Can A Liquidator Claw Back Your Defect Settlement With A Failed Builder?
- John Merlo
- 23 hours ago
- 15 min read
KEY TAKEAWAYS
Offsetting defect claims against retention funds via a final settlement deed may not protect a developer if the builder subsequently enters liquidation.
Under section 588FE of the Corporations Act 2001 (Cth), a liquidator can challenge non-cash releases and set-off arrangements as voidable transactions where they amount to an unfair preference — and recent authority confirms that statutory set-off cannot be used to defend such a claim.
Property development directors risk personal liability for insolvent trading if their Special Purpose Vehicle (SPV) incurs debts while commercially insolvent.
Relying on the statutory safe harbour defence requires developer SPVs to maintain strict compliance with employee entitlements and tax reporting, which are often delayed during cash flow crises.
The builder’s project manager has stopped answering calls, subcontractors are threatening to walk off site due to unpaid invoices, and the list of defective work is growing daily. To stop the bleeding, you negotiate a clean break. You execute a final deed of release with the builder, agreeing to retain the $250,000 in trust account retention funds to cover the defects, effectively zeroing out the final account so you can hire a replacement contractor. You file the deed, assuming the legal risk is contained. Six weeks later, a demand letter arrives from the builder's newly appointed liquidator. They argue that your retention offset constitutes an unfair preference and demand the immediate transfer of the $250,000 into the liquidation pool.
The Distressed Builder Settlement Window And Voidable Transaction Risk
You’ve got a builder on the ropes, defects on site, and retention funds sitting in your trust account. The temptation is to execute a final deed of release where you keep the retention to offset the defects, sign off on the project, and walk away. The uncomfortable answer is that this may not be safe: a liquidator appointed after the fact can challenge the very deal you thought had closed the matter. This section explains why that settlement deed might not survive if the builder subsequently enters liquidation.
Put simply, the deed you sign with the builder is one thing; the power a liquidator has to tear it up afterwards is another thing entirely, and that power turns on a procedural mechanism called the relation-back period. There is a further reason offsetting feels safer than it is. In Metal Manufactures Pty Ltd v Morton [2023] FCAFC 4, the Full Federal Court confirmed that statutory set-off under section 553C of the Corporations Act is not available as a defence to a liquidator's unfair preference claim. In other words, the very mechanism a developer instinctively relies on — "we simply kept what we were owed and called it square" — cannot be used to resist the clawback once the builder is in liquidation. The developer is left to repay the amount into the pool and prove for its loss alongside the other unsecured creditors, which is precisely the outcome the offset was meant to avoid.
Separating Contractual Set-Off Rights From Statutory Voidable Transactions
A contractual right to set off defect costs against retention funds is a fundamentally different thing from a liquidator's statutory power to unwind that arrangement under the Corporations Act 2001 (Cth). Your signature on the deed settles matters between you and the builder; it does not touch the powers a liquidator acquires the moment they are appointed.
When a builder becomes insolvent mid-construction, the settlement deed operates as a binding contract that restrains the builder from pursuing further claims. However, the enforceability of this clause depends entirely on whether it can survive statutory insolvency mechanisms. A signed deed does not extinguish the statutory rights granted to a subsequently appointed liquidator.
In Queensland, documenting the offset in a settlement deed will not automatically protect you from a liquidator's voidable transaction claim under the Corporations Act. The liquidator's powers exist outside the contract, meaning a private agreement to sever ties cannot contractually override the statutory mandate to recover assets for the benefit of unsecured creditors.
Why The Six-Month Relation-Back Period Is Not An Automatic Clawback
Warning: Before assuming the funds are already lost, it is worth understanding a critical point of reassurance: a liquidator's demand can feel absolute, but a transaction made within the six-month relation-back period is not automatically voidable. Under section 588FE of the Corporations Act 2001 (Cth), if a company is being wound up, a transaction of the company may be voidable because of any one or more of the statutory subsections.
