Transcript: Construction Contracts (Retention Money)

Slide 1 – opening

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Text on screen: Construction Contracts Amendment Act 2023. Retention Money Webinar

Logos

• Building Performance
• Construction Sector Accord

Audio

Graham Burke: Kia ora tatou, ko Graham Burke toku ingoa. I'm the Construction Accord Transformation Lead for People. I'm chairing this webinar today on the implementation of the Construction Contracts Amendment Act Retention Money. This is a really important bit of legislation for the sector, that's been basically 10 years in the making. Started off from fallout from the Mainzeal collapse back in 2013. It's been quite a journey to get it to this point. I think, as a kind of a general reflection on the industry, this bit of legislation shows just how far we've come. When this legislation was first discussed to protect retention money, there was a huge divide, in particular between main contractors and subcontractors. And very, very difficult to get consensus on any of these issues. And what we're seeing now is a general acceptance that this is just good practice, something that we need as an industry and something that will level out the industry as good practice for all. So, I think we can pat ourselves on the back that we've actually come a long way in that time. So, importantly, this Act is coming out at beginning of October, and there are some changes.

So, with me today, we've got Amy Moorhead from MBIE who has helped to draft this legislation. She'll be speaking on the kind of policy aspects of the Act. And then we've got Peter Degerholm who is well known to most. He’s a quantity surveyor, he's a mediator, and has dealt with a broad range of contractual issues across the sector and an industry expert who's led the development of this guidance.

So, without further ado, I will hand over to Amy.

Slide 2

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Construction Contracts (Retention Money) Amendment Act 2023.

• Significantly amends the Construction Contracts Act 2002, which transformed payment practices in NZ's construction industry.
• Follows the retention money regime established in 2017.
• Retentions on commercial construction contracts are now held in trust
• Covers all new commercial contracts from 5 October 2023.

Construction Contracts (Retention Money) Amendment Act 2023

• Public Act: 2023 No 12
• Date of assent: 5 April 2023
• Commencement: see section 2

Audio

Amy Moorhead: Thanks, Graham, and kia ora koutou. Welcome to the webinar, Peter is actually driving the slides. So, you'll hear me say, next slide, Peter, for the first couple of slides, and then we'll hand over to him where he can look after himself.

But I thought I'd just start today with a little bit of an overview on the Retention Money Amendment Act. Essentially, this was passed in April of this year. And the changes made in the Amendment Act are really aimed at strengthening and clarifying the retention money regime that came into force back in 2017. And in particular, the changes that we've made are really aimed at clarifying, in particular, the trust elements of the regime. So, these changes come into force on the 5th of October. And that means that they're going to apply to any construction contracts entered into after the 5^th of October, as well as any existing contracts that renews after the 5th of October.

Slide 3

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Construction Contracts 2002

• Outlawed pay when paid clauses
• Cannot contract out
• Progress payments – payment claim/payment schedule
• Fast tracked adjudication
• Enforcement
• But…applications restricted to residential contracts and retentions were not addressed
• Amendment Act 2015 removed restrictions on residential contracts and amended adjudication.

Audio

Amy Moorhead: For anybody on the call who is interested in the liquidation, receivership changes that we've made in the legislation which we'll get onto a little bit later, it’s probably just pertinent to note that you need liquidations and receiverships that start after the 5th of October will also benefit from these new provisions. So, just a little bit of background on the Construction Contracts Act itself. The primary purpose of the Construction Contracts Act when it was first passed, was really to outlaw pay when paid clauses. These clauses caused significant financial instability in the construction contract chain and left a lot of people really exposed. And the original Construction Contract Act originally dealt with this by setting up default payment provisions that are implied into contracts if parties don't agree on express terms for payment. And it also set up an adjudication process to deal with any disputes. Under construction contracts, in particular in relation to the payments schedule in 2015, we made a number of amendments to the Construction Contracts Act. The first set of amendments was really to open up the adjudication process and sort of the general benefits of the Construction Contracts Act to residential construction contracts. Previously, there had been residential construction contracts hadn't been a part of this legislation. The second set of amendments, more pertinent to this discussion today, introduced a new retention money regime that was set to govern the use of retentions.

Slide 4

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Understanding Party A and Party B:

• Party A is usually the main contractor ie the party withholding retention money.
• Party B is usually the subcontractor ie the party retention money is withheld from.

