We have mentioned previously that the rules relating to retentions under contracts covered by the Construction Contracts Act 2002 are changing.  From 31 March 2017 retention money withheld under commercial construction contracts must be held on trust.  This is intended to apply only to contracts entered into or renewed on or after 31 March (presuming that the Regulatory Systems (Commercial Matters) Amendment Bill addressing this is passed in time – all indications are it will be).

The goal is to create greater certainty of payment for contractors (and subcontractors) owed retention money and ensure that retentions are responsibly managed.  Those taking retentions must hold them on trust, or assuming the amendment bill is passed, may obtain a bond or similar instrument to provide protection of retention money.

If a trust is used, the trust arrangement ends when retention money is paid or the contractor agrees to give up their claim or the money ceases to be payable by law e.g. if a final decision is made by the Court.

Developers cannot include terms in a contract to delay payment of retention money.  Such terms will be void.  “Pay when paid” provisions are also prohibited for retention money and conditional payment provisions are banned. Payment of retention money cannot be conditional on anything other than the performance of the contractor under the construction contract.

Developers who retain retentions can only use retention money for remedying a breach of obligations under the contract e.g. fixing up defective work.

Developers do not need to hold retentions in a separate trust account.  They will also be able to mix retentions with other money.  Retentions can be held in cash or other liquid assets.  In our view, that means they would need to be drawn down by a developer from a funding bank in order to be properly “liquid”.  Retentions can be invested and have interest earned on them provided the investment complies with the requirements of the Trustee Act 1956.

Proper accounting records must be kept recording all dealings and transactions in relation to retentions.  Contractors are entitled to see these records.  Interest must be paid where retentions are paid late at the rate agreed under the contract.

For a developer, drawing down retentions monthly impacts cash flow and creates an additional interest cost.  A simpler alternative (that is perhaps also cheaper?) is an on-demand retention bond. Cash retentions are typically preferred by bank’s QS but a true on-demand bond provides good security for a developer.  Whether contractors have sufficient capital to support greater bonds may be an issue though.

If retentions are held in trust, the new requirements will be most relevant if a developer or contractor becomes insolvent.  Retention money is protected and is not available to pay a creditor.  But, given monies can be mixed and do not need to be held in separate accounts in practice the changes create more legal rights for subcontractors and contractors rather than a guarantee that payment will be made.

By Denise Marsden