However, the liquidator must generally prove that the arrangement actually satisfies the legal elements of an unfair preference or an uncommercial transaction. The mere fact that the settlement occurred within the six months prior to liquidation may increase the likelihood of a challenge, but it does not dictate that the developer will lose the retention funds.
Assessing Defect Claims Against Unpaid Contract Balances
You must rigorously quantify your defect costs against the builder's final payment claim, with evidence, before you sign anything. Developers need to substantiate the exact quantum being withheld or set off before executing any settlement. A generic, unsubstantiated building defect claim lacks the evidentiary weight required to defend a final account assessment against future regulatory or liquidator scrutiny.
Developers document these offsets using independent valuation and expert defect reports. ASIC (Australian Securities and Investments Commission) regulates corporate insolvency and investigates director conduct following the collapse of building companies operating in Queensland, making robust, contemporaneous documentation of the defect offset essential to justifying the commercial rationale behind the withheld funds.
Navigating The Unfair Preference And Uncommercial Transaction Tests
You stepped in to solve a practical problem on site, averting a crisis and keeping the project moving, yet now a liquidator views your defect settlement as a prime target for a clawback. It feels profoundly unfair—you are simply recovering your own losses caused by their failure— but the law that governs these clawbacks does not factor in commercial frustration. If the builder goes into liquidation shortly after your settlement deed is signed, their liquidator will inevitably start hunting for assets to distribute to unsecured creditors. This section outlines the voidable transaction triggers a liquidator uses to challenge your non-cash release, and how you can document the arrangement to defend it.
The Statutory Thresholds For Unfair Preferences Under Section 588FE
An unfair preference occurs when a creditor receives a transaction that results in them getting more than they would have if the transaction were set aside and they simply proved their debt in the winding up. For a liquidator to successfully claw back the retention offset, they must establish that the settlement deed resulted in an unfair advantage and that it constituted an "insolvent transaction" entered into when the company could not pay its debts.
Under section 588FE of the Corporations Act, a liquidator can typically only void a transaction if it was an "insolvent transaction" — that is, either an unfair preference or an uncommercial transaction (these are alternatives, not cumulative requirements) — entered into while the company was insolvent. For the six-month relation-back route, the liquidator must establish that the arrangement was an unfair preference (or, alternatively, an uncommercial transaction) and that the builder was insolvent at the time it was entered into.
Because the statutory thresholds for challenging these transactions require careful legal analysis, developers facing liquidator demands should promptly seek commercial law advice.
Without proving that the developer received a disproportionate benefit compared to other unsecured creditors, the liquidator's claim lacks the necessary statutory foundation.
Proving Commercial Solvency At The Time Of Settlement
Example: A developer executes a settlement deed with a struggling mid-tier builder and relies on a recent cash balance sheet to argue the builder was solvent at the time, given the builder still had cash in the bank. However, if the liquidator challenges the transaction, courts may consider the broader "commercial reality" test rather than just strict cash balances. The court is likely to assess whether the builder had access to credit, could liquidate assets, and was paying its debts as and when they fell due. If the evidence shows the builder was chronically delaying subcontractor payments and extending credit terms on the developer's site, the builder can often be deemed commercially insolvent, which may satisfy the insolvency element of the liquidator's claim.
Practitioner Strategies For Securing Final Accounts Against Liquidators
Structuring a final account settlement merely as a "retention forfeiture" can often serve as evidence for an uncommercial transaction if a liquidator later reviews the file. The recitals are where these deeds are won or lost. A deed that simply says the developer "retains the retention to cover defects" gives a liquidator nothing to work against; a deed that recites the builder's outstanding payment claim, the developer's competing cross-claim for rectification, the independent quantum supporting each, and the agreed compromise figure tells a completely different story when it lands on a liquidator's desk eighteen months later. Build the contemporaneous file as though the liquidator is already reading over your shoulder, because in practice the file is usually pulled together in a rush after the builder has gone quiet, and that is precisely when the supporting evidence gets thin.