Audio

Amy Moorhead: Just a little bit of clarification in this presentation. Also in the legislation, and in our guidance material, we talk a lot about party A and party B. And I thought it would be useful at this point just to clarify exactly what we mean by those terms. So, party A is usually somebody like a main contractor. And what we mean by that is, it's the person who's withholding the retention money. Party B is usually someone like a subcontractor, that is the person who retention money has been withheld from. And I think it's important to just note here as well, that it is possible, depending on the contractual arrangements, for one organisation, or one person, to be both a party A and a party B at the same time.

Slide 5

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Construction Contracts Act amendments:

• Retention regime introduced in Construction Contracts Amendment Act 2015
• Minor amendments Regulatory Systems (Commercial Matters) Amendment Act 2017
• Applies to new commercial construction contracts from 31 March 2017 (still in force)
• Party A withholds 'retention money' from payee performing work (Party B) as surety for the performance of contact obligations must set that money aside as trust money
• Party A may 'commingle' retentions with other money
• Party A must keep proper accounting records and make them available to Party B on request
• Prohibited provisions outlaw certain terms, eg making the payment of retentions conditional on anything other than completion of Party B's contractual obligations.

Audio

Amy Moorhead:  So, the 2015 retention money provisions came into force in 2017. And essentially, those amendments were intended to create a deemed trust for retention money. It allowed the holder of retention money to commingle retentions with other money, but it did prohibit holders of retention money from using retention money unless it was paying that money back to the person who it had been withheld from under the construction contract, or if it was using the retention money to fix defective work that that person hadn't come back to fix. The other key amendment made in the 2015 Act was around the provision of information. So, Party A was required to keep good records of the retention money that they were holding, and make them available to Party B on request.

Slide 6

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A flow diagram is displayed with the heading ‘Shortcomings in the 2017 regime’. The diagram shows the following information with arrows connecting the first bullet point to the second, the second bullet point to the third etc

• Ebert construction failed.
• Subcontractor retention money set aside was only significant asset, significantly less than required.
• Receivers applied to the court to establish authority to disburse retentions withheld, how to be paid for that work, and how to address the shortfall.
• Court interpreted 2017 regime as creating an obligation to hold retention monies on trust rather than, as Parliament had seemingly intended, deeming retention money to be held on trust.
• Government moved to address these shortcomings.

Audio

Amy Moorhead:  Then, very shortly after the 2015 amendments came into force in 2017, we had the failure of Ebert construction. So, Ebert held around about $3.7 million in retention but owed around about $9.3 million dollars. And the liquidators in the Ebert case applied to the court to understand how those retention monies should be applied in practice. And the court had quite a lot of findings in relation to the 2015 amendments that introduced the retentions regime. And if you are interested, that court decision is available. But in summary, the court found that the Act wasn't really clear on what the trust requirements were. So, the Government moved to address these issues and the first step the Government took was to commission KPMG to prepare an implementation report to find out exactly how the regime was working, and were people compliant with it. And that KPMG report found key three things. The first, that retention money was being commingled or not being held in trust in a separate account. The second key finding was that information to subbies was being provided on a very variable basis. And the third key finding was that there were a lack of statutory mechanisms to determine the use of retention money as working capital. That really provided the basis for a lot of the policy work that subsequently occurred, and the changes that were made via the 2023 Amendment Act.

And from here, I'm going to hand over to Peter, who's going to take you through, in a bit more detail, what those changes are.

Slide 7

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How the act defines 'retention money'

• 18b(1) Where a commercial construction contract allows one party (party A) to withhold payment of an amount (a retainable amount) that would otherwise be payable to another party (party B) as security for the performance of party B’s obligations under the contract.
• 18B(2) A retainable amount becomes retention money at the time at which the construction contract allows party A to withhold payment of the amount form party B
• 18B (6) [The regime] also applies if…..party A withholds payment …even though the contract does not provide for that
• 18C(1) Retention money is trust money, held on trust by party A for party B, and party A must deal with it in accordance with this [regime]

