The purpose of the retentions trust regime is to protect retention funds in a Mainzeal type insolvency event – trust funds receive special status in a receivership, liquidation or bankruptcy
Brand-new retentions trust regime and its alternative – are you ready? – By Sam Thyne and Jin Guo
Since the passing of the Construction Contracts Amendment Act 2015 (CCAA), the construction industry has waited with baited breath for the retentions trust regime.
The wait is finally over with 31 March come and gone, and the CCAA taking its final form after some eleventh-hour amendments. This article outlines the retentions trust regime and the most recent changes.
By far the most controversial change under the CCAA requires that all retention money withheld by a party (Party A, usually a principal or head contractor) from another (Party B, usually a contractor or subcontractor) is deemed to be held on trust. This applies to all commercial construction contracts where the retentions are above a minimum amount.
While it is open for future regulations to set what that minimum amount is, the Ministry of Business, Innovation and Employment (MBIE) has announced it will not be issuing any regulations at present. We recommend you assume the regime will apply regardless of the amount of retentions withheld.
The purpose of the retentions trust regime is to protect retention funds in a Mainzeal type insolvency event. Trust funds receive special status in a receivership, liquidation or bankruptcy as they are not the property of the party holding them. This means in Party A’s insolvency, Party B will have a claim to the retention funds above other creditors, including the IRD and banks.
Managing the funds
The CCAA specifies how Party A can hold and use the retained sums. The funds must be held as cash, or another liquid asset readily convertible into cash. Party A can invest the retentions money held, so long as they uphold their obligations under the Trustee Act 1956 (and the investment remains readily convertible into cash). Party A will be entitled to keep any benefit of this investment, but must make up for any shortfall.
Party A will also be allowed to co-mingle the retention monies in their current accounts – in other words, with Party A’s working capital. While this is an attempt from the legislators to reduce compliance costs, from a trust management perspective it is not the best practice and erodes away the protections offered by a trust.
The CCAA also prescribes record-keeping requirements for the retention funds. These requirements mirror those contained in the Companies Act and will be familiar to accountants. The CCAA provides that Party B may request a copy of the records pertaining to the trust funds they are the beneficiary of. This is a useful tool for Party B to use to ensure Party A is upholding their obligations.
Party A may only use the retention funds to remedy defects in the performance of Party B’s obligations under the contract, and they must be repaid once Party B has performed all its obligations under the contract to the agreed standard. A contract clause that delays this repayment, or makes it conditional, will be void.
After years of anxious anticipation within the industry, the NZ government finally released an amendment contained within the Regulatory Systems (Commercial Matters) Amendment Bill. The amendment clarified an ambiguity in the CCAA by confirming that the retentions regime would apply to only contracts entered into or renewed after 31 March 2017 (rather than all existing contracts as it initially appeared). Also, on 3 March 2017, less than a month before the regime was to come into force, an alternative to the regime was offered.
The alternative allows Party As to sidestep the retention trust requirements if they take out a ‘complying instrument’. If Party A takes out an instrument that is issued by a licensed insurer, registered bank, or any other person/entity prescribed by regulations; issued in favour of Party B or endorsed with Party B’s interest; and is a means of securing for Party B repayment of retentions should Party A fail to do so; then Party A is not required to hold Party B’s funds on trust. However, the retentions trust regime is still the default position.
The instrument can take any form, provided it complies with the above – the examples given are insurance, bonds and guarantees.
If a party opts to use a complying instrument, there are additional obligations to uphold, bringing into question the alternative regime’s viability in practice.
Party A is responsible for paying all fees associated with setting up and maintaining the instrument, in addition to keeping proper accounting records. The records must note:
- • Party B’s interest and the amount of retention money protected by the instrument
- • Any limitation of the issuer’s liability under the instrument
- • Evidence that the cost of setup or maintenance of the instrument has been paid by Party A
- • Any failure to comply with the terms and conditions of the instrument.
If the instrument fails, then the default position applies and the retentions money is again required to be held on trust. This may result in a situation where a party opts for the alternative regime and stops holding retention funds on trust, only to find the instrument is ineffective and they are suddenly in breach of trust.
New issuesAs you can see, many issues with the retentions trust regime have already been identified. Undoubtedly, within the next few months, as new contracts are entered into, new issues will arise. We will watch the developments closely and report on how the industry addresses them.
Sam Thyne and Jin Guo are solicitors in Kensington Swan’s construction and infrastructure team; Kensington Swan regularly provides comment on the construction industry on its blog site – check out kensingtonswan.com