Where a Queensland Civil and Administrative Tribunal (QCAT) building dispute developer pathway was imminent, documenting the avoidance of that specific litigation cost — the counsel's fees, the expert's hourly rate, the realistic recovery prospects against a builder already shedding subcontractors — gives the deed a defensible commercial rationale rather than the appearance of a creditor quietly being preferred. A practical tactic worth noting: date and retain the defect reports and the builder's own correspondence acknowledging the defects, because a liquidator's first move is to argue the defects were exaggerated to justify the set-off, and a builder's contemporaneous admission is difficult for them to walk past.
Developer SPV Stress And Insolvent Trading Exposure
Even if you successfully defend the deed, the builder's collapse may already have put your own company in the firing line. It is not just the builder's solvency that threatens the project; builder collapse often causes critical delays and cost overruns that drag your own Special Purpose Vehicle (SPV) into severe financial distress. When project cash flow dries up and the intended corporate veil fails to hold, your personal exposure shifts rapidly from managing a corporate problem to defending yourself against potential insolvent trading liability. This section breaks down the specific triggers for personal liability, addressing the severe risk that holding company structures and intermingling SPV funds can present.
The Triggers For Director Liability Under Section 588G
The Corporations Act imposes strict prerequisites for a director to face personal liability for a company's debts. Under the Insolvent trading—director duty to prevent (s 588G), a person is a director of a company at the time when the company incurs a debt, the company is insolvent at that time, or becomes insolvent by incurring that debt. The duty requires the director to prevent the company from trading when it is commercially insolvent.
When a Queensland property developer's SPV incurs debts while commercially insolvent, the directors may face severe personal liability for insolvent trading under section 588G of the Corporations Act.
A liquidator alleging a breach must establish that the director allowed the debt to be incurred and that a reasonable person in the director’s position would have been aware of the company’s insolvency. Understanding these director duty requirements is critical for property developers before authorising new credit commitments during a cash flow crisis.
Intermingling SPV Funds And The "Corporate Veil" Illusion
Developers often set up separate SPVs for distinct phases of a project, relying on the corporate structure to quarantine risk. The problem is rarely the structure itself; it is what happens to the cash when one phase runs short. Directors funnel money from a profitable Stage 1 entity into a struggling Stage 2 entity to keep the subcontractors on site and the bank facility from defaulting, and they do it by way of a same-day bank transfer with nothing more than a notation in the accounting software. When the failing SPV collapses, the liquidator does not see a loan — they see an unexplained transfer out of a solvent company, and they will characterise it as either an uncommercial transaction or, if it landed with a creditor, an unfair preference, then pursue it back into the pool.
In practice, the transfers that survive scrutiny are the ones documented at the time with a loan agreement recording the amount, the interest rate, the repayment terms, and a security position. The transfers that get clawed back are the verbal "I'll move it back when the next settlement comes through" arrangements that never get papered. There is a further trap directors routinely miss: a director who authorises the transfer out of the healthy SPV can find themselves defending the receiving SPV's insolvent trading position as well, because the loan itself is a debt incurred by an entity that may already have been insolvent. Early construction law advice is frequently required to untangle these arrangements before a liquidator is appointed, because once the appointment is made, the transfers are frozen in whatever state the file left them.
Holding Company Exposure Under Section 588V
Section 588V of the Corporations Act exposes the ultimate holding company of a development group to liability if a subsidiary SPV trades while insolvent. Quarantining risk in a single subsidiary fails if the directors of the holding company knew, or should reasonably have suspected, that the subsidiary was insolvent when it incurred the debt. A liquidator can pursue the holding company to recover compensation for the subsidiary’s unsecured creditors.
In practice, the exposure under section 588V bites hardest where the holding company has guaranteed the subsidiary's construction facility or sat on the same board. In those circumstances, the liquidator can argue the parent's directors had direct line of sight into the subsidiary's cash position and chose to let it keep trading. The parent's balance sheet — its accumulated profits from earlier stages, its land bank, its retained development margin — becomes the recovery target precisely because it is the only solvent entity left standing in the group.
