What you need to know about the proposed draft changes to the Construction Contracts retention regime

4 June 2021

On 1 June 2021, the Construction Contracts (Retention Money) Amendment Bill was introduced into Parliament for consideration.  The Bill is intended to address some of the shortcomings of the retention money regime in the Construction Contracts Act 2002 (Act), which came into effect on 31 March 2017.

The regime was intended to ensure that a party in the construction sector (payer) withholding money (retention) payable to another party (payee) did not use that retention as working capital (thereby unduly transferring the payer's business risks to the payee) but rather to hold it on trust for the payee.

However, after it came into effect, several gaps in the regime were identified and highlighted by the High Court in Bennett & Ors v Ebert Construction Limited (in receivership and liquidation) [2018] NZHC 2934:

  • The wording in the Act did not deem retentions to be held on trust. Instead, it required parties to hold retentions on trust
  • If the payer did not comply with the requirement to hold retentions on trust, the retention money would get co-mingled with payer money or used as capital.  The retention would not be easily identifiable if a payer goes into liquidation and the payees would not benefit from the intended security provided by trust law, as certainty of subject matter, an essential element of trust, could not be made out.  The retention money is swept into the pool of the payer's assets made available to the body of unsecured creditors on liquidation
  • Despite this risk to payees, there was insufficient penalties and offences to deter payers from not complying with the trust requirement.

As part of the Construction Sector Transformation Plan, the Ministry of Business, Innovation and Employment (MBIE) has proposed changes to the retention regime in the Act to remedy some of its perceived shortcomings.

When withheld money become retentions and held on trust

Money withheld by a payer, as security, becomes retention money, and the trust is created, when the payer pays the balance of amounts payable to the payee or, when the payer is entitled to withhold the retention, on the due date for paying the full amount. 

It does not matter whether the payer has:

  • Set the retention aside from other money or as security
  • Calculated the retainable amount (if it is capable of being calculated)
  • Prepared, or given to the payee, a payment schedule or other record of the retention
  • Paid any part of the full amount to the payee.

The Bill clarifies that the retention is trust property whether or not the payer complies with the retention regime in the Act.  All of the rules of the common law and equity relating to trusts apply to the trust, the payer as trustee, and the retention as trust property.  If the payer holds retentions for more than one payee, the retention money held for each of them is the subject of a separate trust.

Payer must hold retentions in a separate bank account 

A payer must hold retentions in a (separate) bank account used solely to hold retention money.  This could be retention money for more than one payee however the bank account cannot be used for any other purpose. 

The bank account name must include the words “retention money trust account” and if the account is set up to hold retentions for:

  • One payee under one or more construction contracts, the account name must include the payee’s name
  • Two or more payees, the account must identify the construction contracts or indicate that it is for all contracts under which the payer holds retention money.

The payer must also ensure that:

  • The bank is informed that the account is a trust account for retentions under the Act
  • As far as is practicable, the account is identified in the bank’s records as an account of that sort.

The payer's right to hold a financial instrument (eg an insurance policy or bank guarantee or bond) that covers the retention instead of putting the retention into a bank account remains. 

Payer's record keeping obligations

The payer must keep proper accounting records of all retentions held.  These records must be kept in a way that enables the preparation of financial statements that comply with generally accepted accounting practice. 

In respect of retentions in a bank account, the payer must:

  • Keep separate ledger accounts for each payee and for each construction contract - identifying the payee and construction contract to which the ledger relates
  • Show each payment into or out of the account and which payee and contract each payment relates to.

For complying financial instruments, the information that the payer must keep has remained largely the same whereby the payer must keep a copy of each instrument and for each instrument:

  • Record each payee's (can be more than one) interest, including the retention amount and the total amount if more than one payee is interested in the instrument
  • Record if the payer's liability under the instrument is limited, and the nature of that limitation
  • Keep evidence that the premium for the instrument has been paid to the issuer
  • Record any failure to comply with the terms and conditions of the instrument.

Payer's reporting obligations

Currently, under the Act, there are no express obligations for payers to report to payees the details and status of the retention money held.

