Changes to retention payments

 

Last October Parliament  passed legislation giving better protection to building subcontractors (subbies) by tightening up on retention money held by lead contractors and developers.

The changes are included in the Construction Contracts Amendment Act 2015 which passed through Parliament late last year. The Construction Contracts Act regulates payment provisions in construction contracts, provides an adjudication framework for people with disputes under construction contracts, and provides remedies for recovering non-payment under construction contracts.

There are three key dates to keep in mind.

  1. From 1 December 2015 residential and commercial construction are treated the same under the Act. This gives parties to residential contracts full access to the Act’s dispute resolution and payment regimes.
  2. From 1 September 2016 design, engineering and quantity surveying work will be included under the Act.
  3. From 31 March 2017 retentions withheld under commercial construction contracts must be held on statutory trust.

It’s the third of these changes that is particularly significant. Just to recap, it has been a practice in the building trades for the main contractor or developer to retain part of a contract price (often 5% to 10%) in case there are any faults in the sub contractor’s work which need to be remedied at the end of the job.

The problem is that should the main contractor or developer go broke, the subbies end up as unsecured creditors and at the back of the queue when it comes to getting their retention money. The collapse of  Mainzeal construction left subbies $18 million out of pocket and created a domino effect. That’s patently unfair and it will change from 31 March 2017.

It is also pretty obvious that some developers have been using retention money as interest free finance to fund speculative developments in the hope that presales will meet those obligations. That too will not be possible after 31 March 2017.

From that date, retained retention money will be treated as being held in trust and cannot be used for any purpose other than to remedy a payee’s breach of their obligations under the contract.

The unusual aspect of the new law is how the trust is to be managed. Unlike most trusts, which have an independent trustee (usually a lawyer or accountant), the payer will become a trustee and the retained funds do not need to be ring-fenced into a separate bank account. The only requirement appears to be that the funds are properly accounted for and not used for another purpose.

It seems the Government decided against requiring the money to be held in a separate bank account or an independent trust account because of the costs involved. While I see the merit in not involving lawyers, not requiring funds to be held in a separate bank account makes less sense, given the ease at which bank accounts may be opened and the clarity and simplicity it would add to the accounting and reporting of retention fund transactions. The new regulations will require those records to be made available for inspection without charge.

The advantage of classifying retention money as trust funds is that should the party holding the retention money become insolvent, the retained funds are protected and not available to the receiver or to other creditors.

Some of the other important points are:

  • Penalty interest (at a rate to be prescribed in regulation) will apply to late repayment of retention money, unless otherwise agreed under the contract.
  • Retention money can be invested in accordance with the Trustee Act. If they make a  loss on those investments then the party holding the retention must cover the loss. Conversely, they keep any profits.
  • Repayment of retention money cannot be made conditional on anything other than the performance of the other party’s obligations under the contract.
  • The new regime will only apply to contracts where the amount retained is more than a prescribed minimum. This amount is to be prescribed by regulation.

All in all the new regulations will go some way to tidying up an area that has been badly abused. It is not a perfect solution for subbies because the money will not be held by an independent trustee, but it will give them a higher place in the pecking order when it comes to picking over the bones of a company that has gone belly up.

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