Audio

Peter Degerholm: Thank you Amy. Picking up on Graham's comment at the start, it's quite an auspicious day that 10 years later we have a Supreme Court decision in relation to the Mainzeal case, for those who have caught up with the news. So, it makes it a rather red-letter day. The Amendment Act has gone into a little more depth now in defining retention money. And it actually says that it's allowed, it does not provide to make retentions mandatory. And what it does is say when money is withheld, for the purpose of surety for the performance of the contract obligations, that is retention money when it's provided in the contract. And when it's deducted, and it uses a term 'a retainable amount', which is the amount that the contract actually provides that the payer, Party A, may withhold. It also provides, for example, where a contract, where a party withholds retention money or money as surety for performance, even though there's no provision in the contract for retentions their obligations as a Party A in withholding that money arise. So, they can only hold retention money where the contract provides. But if they do hold retention money, despite the contract not providing, the same rules apply, and their accountability and liabilities as a Party A arise as a result of just withholding money. And you see some contracts, for example, where they'll pay 95% and hold back some money for three months, until you fix the defects. That, under the definition of retentions, means even though it's not a retainable amount in the contract, it is treated as retention money.

Slide 8

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Key changes in the Amendment Act 2023

• Retentions are defined
• Retentions automatically become trust money
• Party A becomes trustee for Party B's retentions
• Money withheld as surety for performance now retentions by default
• Party A must still keep proper records and still can't recover costs of administration
• Retention money protections have been strengthened.

Audio

Peter Degerholm: The definition of retentions is clearly in the Act. It is now very clear that retention money withheld is trust money. And there's been quite a lot of drafting amendments to make that absolutely crystal clear. The Party A that Amy referred to as the party withholding retention money, and as you said, usually our main contractor. Numerically most parties withholding retention money, main contractors, from subcontractors, but every main contractor, as a principal or a client who's holding retention money from them, they are also a Party A. So, the Party A becomes a trustee. And that means they inherit or assume the obligations of a trustee and Party B, the money that is withheld belongs permanently to Party B. And it can only be used for remedying defects and the performance of Party B's obligations. It's a little bit different to saying remedying defects, it means it failed to perform their obligations under the contract, then this is surety for that proper performance. Party A has to keep records and since 2017, every Party A has had to keep records. And my observation around that is that contractors have generally done that- a lot of principals probably haven't been too well aware of just what that means. And the Party A, also inconsistent with the 2017 regime, can't pass on the cost of administering the administration of that retention money. And in this Amendment Act, the retention money protections have been strengthened quite significantly.

Slide 9

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• Withholding retention money
  • MUST be kept in separate bank accounts
  • There must be one account for all retentions
  • Identified as ‘retention money trust account’
  • Bank must be informed of the nature of the account
  • Interest earned belongs to party A.
• Party A may instead arrange a 'complying instrument'
  • Obtained through bank or insurer.

Audio

Peter Degerholm: And I'll just go through just how it does that. In withholding retention money, it must be kept in a separate bank account. Whereas the commingling did leave some question marks as to just how to comply with that. And I think the KPMG report showed there was some fairly variable interpretations. And the Ebert collapse showed that, in fact, it perhaps wasn't being performed as well as one might have thought as it was intended. Now, there may be one account for all retentions, there may be one bank account for each subcontractor, there may be one bank account for one project for all subcontractors. The Act provides that it doesn't have to be one bank account. But in many respects, it probably is easier for most organizations to use their accounting system to account for the money and make sure that they are in a bank account. The bank account needs to be defined as retention trust money, the bank needs to be informed. And that means the label on that bank account means in the event of a liquidation, the liquidater is going to look at that money and say, don't touch it. The bank will also see that as not part of the company's balance sheet. It is money that has held earning interest for the benefit of the party that's holding it. And it's their only interest in that money is the interest that is earned on those funds. There is an alternative to withholding, to setting the money in a bank account. And that is a complying instrument and, in the guidance, there's a fair bit of detail on that but in effect, it's a bank guarantee or insurance product. And the Act is very clear that it's not just any bank or any insurer. They must fit the definition. The bank or insurer is going to require surety from the party taking it out. It's not something you just buy off the shelf. So, in all respects, it's a bank bond or an insurance bond to protect the amount of retention money that is held or part of the retention money as well. So, for example, a payer, a Party A has a million dollars worth of retentions held in the bank account, and they have a half a million dollar complying instrument, then they only need to keep half a million dollars in the bank account, because the other half is protected by the complying instrument.

Slide 10

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Party A must report to Party B

• As soon as possible after each transaction
• May be in payment schedule for a particular contract
• At least quarterly on all contracts.

