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Changes to the construction retentions regime

By Jonathan Aquilina - March 2017

You may be aware of the new statutory regime for construction contract retentions which comes into force at the end of this month.  Essentially the new law imposes a trust regime around retention funds.  We highlight some key information on the law change below.

The Construction Contracts Amendment Act 2015 (“CCAA”) introduces amendments to the Construction Contracts Act 2002, with effect from 31 March 2017.  The retention money requirements only apply to commercial construction contracts entered into, or renewed, on or after 31 March 2017.

The new retentions regime applies to all retention funds held in relation to head contractors and sub-contractors (at this stage MBIE does not propose to set a de minimis threshold for the level of retention).  So a contractor will benefit from the protections of the new regime where it is a head contractor, but it will also be subject to the new regime in relation to how it deals with sub-contractor retentions.  It is not permitted to contract out of the new regime.

Central to the new retentions regime is the concept of a “trust” arrangement:

  • Retention money is to be held on trust by Party A (the principal, or contractor in a subcontracting arrangement) for the benefit of Party B (the contractor or subcontractor), and may only be held in the form of cash or other liquid assets that are readily converted into cash.
  • Retention money is not available for the payment of debts of Party A (other than Party B).  In the event of a retention holder’s insolvency, retention money will be protected.
  • Retention money does not need to be held in a separate trust account and may be commingled with other moneys (although establishing a separate trust account would be best practice).
  • A party holding retention funds must keep proper accounting records of all retention funds (we comment on this further below) and make those records available for inspection at reasonable times and without charge. 
  • Retention money may only be used to remedy default in the performance of Party B’s obligations under the contract.

The CCAA has rules around investment of retention money and accounting for interest.  Any investments must be subject to the Trustee Act 1956.  Any interest earned on invested retention money belongs to the retention holder, to offset the administration costs of the new regime.  Interest must be paid on late payments of retentions at the rate agreed under the contract.  If a rate has not been agreed, the default rate of interest specified in regulations will apply (currently the regulations have not been developed).

A retention holder must account for any difference between retention money withheld and paid out.  Contracts should outline the procedures for the retention holder to lawfully use/deduct (or “appropriate” – the language used in the CCAA) the retention money.

Retention holders assume all the statutory and implied duties, obligations and liabilities of a trustee, including those under the Trustee Act 1956, in accounting for and managing retention money – including director liabilities.  At its most extreme, a breach of trust may be a criminal offence.

The parties to a construction contract are prohibited from:

  • Making the payment of retention money conditional on anything other than the performance of Party B’s obligations under the contract – an extension to the existing Construction Contracts Act rules prohibiting “pay when paid” (conditional payment) clauses.  Party B’s obligations may be pre-practical completion obligations (such as the payment of liquidated damages) and post-practical completion obligations (such as the rectification of defects during the defects notification period);
  • Making the date of payment of retention moneys later than the date on which Party B has completed all of its obligations under the contract; and
  • Requiring Party B to pay any fees or costs for the administering of a trust holding such retention funds.  

The methods of accounting for retention money are set out in the CCAA.  The government has taken a reasonably light touch approach;  the CCAA requires the holder of retention funds to keep “proper accounting records” of all retention money held that:

  • Correctly record all dealings and transactions in relation to the money;
  • Comply with generally accepted accounting principles; and
  • Are readily and property auditable.

The feedback from MBIE is that it expects industry participants to “develop reporting methods that best suit the accounting systems they have in place” – so the government is not being overly prescriptive as to how compliance should be achieved.

Jonathan is an Associate in our Commercial Team, specialising in Building Contracts, and can be contacted on 07 958 7460.