Changes to the construction contract retention money scheme passed by Parliament
Parliament has just passed the Construction and Contracts (Retention Money) Amendment Act 2023, which strengthens and clarifies the retention money scheme in the Construction Contracts Act 2002 (CCA).
Businesses in the construction industry should ensure that their retention money processes comply with the updated procedures by 5 October 2023, when the new regime will comes into force, and apply to contracts entered into or amended after that date.
What is retention money?
Retention money is an amount held back from a payment made under a construction contract. It is usually a percentage of the amount payable of each instalment. It is generally held to ensure that a contractor performs all of its obligations under the contract, and is then released either on practical completion or after the end of a defects notification period.
What are the current requirements?
The CCA currently requires any party to a construction contract (party A) who is withholding retention money from the other party to the construction construct (party B), to hold that retention money on trust for the benefit of party B. The retention money may be held in cash, “other liquid assets that are readily converted into cash”, or a financial instrument such as insurance or a payment bond.
What is changing?
There are a number of key changes being made.
Funds deemed to be held on trust
As a result of some uncertainty in the original drafting, the CCA will be amended to explicitly state that a trust is created automatically; there is no need for any explicit intention of party A to hold the money on trust.
The funds will only cease to be trust property when they are paid to party B, used to remedy defects (after notice of the intention to use the funds for that purpose has been given to party B), or party B otherwise gives up its claim to the funds.
Clarifying what is retention money
The CCA will also state that funds will be considered to be retention money whether or not it has actually retained, and whether any amount has been paid to party B. This will resolve issues that have come to light where, if party A becomes insolvent, a partially paid subcontractor will be in a better position than an unpaid subcontractor.
How retention money may be held
Retention money will be required to either:
- be held in a bank account; or
- be the subject of a suitable financial instrument such as insurance or a payment bond.
It will no longer be permissible to use “other liquid assets”, such as accounts receivable. It will therefore no longer be possible to use the retention fund as working capital.
As the use (and availability) of financial instruments is rare, most retentions will be held in bank accounts. There specific requirements for those accounts, including that:
- the account must used solely for the purpose of retention money; and
- party A must ensure that the bank is aware that the account is a trust account for the purposes of holding retention money.
Any interest that accrues in the account will belong to party A.
Party A may choose whether to have individual accounts for each subcontractor’s retention money or to have one account which holds all subcontractors’ funds. If funds are mingled, then party A must ensure that it has accounting records in the form of separate ledgers, identifying each party B for whom money is held, and the construction contract to which it relates.
Regular reports on retention money
Party A will be required to give specified information to party B at the time that retention money is held (or as soon as practicable) and then at least every three months thereafter. This information must include:
- the most recent amount withheld, the relevant construction contract, and the date of the retention;
- the total amount of retention money held by party A for party B;
- if held in a bank account, the name of the bank and branch, the name of the account, the name of party B’s ledger (if the account has separate ledgers), and the total balance held for party B; and
- if using a financial instrument, the name of the issuer, sufficient information to identify the instrument (such as a policy number), and the protected amount.
The effect of a receivership or liquidation
If party A is placed into either receivership or liquidation, the receiver or liquidator will hold the retention money on trust, and must deal with it in the same way as party A was required to do so. Reasonable fees and costs may be met from the retention money account. The CCA will also confirm that receivers and liquidators will not be liable for any unlawful or improper action taken prior to their appointment. This solves the current position where receivers and liquidators are required to make an application to the court for directions.
Failure to comply
For the first time, the CCA will include penalty provisions for entities who do not comply with the retention money scheme. These penalties include:
- for failure to keep retention money as required, a fine of up to $200,000;
- for failure to keep proper accounting and other records of retention money, a fine of up to $50,000; and
- for failure to provide regular reports on retention money, a fine of up to $50,000.
If party A is a company, each director can also be personally liable for failure to keep retention money as required, with a fine of up to $50,000 for each director.
These penalties are cumulative for each breach, rather than a single penalty for a collection of breaches. This means that a director prosecuted for failing to properly hold retention funds for ten different subcontractors could be liable for a fine up to $500,000, not $50,000.
Compliance with the Act will be monitored and enforced by the Ministry of Business, Innovation and Employment (MBIE), which will have powers to obtain information and issue warrants with offences created for obstructing investigation.
What are the next steps?
The Construction Contracts (Retention Money) Amendment Act 2023 will come into force on 5 October 2023. Businesses should start preparing for the change by establishing separate bank accounts for retention money, and ensuring that there are proper records of who that money is held on behalf of.
If you have any questions about this Act, or about the retention money scheme generally, please contact a member of our Construction & Projects team.
Disclaimer: the content of this article is general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.