23.11.2021

Retention funds:  where is the trust?

The importance of subcontractors scrutinising how retention funds are held, and how they are dealt with by insolvency practitioners, was highlighted in the recent High Court decision in McVeigh v Decmil Australia Pty Limited & Anor [2021] NZHC 2929 (Decmil).  The liquidator sought an order from the Court to be appointed as receiver of the retentions fund.

Previous applications to have a liquidator appointed as the administrator of retention funds on the insolvency of a construction company have generally been unopposed.  There are often good reasons to have the same person acting as both liquidator and administrator of retention funds, as it avoids duplication of activities. 

However, in this case the application was opposed by two subcontractors, who sought an alternative appointee.  They were concerned that the retention funds in issue had been depleted and that the liquidator appeared to have treated trust funds as if they were company funds. The Court was mindful of concerns regarding the liquidator’s independence and partiality and directed that an approved an alternative appointee to administer the retentions fund.

KEY TAKEAWAYS

  • Retention money is trust money. It is not a company asset and cannot be dealt with by a liquidator as such.  It must be held and administered separately.
  • A liquidator or receiver can (and should) apply to the Court for orders permitting it to administer a retention fund.
  • Legislative reform is underway which will avoid the need for a liquidator or insolvency practitioner to seek an order permitting it to administer a retention fund.
  • Managing construction insolvencies and retention funds requires specific expertise and specialist advice should be sought at an early stage.

Background

Decmil Construction NZ Limited (Decmil) is a New Zealand based construction company.  It contracted to perform construction works on the basis that the physical works were fully sub-contracted out. 

In early 2020, Decmil was placed into liquidation and Dermott McVeigh (Mr McVeigh) was appointed as liquidator.  At the time of liquidation, Decmil owed approximately $3.8m in retentions to sub-contractors.  Shortly before Decmil was placed into liquidation, Decmil Australia Pty Ltd (DAP), the 100 percent shareholder of Decmil, transferred $3.3 million to Decmil (the Retentions Fund) for the purpose of meeting retention claims from Decmil’s sub-contractors.

In an earlier proceeding, the Court made a consent order that the Retentions Fund was to be held on trust for the retention creditors.  However, the consent order did not extend to the appointment of someone to manage the Fund.  

Mr McVeigh applied for directions permitting him to manage the Retention Fund in his role as liquidator or through his appointment as receiver.  VAE NZ Limited and Stanley Construction (Auckland) Limited (Retention Creditors), represented a subset of sub-contractors who had retention claims against Decmil under the Construction Contracts Act 2002 (CCA).  The Retention Creditors opposed Mr McVeigh having control over the Retentions Fund and brought an application seeking the appointment of another nominated person.

There were two issues for determination:

  • Could Mr McVeigh manage the Retentions Fund in his role as liquidator of Decmil?
  • If a receiver was required, should Mr McVeigh or someone else be appointed as receiver?

Decision 

Role as liquidator

Whether Mr McVeigh was able to manage the Retentions Fund in his role as liquidator hinged on whether a liquidator could manage property held on trust by a company in liquidation.  As liquidator, he was faced with varied and competing claims and any decision he made would directly affect the retention creditors as beneficiaries of the trust.  The Court considered there was no clear authority as to whether this was appropriate.

In any event, the consent order in the earlier proceedings contemplated the appointment of a receiver.  It made express provision to the recovery of the receiver’s costs in managing the Retentions Fund.  No provision was made for the recovery of the liquidator’s costs in doing the same.  As Mr McVeigh had also applied to be appointed receiver of the Retentions Fund, Duffy J chose not to come to a conclusion on this point, focussing on the application to be appointed as receiver of the Retentions Fund.

Role as receiver 

Mr McVeigh argued his appointment as both liquidator and receiver would result in greater efficiencies.  While there is limited case law on the point, in principle, the Court found that there was no reason why Mr McVeigh could not also be appointed as receiver of the Retentions Fund. 

However, the Retention Creditors opposed Mr McVeigh’s appointment on the basis of a perceived conflict of interest and his initial conduct in dealing with the Retentions Fund.  Mr McVeigh was aware that the Retentions Fund had been transferred to Decmil for the specific purpose of meeting the Retention Creditors’ claims.  Regardless, prior to the Court’s consent order, he disputed the Retentions Fund was held on trust for the Retention Creditors and dealt with it as if it was part of the general pool of property of Decmil.  In dealing with the Retentions Fund as if it was property of Decmil, Mr McVeigh depleted the Fund by roughly $1 million. 

DAP subsequently came to an arrangement that they would top up the Retentions Fund by a maximum of $1.1 million.  This relieved the Decmil directors of any litigation risk.  It also relieved Mr McVeigh from any risk that he would be pursued for making unlawful withdrawals from the Fund. 

Evidence suggested it was unlikely the retention creditors claim would exceed $2 million, in which case the top up DAP agreed to provide would not be required.  However, if the Retention Creditors’ claims did exceed that figure, and a top up was required, Mr McVeigh may become liable to DAP.  The liability could arise through the arrangement he entered with DAP and Decmil (of which the terms were not disclosed) or due to his unlawful withdrawals from the Fund. 

The Court concluded that Mr McVeigh may have a personal incentive to value the Retention Creditors’ claims at around $2 million, rather than $3.3 million.  While these concerns were not based on fact, they were capable of inference from the circumstances.  As such, they were sufficient to disqualify Mr McVeigh being appointed as the receiver of the Retentions Fund.  Mr McVeigh’s failure to ameliorate the concerns of the Retention Creditors and provide evidence of his arrangement with DAP and Decmil proved to be a telling factor in the Court’s decision and the Court appointed alternative nominees to manage the Retentions Fund.

Comment 

Currently, in a formal insolvency appointment, a liquidator or receiver needs a court order to administer retentions held on trust because the CCA is silent on this.  The Construction Contracts (Retention Money) Amendment Bill currently before the Transport and Infrastructure Select Committee (Committee) proposes to amend this by making a liquidator or receiver the trustee of retentions upon their appointment, empowering them to administer the retentions, and permitting them to deduct their reasonable fees and costs from the retention trust money.  We have previously written on the proposed amendments here.  The Committee is expected to report back by 25 November 2021.

However, Decmil and the proposed reforms make clear that retention moneys are trust money and are to be dealt with separately from the general pool of funds in a liquidation.  The proposed amendments to the retentions regime strengthen this position, creating a deemed trust. 

The proposed amendments will also require greater mandatory reporting in the way retention moneys are held.  Regardless, Decmil is a reminder that subcontractors need to be vigilant in ensuring that retentions are appropriately held and accounted for, including during insolvency events.  Insolvency practitioners also need to be mindful of the specific features of a construction insolvency and the statutory regime governing retentions.  Specialist advice should be sought at an early stage.

Our Construction Team has written and presented extensively on the retentions regime and actively participated in the current legislative reform process.  We have expertise in dealing with the specific features of construction-related insolvencies.  Please get in touch with our Construction Team or Insolvency and Restructuring Team if you would like to discuss. 

 

Disclaimer:  The information contained in this article is current at the date of publishing and is of a general nature.  It should be used as a guide only and not as a substitute for obtaining legal advice.  Specific legal advice should be sought where required.

 

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Kerry
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