Must include:

Retention transactions

• Amounts withheld
• Bank account name and number
• Statement that the payee may inspect the payer's accounts and records.

Must report even if complying instrument provided.

Audio

Peter Degerholm:  The completely new requirement, and Amy mentioned that there was fairly patchy adherence to the requirement to provide information. In the regime that came in 2017, RDA had to, on request and without charge, provide information on the accounting records to Party B. Anecdotally, at least, there weren't many responses to those requests, and there was no consequences of a failure to respond. So, Party B could not have any comfort that their retention money was in fact being held properly. So, they’ve turned the tables on that provision and said, well, you still got to hold the accounting records but rather than asking, there's a positive obligation on Party A to declare to Party B, effectively making a statutory declaration. It's not called a statutory declaration, but a statutory requirement to report with every time there's a transaction, and the retentions, a deduction and a payment schedule or release, to notify that we are now holding this amount of retention money. And at least every three months, I've used the term quarterly because it's a bit easier to understand, but at least a quarterly report on the status of all of the retention money held from a party B. So, the monthly one, the routine one will effectively be information that could be contained in a payment schedule, if the information is available, because that's the time when the transaction happens, but the Act says as soon as practical after the transaction. And the quarterly one will be and I've got some examples, which I'll show you in a moment. The information that must be included in each of those reports, whether it's the transaction report or the quarterly report, as the amount of retention money withheld. And transaction withholding another $5,000 from you, now we're holding $20,000. So, these two amounts that are relevant, the bank account number and the bank account name, and the name of the bank. So if the Party B doesn't believe they can check with the bank. It certainly gives the receiver or the liquidator, access direct to that account. And a statement that Party B may inspect the payers accounts and records. Now, they wouldn't need to if they were given adequate information. And even if there's a complying instrument provided, it doesn't take away the need to do the reporting. So having the accounting systems, having the reporting in place are mandatory, and having the choice to hold a bank account or to cover that amount with a complying instrument, a bank or insurance bond, is optional to the Party A, the one holding the retentions.

Slide 11

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Example future payment schedule, for a particular construction contract

• Retentions withheld from (or released with) this payment.
• How retentions are secured
• Statement that party B may inspect party A's retention accounting records and details.

Also displayed on the slide is an example of a payment schedule.

Audio

Peter Degerholm:  An example of a typical payment schedule. In the bottom part of the payment of this model form in the shaded area, is the information that we might see in payment schedules. The Act does not require it to be in a payment schedule, because it's very clear and the select committee was quite clear payment schedules are for a purpose, which is not a retention report. However, that doesn't prevent the reporting information being included in a payment schedule. So, the retentions, withheld or released. Now what we always show in a payment schedule is the total retentions held, but the transaction amount is the difference between this payment and the last payment and the movement of retentions. So, we're likely to see a little bit of a side calculation on the retentions. And this is not a mandatory form, it’s just showing how the content might be presented, how the retentions are secured. And that means for in this case, Party A has got some money protected by an instrument and some of the money in a bank account and the bank account is named the instrument, the insurance company that's holding the instrument, and the number, the policy number or the instrument number is recorded as well, so that it's absolutely traceable. Remember this is trust money. And then thirdly, a statement that Party B may inspect the records and this statement is really just a reflection of what the Act says, it's reminding them that they can look at the records. And it's also pointing to say, you can't look at our accounting system, you can look at the records in relation to the retention money we are holding from you. And it's making it clear that it sort of is intended, that statement, to have statutory effect.

Slide 12

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Example quarterly report. For each party B:

• Retentions withheld, by contract
• Accounting details – transactions
• How retentions are secured
• Statement that party B may inspect party A’s retention accounting records and details.

Audio

Amy Moorhead:  So when we look at a quarterly report in the banks, the Act says not less than every three months, the same information the retention is held, but this is by contract. So, this is all of the retention money held from a party. The accounting details and they may be more or less, it may be that they might put all of the transactions or just the transactions on the quarter. But showing these are the accounting records that we are holding for you. How the retentions are secured, the same as in the monthly report and the statement. That was also in the monthly report about this is intended to be a report under the retention regime.

Slide 13

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Paying and using retention money

Changing:

• Party A may only use retention money for purposes set out in the contract
• Must give 10 working days written notice specifying defects in performance.

