Ebert Construction: Court provides Guidance on the Retentions Trust Regime

Following our previous updates (Ebert Construction Receivership – What You Need to Know and Ebert Construction – Receivership and Liquidation), on 12 November 2018 the High Court ordered that the Receivers of Ebert Construction Ltd (in rec and liq) (Ebert) be appointed as the receivers and managers of the retention funds held on trust by Ebert. The Court also gave directions as to how the funds shall be distributed in circumstances where there is a shortfall, and which subcontractors have an interest in those funds. The decision will establish a precedent for future insolvencies involving retentions on trust, and may lead to legislative changes to the Construction Contracts Act 2002 (CCA).

The judgment is available here.

Background

The Receivers applied to the High Court for guidance because the retention regime introduced to the CCA last year does not say who in an insolvency is responsible for administering and distributing retention money that is held on trust, how that is to be funded, what happens if there is a shortfall, or whether the trust extends to accrued interest.

The Court heard the Receivers’ application on 8 November 2018. Two subcontractors made submissions as interested parties – not opposing the application but expressing concerns about the receivers’ costs (and whether they should be capped) as well as the overall speed of the application. The liquidators did not oppose the application.

The Court determined the following key issues:

1. Whether the Receivers were entitled to manage and administer the retention fund; and
2. How the funds held in the retention fund should be distributed between different classes of subcontractors.

The Decision

Churchman J had no difficulty appointing Ebert’s Receivers as the receivers / managers of the retention fund. Under the CCA they would not be entitled to administer the retentions fund without an order from the Court. This is because the retention monies, being held on trust, is not property of the company and is therefore outside the Receivers’ normal control.

The Court determined that it was appropriate for the Receivers’ reasonable fees to be taken from the fund (in the same way that a receiver’s or liquidator’s costs would be payable from the companies assets before making a distribution).

The Court stopped short of capping the costs (estimated at $150,000 + GST), but has required the Receivers to submit details of its costs for approval before they can be deducted. Those details are to be served on all affected subcontractors who will then have 14 days to make submissions to the Court themselves, if they wish.

Contentious categories

Ebert’s accounting practices involved coding construction contracts that were entered into from 31 March 2017 when the new regime came into force, and reconciling and transferring the retentions under these contracts into a separate retention fund (Retentions Account). In the months leading to the receivership, Ebert’s systems for reconciling and transferring retentions started to break down leading to issues in the present application. Unfortunately, some of the contracts were incorrectly coded (or Wrongly Classified) by Ebert meaning these subcontractors’ retentions were not transferred into the Retentions Account.

The subcontractors’ retentions claims fell into the following categorises:

1. Reconciled and Transferred retentions of $3,609,930;
2. Calculated but Not Transferred retentions of $475,000;
3. Uncalculated and Not Transferred retentions of $380,000; and
4. Released but Unpaid retentions of $69,000; and
5. Wrongly Classified retentions of $170,340.39.

The total funds in the Retentions Account are $3.678m, which is apparently Ebert’s only significant cash asset.

The Court interpreted the CCA as creating an obligation on the contractor to hold retention monies on trust, rather than deeming retention monies to be held in trust as the Government seemingly intended at the time.

The Court noted that three certainties are required to create a trust: (1) an intention to create a trust; (2) a subject matter of the trust; and (3) an object (or beneficiaries) of the trust.

The Court considered that only the Reconciled and Transferred and the Released but Unpaid retentions met those requirements necessary to create a trust, and who have an interest in the Retentions Account (the entitled subcontractors).

Churchman J considered that the other categories (ie (2) and (3) above) were not “retention money” under the CCA as the amounts were not actually “withheld”, and were therefore not subject to the retentions trust regime. Similarly, the Wrongly Classified retentions which were also not transferred to the retentions fund (although they should have been) could not be subject to the retentions trust regime, as they were not being held on trust. Accordingly, none of these are entitled subcontractors, meaning they have no interest in the Retention Account despite Ebert’s obvious failure to comply with the CCA. This may be an area for challenge.

Outcome

Churchman J permitted the Receivers to make an initial distribution to entitled subcontractors of 75% of Retentions Account funds. That distribution will be made on a pari passu and interim basis. This is expected to occur before Christmas 2018.

Ownership of the interest earned on the funds in the Retentions Account is to be determined later.

Takeaways for subcontractors, affected or otherwise

• Affected subcontractors can have a say on the receivers’ fees and costs. Details of the actual costs will be submitted to the Court and affected subcontractors for approval by the Court. Following this, subcontractors may file written submissions within 14 days. If you are an affected subcontractor, you should consider seeking legal advice if you wish to make submissions. The amount of the costs will affect the balance available to entitled subcontractors.
• If you are one of the affected subcontractors who the Court determined is not entitled to the funds held in the Retention Account, you may wish to consider seeking legal advice as to whether this may be challenged. Affected subcontractors who are in the same position could club together to share the costs of such advice and any potential appeal.
• The judgment illustrates a gap in the current retentions regime, which will lead to some subcontractors being prejudiced as a consequence of Ebert’s own failure to comply with the CCA. If you are subcontractor who has entered into a Construction Contract on or after 31 March 2017, in order to ensure your retentions are protected, accounting records can be requested from the Principal relating to your retentions to ensure that retention funds have been administered in accordance with the CCA. Under s 18FC of the CCA, parties holding retentions on trust must keep proper accounting records which correctly record all retention money held on trust. These accounting records must be made available to parties whose retentions are being withheld at all reasonable times and without charge.

Update on liquidation

Since our last update, a creditors’ petition was successful in removing David Ruscoe and Tim Wilson of Grant Thornton as liquidators, who had been appointed by Ebert’s shareholders. Iain Shephard and Jessica Kellow of BDO have been appointed by the creditors as the replacement liquidators. The move, while unusual, serves as a reminder that creditors do have some influence in the conduct of a liquidation. We will be keeping a watching brief on steps taken by BDO as this matter progresses and provide further updates on any future developments.

Key Contacts

Disclaimer:  The information contained here is of a general nature and should be used as a guide only.  It is not a substitute for obtaining legal advice.  Any reference to law and legislation is to New Zealand law and legislation.