Where the holding company has been used as the central treasury, sweeping cash up from each SPV and redeploying it, that intermingling makes the section 588V argument considerably easier for a liquidator to run, since the parent can no longer credibly claim it was a passive shareholder unaware of the subsidiary's trading. What this means in practice is straightforward: if your parent entity has guaranteed the construction facility, shares directors with the SPV, or operates as the group's central treasury, you should treat it as exposed and have the group's cash-sweep arrangements reviewed before any SPV is allowed to fail.
Establishing Defences And The Safe Harbour Trap
When a liquidator threatens an insolvent trading claim, your first instinct is to point to your genuine belief that the project would eventually turn a profit upon settlement. Under the Corporations Act, "hoping for the best" is not a legal defence. This section details the strictly defined statutory defences available—the procedural mechanisms that actually hold weight in court—and the fatal compliance traps hidden within the safe harbour regime.
The Strict Requirements For The "Reasonable Grounds" Defence
To defend an insolvent trading claim, a director must prove that their expectation of the company's solvency was based on objective financial analysis, not just commercial optimism. Under Section 588H, it is a defence if it is proved that, at the time when the debt was incurred, the person had reasonable grounds to expect, and did expect, that the company was solvent.
In McLellan, in the matter of The Stake Man Pty Ltd v Carroll [2009] FCA 1415, the Federal Court confirmed that the s 588H defence requires a director to have reasonable grounds for expecting that the company was solvent and would remain solvent. Notably, the director in that case failed to establish the s 588H defence — the Court found that his accountant was not a person "responsible" for providing solvency information in the sense required by s 588H(3), notwithstanding that the accountant had advised on solvency.
The director ultimately avoided liability only because the Court exercised its separate discretion under s 1317S to excuse him on the basis that he had acted honestly and had acted promptly on expert advice. The case is therefore a cautionary illustration: informal reliance on a company accountant will not, of itself, satisfy s 588H, and developers should not assume that taking advice is the same as having a defence.
For developers, simply anticipating future revenue from off-the-plan settlements is insufficient if a development finance default is a live risk and current trade creditors cannot be paid.
Why The Section 588GA Safe Harbour Fails Mid-Tier Developers
The safe harbour framework is designed to protect directors who are actively pursuing a genuine turnaround strategy rather than placing the company into immediate voluntary administration. Under the Safe harbour (s 588GA) provisions, subsection 588G(2) does not apply if the person starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company. The Review of the Insolvent Trading Safe Harbour confirmed that this protection encourages restructuring.
However, relying on this defence carries a severe procedural trap for developers. The protection is strictly conditional on the company meeting all of its employee entitlement obligations and tax reporting requirements (such as lodging BAS and PAYG returns). During a cash flow crisis, these are frequently the first payments a mid-tier developer delays to keep a site open.
Failing to maintain this compliance can strip away the safe harbour protection, leaving the director exposed to court proceedings without the statutory shield. The provision is not entirely unforgiving — section 588GA(4) is enlivened where the failure amounts to less than substantial compliance, or where there are two or more failures in the preceding twelve months, and the Court retains a limited power under section 588GA(6) to excuse a failure in exceptional circumstances or in the interests of justice. In practice, however, a developer who has let multiple BAS or PAYG lodgements slip to keep a site open should assume the protection is gone rather than rely on the dispensation.
To rely on the safe harbour defence under section 588GA of the Corporations Act, developers must ensure all employee entitlements and tax reporting obligations remain strictly up to date.
Immediate Steps When SPV Solvency Is Threatened
When project delays and builder issues threaten the solvency of your SPV, immediate procedural action is required to preserve your statutory defences and limit personal liability exposure.
Halt new commitments: Immediately cease authorising the SPV to incur any new debts, including variation approvals or new consultancy agreements, until a formal solvency assessment is conducted.
Document the assessment: Obtain an independent financial review of the SPV’s cash flow and access to credit, ensuring you have documented evidence to support a "reasonable grounds" defence under section 588H.
Verify tax compliance: Confirm that all employee entitlements, BAS lodgements, and PAYG reporting are current; failure to do so invalidates eligibility for the safe harbour defence.
