 or more.

If the ABIC SW H Contract requires a deposit then the architect must assess, ie apply, the deposit only after the time the contractor submits the claim immediately after practical completion (clause N17.1). Operating in parallel and separate to this, if the ABIC SW H Contract requires the contractor to provide security (typically set at 5% of the contract price), the security regime under clause C would apply.

The current ABIC SW H Contract does not set out a time for the deposit to be returned following practical completion and owners should be clearly informed about this risk as well as provided with the alternative options outlined at the end of this note.

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Payments for unfixed goods or materials

Recently, financial strains on projects have intensified due to rising costs for materials and labour, higher interest rates, delays in obtaining materials due to increased demand and many subcontractors requiring ‘up-front payments on order’. Consequently, contractors are keen to apply the money provided by a deposit prior to project commencement or before works are completed on site. It is becoming commonplace for suppliers to require partial (and in some cases fully make) payment for unfixed goods and materials before international items are shipped or fabricated. These are typically referred to as ‘payments for unfixed goods or materials’.

The phrase 'unfixed goods or materials' term is often used in other building contracts, which may stipulate that particular goods are identified and insured as the property of the owner until they are incorporated into the building works and that payment is to be made to the contractor before the materials or goods are fixed to the site. In some cases, the contractor is required to supply a bank guarantee to the value of such ‘goods’ and materials. This security would be released once the goods and materials have been fixed on site.

From a risk perspective, 'payments for unfixed goods or materials' are not in the interests of the owner as the owner is making payment before the works are completed on site and therefore exposed to the risk of the contractor not procuring or providing the goods or materials including where the contractor becomes insolvent.

If the owner agrees to pay for any material prior to delivery to site and/or incorporation into the works, notwithstanding that clause N3 does not permit such claims, the ABIC SW H Contract should be amended to provide that the contractor should provide evidence showing that the purchase has been made, and that it has insurance to cover any potential loss to the owner in the event that the goods fail to arrive, are damaged or are destroyed and provides separate security (for example, in the form of a bank guarantee) for any such payment.

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Application of a deposit and its management during the contract

As noted above, the architect must assess the deposit only after the time the contractor submits the claim immediately after practical completion (clause N17.1). There is a risk that the amount of the final claim at practical completion may be less than the deposit amount. In such instances, the contractor would be required to make payment to the owner, however it does not have any incentive to do so and the owner does not have any leverage.

Clause N16.2a states that the deposit should only be applied to the contractor’s 'cost of building work and to no other purpose'.

While it is reasonable for a contractor to request a deposit in the early stages of a project, retaining the full amount of the deposit until practical completion represents a risk to the owner that it may not be repaid in a timely fashion or at all. Further, since the deposit is often the same value as the security, this practice can negate or reduce the effectiveness of holding security.

Additionally, if a contractor is terminated due to poor performance or becomes insolvent, the likelihood of the owner recovering their deposit is low, particularly where the full deposit has been retained until practical completion.

Accordingly, owners should consider the alternative approaches outlined below.

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Alternative management of a building contract deposit

1. A deposit to the contractor is acceptable provided the deposit is released to the owner well before practical completion. The release can either occur progressively over a number of progress claims, or as a lump sum during the initial months of the construction, or at another specified time prior to practical completion agreed between the owner and contractor. If the owner and contractor agree to this approach, a 'special condition' will be required to be included in the ABIC SW H Contract. This is most suitable for contracts where there are monthly progress payments. However, this arrangement may be challenging to implement if the owner is reliant on bank financing.
2. A pro forma can be prepared to record the progressive release of the deposit with each progress payment made to the contractor. Typically, there will not be an actual cash payment back to the owner, but rather a credit to the owner against construction work completed by the contractor in subsequent progress claims.

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