Amendments to Retentions in Construction

On 10 August 2023, Tina Hwang was asked to present to some project managers about the latest changes to the retentions scheme in the Construction Contracts Act 2002.  Here is a summary of her presentation.

1. Why did this come about?

• Contractors and subcontractors continued to struggle with retentions.
• There was a need to protect contractors and subcontractors regarding their retentions.
• Inherent imbalance in powers.
• Existing retentions regime was not working (Ebert and Mainzeal cases).
• Principals and Contractors were often co-mingling retentions with working capital.
• Retentions were not automatically “held on trust”.
• The amendment aims to strengthen the regime and confidence in retentions. It also gives MBIE powers to investigate and prosecute.

"The amendment aims to strengthen the regime and confidence in retentions. It also gives MBIE powers to investigate and prosecute."

 2. Legal status

• The Act was passed in April 2023 and will come into force on 5 October 2023 (applying to commercial construction contracts signed or renewed after this date). 
• However, NZS3910 was last updated in 2013, so does not accommodate the new retention provisions.  The NZS 3910 standard terms are likely to be updated in October 2023.

3. Summary of Amendments

A. Trust

• Retention monies are now automatically deemed to be “held on trust”. This is because the Ebert case proved there was no automatic trust created for retentions.
• New section 18C(4)(c) provides that all the rules of common law and equity relating to trusts apply to the trust.
• This means that:
  i. There are fiduciary duties;
  ii. There is a duty to account; and
  iii. Beneficiaries have entitlements.
• Party A is a trustee and Party B is a beneficiary of the trust and has equitable rights to claim and request information from Party A
• Strangely, interest earned on retentions belongs to Party A and not Party B (but you can amend this in the contract if you wish).
• If Party A goes into liquidation or receivership, the receiver or liquidator becomes trustee of the retention money (another key change).

B. Retention Money (set up)

• You can no longer co-mingle with working capital or other non-retention moneys.
• You can, however, co-mingle with other retentions for other parties.
• You do not require separate bank accounts for each project or contractor, and can instead have separate ledgers (within the trust account) for each party and each construction contract
• It pretty much allows only “cash”.
• However, it provides “complying instruments” (such as an insurance policy or a guarantee).
• You cannot use other “liquid assets” that can be converted to cash anymore (like accounts receivables, shares or working capital).
• Must be held in a trust account for the sole purpose of retentions at a registered bank in NZ.
• The banks need to be notified it is a bank account for retentions, to prevent them from taking a lien or set-off.
• Otherwise, there are specific provisions allowing it to be held by a lawyer, public trust, trustee company, chartered accountant, etc.

C. Use of Retention Money

• While the legislation’s purpose is said to be to provide retentions “as security for the performance of Party B’s obligations under the contract” (s18B), the Act only allows Party A to use it to remedy defects.
• If Party A wants to use retentions to remedy defects, they must provide 10 working days of notice to Party B to give them a chance to remedy (and the construction contract must allow them to use retentions for this purpose).
• There has been some criticism that Party A cannot use for unpaid or delayed liquidated damages payments, or as compensation for a defective or under performing asset that the payer decides to accept for commercial reasons.
• Section 18J provides that where a receiver or liquidator is appointed, party A ceases to be the trustee of the retention money trust and the receiver or liquidator becomes the trustee.

D. Record Keeping

• Mandatory reporting requirements now.
• Party A must keep proper accounting and other records of retentions held for Party B.
• Records must be available for inspection at all reasonable times without costs.
• Party A must report at least every 3 months to Party B.
• They must be kept in such a way that:
  i. enables the preparation of financial statements that comply with generally accepted accounting practice (as defined in section 8 of the Financial Reporting Act 2013); and
  ii. complies with any other requirements specified in the regulations.
• Crown entities have obligations under Party 7 of the Public Finance Act 1989 (this section deals with Trust).
• Accounts and record requirements under 18FC are stringent:
  i. The records must be appropriate, having regards to the amount of retention money and the circumstances of the case.
  ii. The records must identify the relevant bank account and construction contracts, and include details of payments made in and out of the account.
  iii. The records must include complying instruments and details relating to these.
• The information required includes:
  i. Each amount received, the construction contract it was received for, and the date the money was received.
  ii. The total amount of retention money held by Party A for Party B (with details of each construction contract between the parties).
  iii. Details of the registered bank account used for the retentions .
  iiii. A statement detailing the records held by Party A and allowing Party B to inspect.

E. Penalties

• Act now empowers MBIE to investigate and prosecute.
• Failures could result in a fine of up to $200,000.  If Party A is a body corporate, each of its directors can be liable to a fine of up to $50,000.
• The Act now empowers Party B to chase Party A if they are in breach, as currently there is nothing to really push if Party A fails.

4. Comments

• As retentions are so onerous now, parties are likely to use bonds in lieu of retentions now.
• NZS3910:2013 includes an option and form for bonds.
• However, NZS 3910:2013 does not include clauses stating that bonds or retentions can be used to remedy defects, but the Act specifically requires this to be incorporated into the construction contract if the Principal/Contractor wants this right (and requirement to provide 10 working days notice).
• Parties need to properly understand the retentions obligations as it is onerous.
• The mandatory reporting requirements and information goes well beyond what is commonly provided in the industry.
• Setting up new trust accounts AND notifying the banks is a big step.
• The record keeping obligations and need to update each contractor every 3 months is another onerous obligation with costs.
• Parties need to add special clauses to accommodate the changes to retentions as the NZS3910:2013 has not been updated for 10 years.
• Any contracts signed after 5 October 2023 will be affected.
• Any contracts signed close to this time will likely be affected if any part of the contract is varied or renewed, triggering the Act provisions for the new retentions scheme.

If you have any property, construction, or litigation queries, please feel free to contact Tina Hwang or Max Shin at Queen City Law.

Disclaimer:
We have taken care to ensure that the information given is accurate, however it is intended for general guidance only and it should not be relied upon in individual cases. Professional advice should always be sought before any decision or action is taken.