Facts.

On 31 July 2018 the Applicants were appointed the receivers of the respondent, Ebert Construction Limited (EC), which was a large construction company.

The Construction Contracts Act 2002 (CCA) provides that in relation to commercial construction contracts entered into after 31 March 2017, a head contractor (i.e. EC) must hold sums required to be paid to a subcontractor (retentions), on trust for the subcontractor. This was implemented as a response to head contractors using subcontractor’s retentions as working capital, leaving subcontractors as effectively unsecured creditors for the retention amounts.

EC had a Retention Account with a balance of approximately $3.6 million. However, at the date of receivership, EC owed its subcontractors approximately $24.5 million, of which $9.324 million was subcontractor retentions.

The general practice prior to 31 March 2017 was that EC would pay out subcontractor invoice after deducting amounts to keep for retentions, but would keep those deductions in their general account.

Subsequent to 31 March 2017, EC utilised a computer software to calculate the amount of monies to be held on retention, and the amount to be kept in their general account. However, in June 2018, the computer system malfunctioned, which led to the retention amount not being placed in the retention account, and subcontracts being incorrectly identified.

Legal issues.

There were three main legal issues in this case, namely:-

1. Whether the Applicants should be appointed by the Court as receivers to manage and distribute the Fund?
2. Which subcontractors have a claim to the Fund and on what basis?
3. How to distribute the Fund if, as expected, there is a shortfall?

Appointment of applicants.

The Court held that the Applicants were entitled to administer the Retention Fund based on the Court’s inherent jurisdiction to appoint receivers and managers, for the purpose of distributing retention funds. It held that if the receivers were not appointed, this would mean that the subcontractors would be affected in that they would not be able to recover any of what they were rightly owed.

Subcontractor’s claim/how to distribute fund.

There were three months of contentious retention funds (May, June, July 2018), and therefore, it had to be determined whether the subcontractors with invoices rendered for these months had a claim in the retention fund. In order to establish that a trust had been created/that the subcontractor for each specific month had a claim in the fund, the Court had to be satisfied of three certainties:-

1. Intention to create a trust;
2. Subject matters of the trust; and
3. Object or beneficiaries of the trust.

With regard to the retentions that were calculated but not transferred to the fund, the Court held that EC had no intention to transfer monies, as these would have been transferred had there been an intention to do so. With regard to the retentions that were uncalculated and not transferred to the fund, the reasons are the same as above, in that it lacked the element of intention. With regard to retentions that were reconciled and transferred to the fund, all elements could be said to be satisfied, and therefore these subcontractors did have an interest in the fund. With regard to the wrongly classified subcontractors, although EC intended to pay the funds into the retention account, the funds were never transferred. The difficulty was that while EC intended to pay the funds, they were never actually transferred into the account.

The Court agreed that as much as 75% of the retention fund could be distributed on a pari passu basis to the qualifying subcontractors. It is noted that even though most of this fund was distributed, around $21 million will still remain owing to the subcontractors. Overall, the retention provisions have achieved little in this particular instance in terms of protecting the subcontractors interests.

NOTE: This article is not intended to be legal advice (nor a substitute for legal advice).  No responsibility or liability is accepted by Legal Vision to anyone who relies on the information contained in this article.

The final details of the new retention regime have been revealed by route of the Regulatory Systems (Commercial Matters) Amendment Bill.  This passed its third reading on 24 March 2017 and should receive royal assent making it law on or about 31 March 2017.

Key aspects to the retention regime brought in by the Construction Contracts Amendment Act 2015 and this soon to be passed Act are as follows:-

• It will only apply to construction contracts entered into before 31 March 2017 unless renewed after that date;
• It will only apply to commercial construction contracts, and by this it is meant that it will not apply to construction contracts entered into with residential occupiers;
• No minimum amount has been specified such that the regime applies to any amount withheld or payment arrangement that acts as a retention;
• Retention money must be held on trust in the form of cash or other liquid assets that are readily converted into cash;
• Alternatively a complying financial instrument can be used for example bond or guarantee or a combination of liquid assets and complying financial instrument;
• A complying financial instrument must be issued by a licensed insurer or registered bank;
• It must be issued in favour of, or endorsed with the interest of, the payee, require the issuer to pay retention money to the payee if the payer fails to pay when contractually due, and the payer is responsible for ensuring premiums are paid and up to date;
• The retention money need not be paid into a separate bank account and can be mixed with other funds;
• Proper accounting records must be kept of all transactions relating to retentions;
• The trust status of retention funds only ends when the retentions are paid out, the payee gives up its claim, or when the money otherwise is no longer payable under the contract or by law;
• Retention money held on trust is not available for payment of the payer’s debts and cannot be taken by a receiver of liquidator;
• Retention money can only be used by the payer to remedy defects in the payee’s performance of its contractual obligation;
• Retention money can be invested but is at the risk of the payer, and subject to the Trustee Act 1956;
• The financial obligation of administering a trust remains with the payer;
• Where a payer is late in making payment of retentions it will automatically be liable for interest at the contractual interest rate;
• Any term in a construction contract which make payment conditional upon anything other than the completion of the payee’s contractual obligations, or makes the retention release date later than the completion of the contractual obligations, or requires the payee to contribute to the cost of administering the trust, is void;
• Construction contracts that include milestone payments are most likely caught by the retentions regime.
• In the usual principal/head contractor/subcontractor scenario, it is most likely that retentions held up-stream by the principal will not satisfy the head contractor’s retention obligations for sub-contractors.  Specific provision of retentions on trust, must be made by head contractor for sub-contractor.

The most likely outcome from the introduction of the new retention regime is that we are likely to see less use of the retention regime so that construction parties can avoid costly compliance.  It is likely that most building contracts, (unless made with residential occupiers), or sub contract agreements, will need some adjustments/amendments to reflect the changes brought in.

The application of the new retention regime will impose challenges for the industry.  It is difficult to see exactly how these will play out, but inevitably one by-product of avoiding the difficulties created by collapses such as that of Hartner Construction, is going to be increased costs of construction.

NOTE: This article is not intended to be legal advice (nor a substitute for legal advice).  No responsibility or liability is accepted by Legal Vision to anyone who relies on the information contained in this article.