It is common practice in the construction industry for retentions to be held under construction contracts to ensure that, if there are defective works, the principal or head contractor can recover the cost of fixing the defects from the contractor or subcontractor.
The Construction Contracts Amendment Act 2015 introduces subpart 2A into the Construction Contracts Act 2002. Subpart 2A applies to all commercial construction contracts where the retention money is above a ‘de minimis’ amount. There is currently no guidance indicating what the de minimis amount will be, although we anticipate it will be less than $100,000 in order to protect smaller sub-trades. Subpart 2A creates a ‘deemed trust’ regime for retentions: a party that holds retention money (party A) must hold it ‘on trust’ for the benefit of the intended payee (party B).
The new retentions regime will come into force on 31 March 2017. MBIE had previously indicated that any retention held on this date must comply with the new regime. However, a bill currently before Parliament clarifies that the new retentions regime only applies to construction contracts entered into or renewed for a further term on or after 31 March 2017.
The new regime
Subpart 2A provides: “All retention money must be held on trust by party A, as trustee, for the benefit of party B.”
The retention money must be held in the form of cash or “other liquid assets that are readily converted into cash”. The meaning of ‘liquid assets’ is yet to be clarified. We predict that it will include accounts receivables but exclude upstream retentions (i.e. a head contractor cannot set off retentions that it owes against retentions that it is owed).
While the new regime does not require retention money to be held in a separate bank account from other funds, our view is that it is best practice to do so. The risk of holding retention funds in the same account as other funds is that party A may inadvertently use the retention funds in breach of its trustee obligations. That would amount to a breach of the Trustee Act 1956 and trustees (or trustees’ directors) could be found personally liable.
A separate retention account also makes it easier for party A to comply with the accounting requirements under Subpart 2A. Party A must keep accounting records of the retentions, and the records must be auditable and available to party B free of charge. It is unclear at this point how the auditability requirement will play out in practice.
Although retentions can legally be commingled with other funds, the new regime prevents party A from using retentions for anything other than remedying defects in the performance of the party B’s obligations under the contract. Retentions can be invested, and party A can keep the interest, but it is liable to make good any loss if the investment is unsuccessful.
If party A pays the retention to party B later than the date on which party B fulfils its contractual obligations, then party A is obligated to pay penalty interest. The interest rate will either be set by the contract or by regulations.
The trust over retention money only ends when it is paid out, when party B agrees to give up its claim in writing, or when the money ceases to be payable to party B at law. Up until then, party A must hold the retentions on trust for the benefit of party B.
Awaiting guidance
Parliament has not offered a great deal of guidance on the new regime. The industry would particularly benefit from guidance on the concepts of ‘liquid assets’ and auditable accounting records. Until these are clarified, retention holders should act cautiously in order to avoid incurring liability.
How can we help?
Parties that hold retentions under construction contracts may need to update their practices to comply with the new regime. We suggest that such parties consider keeping retention money in a separate bank account in order to ensure compliance. Parties to which retentions are payable should be looking to benefit from the new regime by utilising its accounting and enforcement provisions.
Get in touch with one of the team at Lane Neave if you require any advice in relation to the new retentions regime.
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