In addition to the existing obligation to make the accounting and other records available for inspection by payees at all reasonable times without charge, the Bill requires the payer to give the payee information about the retention as soon as practicable after the retention is withheld (which could be in a payment schedule) and then at least every three months.

The information that the payer must give is:

  • The most recent amount withheld, the construction contract under which it is retained, and the date of its retention
  • The total amount of retention held by the payer for the payee under each construction contract
  • The following account details for the bank account in which the retention is held:
    • the name of the bank and the branch at which the account is held
    • the name of the account
    • if the account has separate ledgers, the name of the ledger relating to the payee
    • the balance in the account that is held for the payee
  • The following information for each complying instrument held for the benefit of the payee:
    • the name of the issuer
    • sufficient information to identify the instrument (eg a policy number)
    • the retention amount
  • A statement that the payee can inspect the accounts and records that the payer keeps under the Act.

Effect of receivership or liquidation of payer on retentions

As mentioned above, the payer is the trustee of the retention money trust.  However, if a receiver or liquidator is appointed to the payer, they will become the trustee of the retention money trust. 

The receiver or liquidator must:

  • Collect, manage, and disburse the retention in the same way as the payer is required to do by the Act
  • Give the payee:
    • notice of their appointment within 10 working days
    • all information they would give to creditors in their capacity as receiver or liquidator.

They will:

  • Have all their powers in the act under which they are appointed (Receiverships Act 1993 or the Companies Act 1993) to carry out their obligations
  • Be entitled to have their reasonable costs met from the retention
  • Not be liable for any unlawful or improper action taken by the payer in their capacity as trustee of the retention money trust before the receiver or liquidator was appointed.

The High Court can, on application of a payee, receiver or liquidator, remove or replace the receiver or liquidator as trustee of the retention trust if it considers it appropriate to do so or if the receiver or liquidator apply to the court to appoint a replacement if they are not willing or able to continue as trustee.

Offences and penalties

The Bill introduces new offences and penalties.

It is an offence if a payer fails to hold a retention on trust in a separate bank account or a complying financial instrument.  This offence has a maximum fine of $200,000.  If the payer is a body corporate, each of its directors also commits the offence and will be liable for a maximum fine of $50,000. 

The definition of director is quite wide and includes a person:

  • Occupying the position of director even if not called a director
  • Who has powers similar to those of the payer's board
  • Who has been directly delegated by the payer's board powers or duties with that person's consent or acquiescence, or exercises those powers or duties with the payer's board's consent or acquiescence
  • Who directs or instructs the above persons (including the payer's board) and they are required or accustomed to act in accordance with those directions or instructions.

A receiver or liquidator of a payer will not be considered to be a director.

The payer has a defence to this offence if:

  • The payer took all reasonable steps to ensure that the payer complied with the requirement
  • If the defendant is a director, that they took all reasonable steps to ensure the payer complied with the requirement.

It is also an offence if the payer fails to comply with the record keeping or reporting requirements.  Each offence has a maximum fine of $50,000. 

Transition – what contracts will the Bill apply to?

The Bill will come into effect six months after it receives royal assent.  Parliament's first reading of the Bill is expected to occur within the sitting week beginning on 8 June 2021.  Hopefully, it will progress relatively quickly through the parliamentary process. 

The Bill's requirements will apply to those commercial construction contracts that:

  • Are entered into after the Bill comes into effect
  • Were entered into before the Bill commenced but were amended afterwards.

The Bill will not apply to construction contracts that were entered into before the Bill came into effect.

However, the provisions relating to receivership or liquidation apply to a receivership or liquidation that commences after the Bill comes into effect regardless of when the construction contract was entered into or when the retention money was withheld.

A big step in the right direction

While the Bill clearly increases the administrative burden on payers holding retentions, this inconvenience is well outweighed by:

  • The better protection afforded to retentions through automatically being deemed to be held on trust even if the payer has failed to comply with its obligations
  • The increase in information flow to payees which will give payees more certainty and confidence that their retentions are secure.

If you have any questions about how the Bill in its current form may impact you, do get in touch.  You can review the Bill in its entirety here.