The new retentions regime to be introduced by the Construction Contracts Amendment Act includes some key issues which will need to be resolved, either by regulations or by time and disputes
Changes to construction contracts regime – are you ready? – By Karen Kemp and Harriet Quinlan
If you are party to construction contracts that have retentions provisions, chances are you have heard about the new retentions regime to be introduced by the Construction Contracts Amendment Act 2015.
The changes will affect most commercial construction contracts and there is no contracting out of the regime. In this article we take a snapshot look at the changes and what this means for industry participants.
From 31 March this year, any party to a commercial construction contract withholding retention monies from another party will need to hold that money on trust for the other party, and will have fiduciary obligations in respect of those retentions. For ease of reference, we will refer to the person holding retentions as the ‘trustee’ and the person they are held for as the ‘beneficiary’.
The trustee will include principals and head contractors, subcontractors – if they have their own subcontractors – and perhaps residential property owners who do not live in the subject property.
The regime prevents the use of retentions for any reason other than performance of the beneficiary’s obligations. This ensures that retentions are separate from the general pool of assets, and in the event of insolvency the beneficiary’s retentions will be preserved for the beneficiary.
Parliament is currently in the process of clarifying that the regime will only apply to contracts entered into, or renewed, on or after 31 March 2017.
What does this mean in practice?
Holding on trust
Retentions cannot be used as working capital for future projects, or to pay off creditors with the intention that future funds will become available when retentions need to be released. Trustees can invest retentions, but have to comply with the duties of an investment trustee under the Trustee Act 1956.
Retentions must be held as cash or liquid assets readily convertible into cash, which will further limit options for investment. Interestingly, trustees do not need to hold retentions in a separate account and can commingle them with other funds.
There is an exception for retentions which are less than the ‘de minimis amount’. Regulations should clarify what this amount will be so trustees should watch this space.
There is debate and some concern about what counts as a ‘liquid asset’. Guidance to date from accounting firm BDO (who are advising MBIE) is that, based on accounting standards, if you are not holding retentions as cash, the asset must mature within three months and must be subject to no change or minimal change in value in order to qualify.
This probably excludes retentions receivable from higher up the chain, other accounts receivable where payment is not guaranteed and imminent, and loan facilities unless the funds are already drawn down.
The trustee must keep readily auditable accounting records that comply with generally accepted accounting principles, and make those accounting records available to the beneficiary at all reasonable times and without charge.
The trustee must release the retentions once the beneficiary has performed its obligations to the standard agreed under the contract.
This could be problematic. Take the contractor’s obligation to remedy defects that arise during the defects liability period: when has the contractor performed its obligations? Where there are defects, the obligations will be performed when the defects are remedied. However, if no defects arise during the defects liability period, the contractor performed its obligations at some point in the past and retentions should have been released then.
As the use and release of retentions is dependent on the contract, parties will need to ensure careful drafting so that their intentions are enforceable, and they do not breach the act.
Questions for trustees
As highlighted in this article, some key issues about this regime, like ‘liquid assets’ and accounting records, remain to be resolved, either by regulations or by time and disputes. We will be monitoring developments and will provide updates.
Some questions for trustees to consider will be:
- • Will you have sufficient cashflow to set aside retentions with each payment claim/schedule, or will you need to look at extra funding?
- • Can your accounting system record retentions in a way that can be disclosed to the beneficiary, or will you need to investigate other options?
Readers are reminded that the retentions regime is only one change in a list of reforms made to the Construction Contracts Act 2002 over the last year or so, including bringing design, engineering and quantity surveying work under the act, modifying the requirements for commercial payment claims, and altering the adjudication process and the enforceability of determinations.
If in any doubt about the above changes, or for practical advice on the new regime and your business, contact the authors.
Karen Kemp is a partner and Harriet Quinlan an associate within the litigation team of Anthony Harper, a leading New Zealand commercial law firm with offices in Auckland and Christchurch