Review inter-company loans: Identify and formally document any funds transferred between project SPVs to reduce the risk of these transfers being characterised as uncommercial transactions by a liquidator.
Consult ASIC guidance: Review the ASIC Regulatory Guide 217 (RG 217) Duty to prevent insolvent trading: Guide for directors to align your immediate actions with the regulator's baseline expectations for corporate governance during distress.
Conclusion
The scenario where a builder walks off the job, leaving behind defects and unpaid subcontractors, requires immediate commercial triage. However, as the statutory framework dictates, fixing the problem on site by offsetting retention funds via a final settlement deed does not neutralise the insolvency risks that follow. If that builder enters liquidation, a deed of release cannot extinguish the liquidator's statutory mandate to recover assets through voidable transaction claims.
Simultaneously, the financial contagion that builder collapse brings to your development SPV can rapidly escalate from a corporate cash flow issue into personal exposure for insolvent trading. Attempting to prop up a failing entity with undocumented inter-company loans or relying on a safe harbour defence while tax compliance slips will often fail when scrutinised by a liquidator.
Before signing any settlement deed that involves the forfeiture or offset of retention funds with a distressed builder, developers should obtain independent quantification of the defect claims and structure the agreement to demonstrate genuine commercial benefit, rather than an uncommercial transaction.
Timing matters more than most developers realise. Once a liquidator is appointed, the transfers, deeds and inter-company loans are frozen in whatever state your file left them, and advice taken at that point has far less room to work. Advice taken before the builder collapses, while the deed is still being drafted and the cash position can still be documented properly, is where the real protection lies.
If you are negotiating a final account with a builder showing signs of distress, facing a liquidator's demand over a settlement you thought was closed, or worried that your SPV or holding company may be exposed, the team at Merlo Law can help you structure the deal defensibly and protect your position before the window closes. Contact us to arrange a confidential discussion about your project and the steps available to you.
FAQs
What is the relation-back period for voidable transactions in Queensland?
The relation-back period is the statutory timeframe prior to a company’s liquidation—typically six months for unfair preferences—during which a liquidator can review and potentially challenge transactions. In Queensland, a transaction made within this period is not automatically voided; the liquidator must prove it satisfies the legal elements of an unfair preference or uncommercial transaction.
Can a liquidator unwind a signed defect settlement deed?
Yes, a liquidator can apply to unwind a signed settlement deed if it operates as an unfair preference or uncommercial transaction under section 588FE of the Corporations Act. The deed binds the builder contractually, but it does not extinguish the liquidator's statutory powers to recover assets if the company was insolvent at the time.
How does a liquidator prove a builder was commercially insolvent?
A liquidator assesses commercial insolvency by examining whether the builder could pay their debts as and when they fell due, rather than just relying on a cash balance sheet. Courts may consider the builder's access to credit, ability to liquidate assets, and their history of delaying payments to subcontractors when determining insolvency.
When are property development directors personally liable for SPV debts?
Under section 588G of the Corporations Act, property development directors may be held personally liable for insolvent trading if they allow their SPV to incur debts while it is commercially insolvent. A liquidator can pursue the directors if a reasonable person in their position would have been aware of the insolvency risk.
What is the "reasonable grounds" defence to insolvent trading?
The reasonable grounds defence under section 588H allows a director to defend an insolvent trading claim if they had a reasoned, objective expectation that the company was solvent when the debt was incurred. This requires the director to demonstrate reliance on adequate financial data, not merely optimism about future off-the-plan sales.
Why is the safe harbour defence risky for property developers?
The safe harbour defence under section 588GA is conditional on the company maintaining strict compliance with its employee entitlement and tax reporting obligations. For developers facing a cash flow crisis, repeatedly delaying BAS or PAYG payments to keep a site running can readily forfeit this statutory protection, and a director should not assume a court will excuse the lapse.
This guide is for informational purposes only and does not constitute legal advice. For advice tailored to your specific circumstances, please contact Merlo Law
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