New rules on use of retention funds may miss the mark

Tuesday 3 November 2015

Authors: Tom Bennett and Brendan Cash

​New legislation has been passed that will place fresh obligations on developers and contractors over their use of retention amounts held by them under construction contracts. However, an initial review of the changes suggests the amendments may introduce red tape without providing substantially greater protection for subcontractors in the event of a developer or contractor becoming insolvent.

The amendments may even expose directors, officers, subsidiary companies and possibly other third parties (such as banks) to new claims as recipients of retention amounts.

Retention amounts are typically used as working capital at present, but the collapse of Mainzeal in 2013 highlighted the risks of this practice. Subcontractors lost around NZ$18 million of retention money classified as unsecured debt in Mainzeal’s liquidation.

One of the key aims of the Construction Contracts Amendment Act 2015 (the Act), which was passed by Parliament on 20 October 2015, is to provide more certainty surrounding retention money. These are amounts retained from the contract price by the developer or contractor (in the case of subcontractors) as security for performance.

Key changes

As at 31 March 2017, retention money over a certain amount held under a construction contract will be subject to a trust obligation, imposing on the holder of the retention money (the developer or the contractor) an equitable fiduciary duty. There is no requirement for the retention money to be held in a separate trust account as the trustee is deemed to hold the retention money on trust in its bank account. While this allows flexibility and low compliance costs, subcontractors will still face hurdles in obtaining retention money in the event of trustee insolvency.

The Act requires the trustee to keep proper accounts which correctly record all dealings and transactions in relation to the money. To ensure transparency, these records must be available for inspection to parties owed the money or auditors at reasonable times and without charge. The Act allows for regulations to be introduced prescribing the required methods of accounting.

The retention money may be invested by the trustee in accordance with the Trustee Act 1956 and any interest or increase in investment may be kept by the trustee. If, however, upon the realisation of the investment, there is a loss in the investment, the trustee must cover the loss.

Parties to a construction contract cannot contract out of these new provisions in the Act, or include provisions to delay payment of retention money. Nor can they include conditional payment provisions for retention money. However, the Act will only apply where the amount of retention money is more than the minimum amount (to be prescribed by regulations which are yet to be issued).

Other amendments

The Act has removed the distinction between residential and commercial construction contracts (a change coming into force on 1 December 2015) and expanded the definition of ‘construction work’ to include design, engineering and quantity surveying work (coming into force on 1 September 2016). These changes will allow parties to these types of contracts to benefit from the default payment provisions and the adjudication process under the Act. Charging orders against owners who are residential occupiers of the construction site are, however, exempt from this change.

The Act has also made some changes to the adjudication process and the enforceability of determinations. From 1 December 2015, in addition to their current binding powers surrounding payment disputes, adjudicators will have the ability to issue binding determinations on the rights and obligations of the parties. At present, such determinations are not binding.

Under the new rules, parties to commercial construction contracts will have to issue notices of adjudication in the prescribed form, a statement of the respondent’s rights and obligations in the adjudication and a brief explanation of the adjudication process. This requirement previously only applied to residential construction contracts.

The procedural changes to the adjudication process include:

  1. a minimum period of five working days between the service of the notice of adjudication and selection of adjudicator;

  2. a minimum of five working days (unless otherwise agreed between the parties) for a respondent to serve a written response to the adjudication claim. The adjudicator may extend this time frame if they deem it necessary due to the size or complexity of the claim; and

  3. claimants having the right to serve a written reply and the adjudicator having the ability to allow the respondent a further right of reply.

Implications

While the new trust regime allows flexibility and low compliance costs, subcontractors will still face hurdles in obtaining their retention money in the event of trustee insolvency. This is because there is no requirement for the trust money to be held separately from non-trust money. Typically, in the case of co-mingled funds, it is difficult for a beneficiary to trace their money if a trustee becomes insolvent. The Act offers no guidance as to how this may work in practice.

The Act does not clarify how these trust obligations will interact with the rights of secured creditors and the registration regime under the Personal Property Securities Act 1999 (PPSA) and how competing claims are to be dealt in light of such rights and the PPSA.

The Act also offers no sanctions should a developer or contractor (or the directors and officers of a developer or contractor) fail to comply with it.

Instead of protecting the interests of subcontractors, the amendments appear to offer little real assistance to subcontractors in the event of a contractor’s insolvency. In addition, the Act may have unintentionally opened up recourse to directors, officers, subsidiary companies and possibly other third parties (such as banks) given that recipients of funds in breach of trust or accessories to such breaches can in some circumstances be held liable. However, such claims would be protracted and, unless the sums involved are large, be too costly for most subcontractors to pursue. All the amendments may have really achieved is introducing more red tape to the building industry.


Disclaimer

This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

For more information
  • Tom Bennett

    Partner Auckland
  • David Chisnall

    Partner Wellington
  • Simon Ladd

    Partner Auckland
Related areas of expertise
  • Construction
  • Infrastructure and projects
  • Restructuring and insolvency
  • Property and real estate