Not changing:

• Due date for payment of retentions cannot be later than date of completion of contract obligations
• Terms making payment of retentions, or due date for payment, conditional on anything other than party B's performance of its contract obligations are 'prohibited provisions'
• Interest payable on late release of retentions.

Audio

Peter Degerholm: So other changes are clarified and strengthened is things that are changing. It's quite clear now that Party A can only use retention money for the purposes set out on the contract. A contract that says we have the right to hold retentions does not specify the purpose of those retentions. And I suggest that a lot of contracts and subcontract agreements are going to have to be looked at closely to make sure that they actually do specify a purpose. If there's no purpose stated, there's absolutely no reason to use the retentions. There's also a new requirement that a Party A intends to use the retention money, then they've got to give 10 working days written notice to Party B, setting out their intention to use that retention money and specifying the defects under performance to be remedied. My guess is that that's intended to provide your party B an opportunity to remedy them. So, the retention money doesn't have to be spent. But it also reflects that it is trust money. The other things in the regime that haven't changed, there's prohibited provisions. If you have a contract that says we'll pay, here's a provision for release of retentions that's related to anything other than the date of completion of the work. For example, a scaffolder might have some retentions held from them, seems a little unlikely, but if they do have, we can't tie them to practical completion of their head contract or the retention release date. When they've removed the last of this scaffolding, any retention money withheld from them must be released. So although a head contractor will have retention money held up until practical completion. And many of those, of the sub trades will, because their work is inspected finally on practical completion, some early finish trades, the contractor will be releasing those subcontractors retentions earlier, and it's normal practice. But it's just very clear that if a subcontractor signed a subcontract agreement, and there was a prohibited provision, it would be like a pay with pay clause, it would have no legal effect. Any terms making payment of retentions subject to Party B's performance of their obligations under the contract, will also be a prohibited provision. There's also the existing provisions for interest payable on the late release of retentions. There is provision for regulations. And it'd be interesting just to see whether regulations are eventually made. As it stands it is the higher of the rate under the contract or regulations. I haven't seen a subcontract agreement with an interest provision. So, for most subcontracts, the effective interest rate is presently 0%. Perhaps Amy, you'd like to speak to the accountability of directors of organisations.

Slide 14

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Directors of organisations are liable:

• Fail to keep retentions in separate account (up to $200,000)
• Fail to keep proper accounting records ($50,000)
• Fail to provide quarterly report to payees ($50,000)
• Give false or misleading information to party B in relation to retention money or complying instrument ($50,000)
• Fail to provide information to MBIE ($50,000/$200,000)

MBIE Chief Executive has the power to take enforcement action.

Audio

Amy Moorhead: Sure thing, thanks Peter. Another one of the major changes that we've bought in the 2023 Amendment Act is offenses and penalties. As I mentioned earlier, one of the findings of the KPMG report is that there wasn't really sufficient tatutory deterrence for people failing to uphold their obligations under the retention money regime. And as a result, we have now introduced a range of offenses and penalties for people who fail to meet their obligation under the retention money regime. So, I won't read through all of them, you can see them up there on the screen. And these are outlined in our guidance document as well. What I would point out is that there are offenses and penalties both for individuals, as well as companies, as well as directors of companie in some instances. In terms of how these offenses and penalties might be applied in practice, anyone who discovers any breach of the Act is of course free to take their own legal course of action through the courts to have those fines applied. One of the other amendments that we have made is that the MBIE Chief Executive also has the power to take enforcement action. So, this would be in cases where you have somebody who is not just in breach of the Act, but that breach is significant and egregious and would make the usual test set out and the Solicitor General guidelines. MBIE would in those cases, step in to take enforcement action as appropriate.

Peter Degerholm: And my guess, my hope is that the accountability will actually lift the compliance of itself. But if a Party B felt the obligations weren't being met, I would expect that they would first approach Party A, and perhaps a little bit of education might be a good start, because Party A may not even be aware of their obligations. It will take some time to be done.

Slide 15

Visuals

Impact on party A

• Dedicated band account, cannot commingle
• Must proactively report to each party B
• Must give advance notice before using retentions
• Severe penalties for non-compliance.

