In our previous update on the reforms, at which point the Amendment Bill was reported back from Select Committee, we noted that the amendments should bring greater clarity and certainty to the retentions regime, although we expressed some concern with the risk of liability for directors and the potential increase in compliance costs for companies. Since our last update, a number of further changes have been made. These changes give the chief executive of the Ministry of Business, Innovation and Employment (MBIE) the powers to administer and enforce the new regime and clarify aspects of how it will apply in certain scenarios. The changes have not, however, addressed the concerns we earlier identified.
The Amendment Bill
Commonly, construction contracts provide for an amount of money to be withheld by a party to the construction contract (the payer) from an amount payable to another party to the contract (the payee) as a security for the performance of the payee’s obligations under the contract. For example, a head contractor may retain money owing to a subcontractor as security for the performance of the subcontractor, and may apply that money to remedy any defect in the performance of the subcontractor’s obligations.
A statutory regime governing retention money was introduced into the Construction Contracts Act 2002 (the CCA) in 2017 in the aftermath of Mainzeal’s failure. The regime was intended to protect payees from the (mis)use of retention money as working capital by payers, and in particular the risk of being left out of pocket in the event of the payer’s insolvency. However, there was a lack of detail in the CCA around key aspects of the regime, including requirements for compliance (and what this meant in practice) and consequences of non-compliance. The Amendment Bill was introduced with the intent of strengthening and providing clarity to the regime.
In our previous update, we outlined the key proposed changes to the regime. To recap, these include:
Retention money will be held on trust
- Retention money will now be held on trust directly by operation of the statute, once the Amendment Bill comes into force on 5 October 2023. A retention money trust will be formed when a construction contract allows a payer to withhold payment of an amount from a payee. However, a retainable amount will not become retention money if the payer chooses not to retain the amount and pays it to the payee, or if the retainable amount is less than a minimum amount to be specified in regulations.
- Retention money held for different payees will be subject to separate retention money trusts.
- The retention money must be held separate from the payer’s other money and assets. This includes either in an account with a registered bank in New Zealand used solely for that purpose or in the form of complying instruments (such as an insurance policy or a guarantee).
- If the money is held in a bank account, the bank must be informed that the account is for the purpose of holding retention money that the payer holds on trust under the CCA. This ensures the money is not subject to a banker’s lien or other set-off rights.
Use of retention money
- The payer cannot use the retention money for any purpose other than to remedy defects in the performance of the payee’s obligations under the contract. Otherwise, the payer must pay the retention money to the payee when required by the contract.
- If the payer proposes to use the retention money to remedy defects, it must give the payee 10 working days’ notice to allow the payee an opportunity to remedy the relevant defect in the performance of its obligations or to dispute the payer’s claim.
Liquidation or receivership
- If the payer goes into receivership or liquidation, the receiver or liquidator becomes trustee of the retention money. If it is a role that the receivers or liquidators do not wish to perform, they can apply to be excused by the court.
- As trustee, the receivers or liquidators are entitled to have their reasonable fees and costs in dealing with the retention money met from the retention money.
Record keeping and reporting
- The payer will be required to keep separate ledger records for each party it holds retention money for and, as noted below, it will be an offence if the payer fails to keep appropriate accounting and other records.
- The payer must give the payee information about the retention money held on trust when the retention money is first retained, then at least once every three months. This information includes the total amount held and the details for how it is held.
Of particular note, the Amendment Bill introduces a number of penalties for non-compliance, with each separable offence attracting a separate penalty.
If the payer does not hold retention money as required, the payer commits an offence and is liable for a fine up to NZ$200,000. If the payer is a body corporate, each of its directors also commits an offence and is liable for a fine up to NZ$50,000 each.
It is a defence to these charges if:
- A defendant (including a director) proves they took all reasonable steps to ensure that the payer complied with the relevant requirements.
- A defendant payer can prove that it acted in good faith and honestly believed it was permitted to use retention money in order to remedy defects in the performance of the payee’s obligations.
There are separate offences if a payer does not hold adequate records, or does not give the payee the required information about the retention money trust, or gives information that is false or misleading. If the payer commits one of these offences it is liable for a fine up to NZ$50,000. There is no separate liability for directors if the payer commits this offence.
Further changes to the Amendment Bill
The Amendment Bill has now worked its way through the Parliamentary process. In that process, at Committee of the Whole stage, the Minister introduced a number of smaller amendments by way of Supplementary Order Paper with the intention of further strengthening and clarifying the amendments. The further amendments included:
- Adding powers for MBIE to administer and enforce the regime: This includes the power to require the provision of any information by written notice; the ability to obtain a search warrant if there are reasonable grounds that an offence has been, is being, or will be committed; and offences for failing to comply with requests or hindering MBIE.
- Clarifying how the amendments apply to local authorities: Including by ensuring that members of local authorities are not caught in the definition of “director” and allowing payers that are council-controlled organisations to hold retention money in a bank account of the relevant local authority.
- Clarifying that the regime applies to the retention of funds in relation to a commercial construction contract even if the contract does not provide for such a retention.
- Various minor amendments: Including to clarify the references to receivers and account for different situations where retentions may be held.
As noted, the new regime comes into force from 5 October 2023, so parties have time to prepare to meet the new requirements. The new regime will apply to construction contracts entered into – or amended – after the Amendment Bill comes into force.
It remains to be seen whether the Amendment Bill will have the desired effect in clarifying and strengthening the current retentions regime. The Amendment Bill does clarify when a trust is formed and the steps required to protect retention money (such as holding the funds separate from other funds or assets).
However, there may be wider consequences and new areas for potential uncertainty. As we have previously noted:
- The new obligations and penalties may give rise to an increase in the number of principals requiring a bond from contractors in lieu of retentions which could put further pressure on contractor cashflow in a tightening market. This may, in turn, increase the use of insurance-backed bonds.
- The new regime introduces new criminal and regulatory risks, including for directors. While affirmative defences are available, directors will bear the onus of proof in establishing that they took all reasonable steps to ensure their organisation complied with its statutory duties.
The response by the industry, and the courts, will therefore be important factors in the success of the new regime.
For more information or if you have any questions about how to prepare for the introduction of the new regime, please get in touch with the contacts listed or your usual Bell Gully adviser.