Retention monies under commercial construction contracts: Are you ready for change?

Key changes introduced by the Construction Contracts (Retention Money) Amendment Act

The Construction Contracts (Retention Money) Amendment Act (Amendment Act) was passed on 5 April 2023 and comes into force on 5 October 2023.  The Amendment Act changes the way parties to commercial construction contracts are required to administer retention money.  It will apply to all commercial construction contracts entered into, or renewed, after 5 October 2023.  Parties will need to carefully consider the use of retention moneys in their commercial construction contracts and take active steps to ensure compliance with new obligations.

What are retentions?

Retention money is part of a payment under a construction contract held back by a payer (a principal or head contractor) as security to ensure that a payee (a head contractor or subcontractor) performs its obligations under a contract, including attending to defects.  Retention monies provide a form of security to payers and are commonly used in standard form construction contracts as opposed to other forms of security such as bonds.

Why change?

The current retentions regime was introduced in response to the Mainzeal failure.  However, shortcomings in the regime were exposed by the collapse of several high profile construction companies including Ebert Construction in 2018, which left contractors and subcontractors out of pocket on a payer going into liquidation or receivership.  In particular, the requirement for active steps to be taken to create a trust left parties exposed where retention holders failed to administer retentions correctly.  Additional costs were also required, on formal insolvency procedures being implemented, for liquidators or receivers to apply for Court orders to administer retention moneys.

The Amendment Act is designed to strengthen and clarify the provisions regarding retention money and to provide increased protection for parties entitled to retentions in an insolvency event.

What are the key changes?

The key changes introduced by the Amendment Act are:

  • Automatic Trust: Retentions will now be automatically deemed to be held on trust as soon as an amount becomes retention money, regardless of any payment or other steps taken.  Taking steps to create a trust will no longer be necessary.  A trust will be deemed when a construction contract allows a payer to withhold payment of an amount to a payee.
  • Retentions Account: Retention money will be required to be held separately from other monies or assets.  Payers will no longer be allowed to commingle retentions with other money and must hold retentions in a dedicated account.  This can be in the form of a separate trust account registered to a New Zealand Bank or another complying instrument such as an insurance policy or guarantee.  Retention holders must inform the bank that the account is for the purpose of holding retention money on trust under the Construction Contracts Act 2002 (CCA).
  • Use of Retentions: The Amendment Act confirms that it is acceptable to use retention money to remedy defects caused by the payee’s failure to comply with its obligations set out in the commercial construction contract.  However, this is only the case if the contract permits this use of retentions and all relevant procedure set out in the contract is followed.  The party intending to use retentions for this purpose must also give the other party at least 10 working days written notice prior to use, outlining the details of defects to be remedied and the intended use of retention money for that purpose.
  • Reporting Obligations: A retentions holder will continue to be required to ensure proper accounting records are kept.  Further guidance is now provided what form those records must take.  New reporting obligations have also been introduced, in place of the existing regime which permitted payees to request or inspect records.  A retentions holder will need to provide “required information” to the party entitled to payment about how/where retention money is kept as soon as practicable after an amount becomes retention money and at least every three months until the retention money trust ends.  
  • Offence/Penalties: The current retentions regime was something of a toothless tiger, with any absence of any sanctions for non-compliance.  A failure to keep and use retention money in accordance with the Amendment Act will now be an offence with fines of up to $200,000 for the holder and $50,000 for each director (as defined in the Financial Markets Conduct Act 2013).

    Parties will have a defence if they can provide that they took all reasonable steps to ensure compliance.

    A failure to comply with reporting obligations will be an offence, liable on conviction to a fine not exceeding $50,000 for each defence.

    These sanctions are further supported by MBIE having powers to request information reasonably necessary for the purposes of monitoring, investigating, or enforcing compliance with the regime, with further offences and fines being created for failing to provide information requested, or providing incomplete, false, or misleading information.

  • Receivership / liquidation: When a receiver or liquidator is appointed, the insolvency practitioner will become trustee of the retention money trust.  This will avoid the need for the insolvency practitioner to apply to the Court for directions to administer the retention money.  The receiver or liquidator will be required to collect, manage, and disburse the retention money in the same way a payer is required to under the CCA, and is entitled to have their reasonable fees and costs met from the retention money trust.

Our comment

With three months until the new regime is in place, parties need to start preparing for change now. 

There are several administrative matters retention holders will need to ensure are in place if retentions are to be used in new or renewed commercial construction contracts from 5 October 2023.  This will include the setup of bank accounts and communication with banks, as well as determining how a payer will comply with their reporting obligations.  For example, parties may wish to consider amending their payment schedule templates to ensure there are no oversights in the information that is required to be reported on, or that parties ensure reporting is carried out at least once every three months.

The presence of criminal and regulatory penalties may alter the risk profile for parties considering administering retentions, including their directors.  Directors will need to take additional steps to ensure compliance with the retentions regime, and review their existing insurance coverage.  It is possible that we will see an increase in alternative security mechanisms being used as a result.

If you have any questions about the incoming changes to the retentions regime, please get in touch with our Construction Team or your usual contact at Hesketh Henry.

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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Contact the expert team at Hesketh Henry.
Media contact - Kerry Browne
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