By: David Dingwall
Published: 6/10/2014
The forecast for national building and construction is at an unprecedented level, and with a sustained rate of growth that has not been seen in the past 40 years. [1]

Despite the positive prognosis for New Zealand's construction industry, cashflow problems have proved terminal for many building firms in recent times. [2]

One of the factors affecting cashflow is retentions, which are sums withheld from payments owed to the head contractor (commonly 5-10% of the total contract price), and which are designed to guarantee quality of the head contractor's work, and to ensure that any defects are put right.

In most cases, the head contractor does not become eligible to receive all or part of the retained sum until the whole of the construction works are complete, or until the end of the defects liability period, which can be months or even years after completion. This amount often comprises the head contractor's entire profit margin.

Unsurprisingly, most head contractors adopt the same process for paying their subcontractors, who are generally not as informed about the viability of a certain project.

Background to the Problem

Until such point as the subcontractor receives the retained sums, those funds remain with the head contractor, placing them at significant risk if the head contractor becomes insolvent. To cite an extreme example, approximately $18 million of subcontractors' retention money was lost as a result of the Mainzeal collapse in February 2013. [3]

If the head contractor does not separate retentions from their general account (under current New Zealand law there is no requirement to do so), then those funds will become part of the pool of assets available to secured creditors if the head contractor goes into receivership or liquidation. Unfortunately, a subcontractor's interest in those funds will generally be unsecured and, as a result, the subcontractor may miss out entirely.

Exacerbating the problem, some head contractors use retentions to keep their own businesses afloat (perhaps while waiting for their own retained sums to be paid out), which can result in subcontractors not being paid the retentions immediately upon becoming eligible to receive it.

Identifying the Problem

In January 2013, the Independent Inquiry into Construction Industry Insolvency in NSW chaired by Mr Bruce Collins QC (the 'Collins Report'), found that retention moneys were regularly placed at risk, with subcontractors frequently not receiving retention moneys at the end of either the completion of the works or the defects liability period. The insolvency of the head contractor will in many circumstances also result in the loss of these subcontractor moneys contributing to financial stress on that company. [4]

In recognition of the existing model's potential effects on small businesses, the NSW government has committed to implementing legislative change to more effectively secure subcontractors' retentions held by head contractors.

The NSW Proposal

Of the possibilities put forward in the Collins' Report, the model preferred by the NSW Government involves the payment of retentions by the head contractor directly to an independent fund, as set out below.



 

In addition to preventing the mixing of retentions and general moneys by the head contractor, the above model confers the additional benefit of an independent dispute mediator.

It is anticipated that the NSW Government will adopt this model which will, by the end of 2015, be extended to cover residential work in addition to commercial work.

New Zealand's Response

The New Zealand Government has also recognised the need for legislative change in this area. However, proposed changes to New Zealand law lack the teeth of those proposed in NSW.

On 9 September 2014, Building and Construction Minister Dr Nick Smith announced that the Construction Contracts Amendment Bill would incorporate changes to better protect subcontractors for work done.

The proposed law change will:

1.            Require head contractors to hold retentions on trust for subcontractors;

2.            Impose penalties on head contractors who use retentions for purposes other than those relating to work done by the subcontractor;

3.            Provide for a default rate of interest to be charged for late payment of retentions; and

4.            Clarify that the prohibition on the 'pay-when-paid' practice, a hallmark of the Construction Contracts Act 2002, will also apply to retentions.

However, under these proposed changes, head contractors will not be required to transfer retentions into a separate account. As a result, retentions will:

1.            Remain available for the head contractor's use and misuse; 

2.            Be very difficult to identify and protect in the event of the head contractor's insolvency; and

3.            Place third parties dealing with head contractor funds (e.g. banks, accountants and lawyers) at risk of becoming embroiled and liable in disputes over the identity of funds they are holding for the head contractor.

The model favoured by the New Zealand Government was dismissed in NSW because it did not address the root of the problem, which is the underlying need to clearly identify and separate retentions.

In response, the Minister said that he had not opted for a model requiring retentions to be put into a separate bank account or lawyer's trust fund, "because the compliance cost is too high."

Time will tell whether the changes, if implemented, will provide improved certainty and stability in the construction sector.
 


[1] New Zealand Building and Construction Productivity Partnership, National Construction Pipeline (November 2013)
[2] B Ensor and C Meier Building Firms Go Bust Despite Rebuild The Press Online (3 May 2014).
[3] N Smith Subbies to get better protection for payment Beehive.govt.nz (9 September 2014)
[4] New South Wales Department of Finance & Services Consultation Paper: A Statutory Retention Trust Fund for the Building and Construction Industry (November 2013)

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