Updated Retentions Regime – What compliance requirements will project funders impose?

In this brief, we discuss this question and how changes to the retention moneys regime provide increased insolvency security and enforced accountability.

A Pivotal Time to Increase Subcontractor Protection 

In today’s market, we see an increasing number of liquidations within the construction sector. It is therefore crucial to ensure that all contracting parties have sufficient security in place to mitigate risks, and are reciprocally releasing securities once the other party fulfils its contractual obligations. Mismanagement of security releases puts undue pressure on cash flow and risks a domino effect which in some instances culminate in liquidation.

The recent amendment of the Construction Contracts Act 2002 (“CCA”) brings a welcome and timely change to the retention money regime. It increases and enforces the accountability of the Head Contractor to hold and report retention money correctly, in a way that reduces Subcontractors’ exposure. 

A sizeable percentage of projects are funded by banks and/or other financial institutions. The question arises whether funders will impose additional compliance obligations upon borrowers. 

Key changes to the CCA are as follows: 

 

Issues with the Original Act 

Retention money, as between Head Contractors and Subcontractors, can be defined as a portion of payment that Head Contractors can choose to withhold from specialist tradespeople for up to 12 months. Retention money provides the Head Contractor with security if work is not completed to standard and incentivises Subcontractors to perform their defects remediation obligations. 

Under the current retentions provisions of the CCA, retention money can be intermingled with other company money or assets. However, the misappropriation of retention money as working capital has proven to be problematic. Subcontractors “are often the first to miss out in the event a construction company becomes insolvent,” says Hon Dr Megan Woods, Minister for Building and Construction. Subcontractors usually have no visibility of how their retention money is being held or used. 

The Construction Contracts (Retention Money) Amendment Act 2023 (“the Amendment”) addresses both issues.

 

Commencement Date and Applicable Contracts 

The Amendment will come into effect from 5 October 2023, and will apply to all new or renewed commercial construction contracts where retention money provisions are included. 

We note that the holding of retention moneys against Subcontractors remains a choice, not a legal requirement. 

 

Requirement to Hold Retention Money Safely 

Under the Amendment, Head Contractors will need to hold retentions on trust in a separate bank account or complying instrument. This trust is automatically created when an amount falls within section 18B’s definition of ‘retention money’. The bank account, or other instrument, must be ‘compliant’ as outlined in section 18E, and Head Contractors must inform their bank or account holder upon deposit that there is retention money being held on trust.

 

The only instances where retention money usage is permitted: 

• To cover the value of defects requiring remediation, in which case the Head Contractor is required to provide written notice to the Subcontractor, minimum 10 days before use, outlining the details of such defects; 
• As permitted by the contract, in which case the relevant contractual procedures need to be followed. 

 

A trust containing retention money will end when any of the following occur: 

• The Subcontractor receives payment of the retention money; 
• The Subcontractor releases the Head Contractor of such payment in writing; 
• The retention money is used to remedy defects as above; 
• The retention money otherwise ceases to become payable to the Subcontractor. 

 

Retention money may be held for multiple parties in the same trust account. If a deposit or withdrawal cannot be clearly attributed to a party, the amount deposited or withdrawn will be apportioned according to each party’s ledger record balances at the time it was made. 

Interest on retention money can be kept by the party holding it, providing the contract does not say otherwise. 

Notably, liquidators and receivers for all liquidations and receiverships commencing after 5 October 2023 will immediately become trustees of retention money, regardless of the contract commencement date.

 

Enforcement of Accountability 

One of the most significant changes in the Amendment is that it substantially increases the level of accountability. 

It is now a requirement for the Head Contractor to keep thorough accounting records of all retention money held and provide detailed information to the Subcontractor. This provision of information must be done as soon as possible after an amount is deemed ‘retention money,’ and at minimum every three (3) months thereafter until the retention money is released. The extent of reporting requirements can be found in Section 18FD, which includes:

• The bank account holding the retention money; 
• The applicable construction contract; 
• Details of any account transactions. 

 

The Amendment also introduces several strict non-compliance penalties. These include:

Failing to Keep or Use Retention Money as Prescribed: 

• Directors: Up to $50,000 NZD (New Zealand Dollars) for each offence; 
• Companies: Up to $200,000 NZD for each offence; 
• Intentionally providing false information about retentions held: Up to $50,000 NZD for each offence. 

 

Failing to Keep Accounting Records as Prescribed: 

• Up to $50,000 NZD for each offence. 

 

Failing to Provide Regular Reports of Retentions Held: 

• Up to $50,000 NZD for each offence.

 

In addition, the Ministry of Business, Innovation and Employment is now empowered to investigate and enforce retention money offence related penalties. Head Contractors that fail to provide information requested during an investigation could incur additional penalties. 

 

Third Party Funded Projects 

We provide project funding representation quantity surveying services on a range of projects, working with all the major funders in New Zealand. As part of monthly draw down certifications, funders traditionally expect quantity surveyors to advise:

• the sum of retentions certified by that draw down;  
• that it is appropriate for the facility to be drawn and the funds credited to the nominated stakeholder; and 
• with verification, that borrowers are retaining the correct amount of retentions. 

 

Funders usually require that construction contracts contain appropriate retention provisions. 

We suspect that funders will bolster their compliance requirements to align with the additional requirements prescribed under the amended CCA. This will inevitably include a precondition that construction contracts must respond to the amended CCA. However, experience has shown that simply referencing an Act does not produce the desired outcomes. We recommend that the mechanisms prescribed under the amended CCA be summarized in contracts thereby patently drawing the user’s attention to the express requirements. This will furthermore assist quantity surveyors in verifying compliance. 

Borrowers and contracting parties will need to ensure they understand and are in a position to comply with the new legislation when it comes into force. 

We are liaising with the various funders to provide them further advice and recommendations in this regard and will accordingly share further updates as we become aware of any additional requirements set by them. 

 

Further Information 

You can find more detailed information about the Amendment below: 

• View the Amendment and related Supplementary Order Papers 
• MBIE – Understanding the Construction Contracts Act 
• Beehive – Announcement of Passed Amendment 
• View Parliament readings of the Amendment and the Amendment timeline 

MBIE will provide additional resources, including guidance information for businesses and Subcontractors, over the coming months. 

 

Further Guidance 

If you require further guidance, please feel free to contact our Advisory division leads. 

This article was contributed by Jesse Conradie and Gemma Christall.