Audio

Peter Degerholm:  So if we look at the impact on Party A, and bear in mind that Party A is not just contractors. Party A is every principle that’s holding retention money from a contractor, it is every contractor holding retention money on a subcontractor, and we're talking about on commercial construction contracts, that is, not with a homeowner. And even a subcontractor holding retention money on a sub sub contractor is a Party A in that situation. So, in discussion with contractors and the organisations that provide the accounting systems to the contractors, I think my observation, and it's anecdotal, is that most of the contractors do have money set aside in a bank account. They are going to have to least rename those bank accounts, they're going to have to make an adjustment to the bank account, because even though they were not commingling the money, it probably doesn't meet the requirements. And they're going to have to check in with their bank and make sure the bank has been notified, that’s just one important step. They're going to have to now report proactively to each Party B on the retention money. Once again, and so exploring just how this might work, in practice, most of the contractors, construction accounting systems are pretty sophisticated with their retention money, it's a large part of the money that sits in a contractor's bank account. And for most of them, it will be simply a matter, once I've adjusted the bank accounts, it's actually customizing a report, it may be pressing a quarterly frequency or a monthly frequency and spitting out an email report. I suggest for a lot of other organizations that might be a little more difficult. First of all, they’ve got to set up the accounting system, the accounting, and then they have to set up the reporting. And that will be a certainly a fairly manual operation. I mean, even for example, a school committee, a board of trustees engaging a contractor to do a school building, they're going to have the same obligations for tracking the retentions, accounting for the retentions and reporting on those retentions. So, they're going to have to look very closely at how they manage those going forward. The old story of how we've used up/there's no money due, won't work. So, if there's a defect, the contractor or subcontractor, depending on who the Party B is, will need to be notified, given the opportunity to remedy them and then the 10 working days before the retention money is spent. And as Amy said, there's potential severe penalties for compliance and those penalties are not just a penalty, that is per offence. A contractor, that's got 100 subcontractors, do the maths, work out their potential liability. So, the consequences for just ignoring this are potentially very significant.

Slide 16

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Impact on party B:

• Retentions are protected against failure of party A
• Receiver or liquidator would be trustee for distribution of retentions upon failure of party A
• Entitled to receive regular reports from party A on how retentions are being withheld
• Party A is liable to fines for non-compliance.

Audio

Peter Degerholm: So if you're a Party B, I think the subcontractors, I guess they can sit back and say, well we are the ultimate beneficiaries. They won't see anything different other than that they're going to start receiving the report. And I think that's going to take away perhaps some of the practice that certainly preceded the 2015 Amendments, where retention money that was never claimed, never got paid out. That should not happen because the retention money permanently belongs to Party B, they are the trustee so that it's held on trust for them. It also means that in the event of a liquidation, the liquidator doesn't have to apply to the court to give directions on how to manage the shortfall, because that's addressed in the regime. They don't have to apply to the court to get even the power to administer it, the regime provides the power to the administrator, be it a liquidator, or a receiver of the assets of the failed Party A company. And I think their reporting is something that will also mean subcontractors will be in a far better position to be reminded, oh there's some retention money being held from you, oh we finished that job. Even if that's not proactively released to them, they will be more likely to be aware of the retention money and their rights to pursue the recovery of those. In practice, I think we'll see Party As saying we really don't want to hold on to the retention any longer than we need to. And they'll proactively manage the release of retentions. We've got practical completion, sow let's release them to this group of subcontractors on a particular contract. And I think we'll see cashflow benefits arising from that. And I would hope we don't see lots of fines being bandied around that would just mean people are ignoring it, I just would not want to be the one who has been found to be falling short of it.

Slide 17

Visuals

Action is required

Not already complying with the 2017 regime:

• Establish proper retention accounting
• Establish compliant bank accounts
• Implement reporting to each party A.

Already compliant with the 2017 regime:

• Establish compliant bank accounts
• Implement reporting to each party.

Check contracts are consistent with the regime eg no 'prohibited provisions'.

Audio

Peter Degerholm: So it's particularly the Party A's that have work to do. And as Amy said, a Party A could be a client, an owner, a principal, but mostly they are contractors and occasionally, they'll even be subcontractors where they employ sub subcontractors in a residential building situation. A builder who's working for a homeowner, their retentions aren't protected by the regime. But if they hold retentions from their subcontractors, then they are a Party A. So, while the builders working for a homeowner, the subcontractors are working for a builder and theirs is a commercial subcontract, as a commercial contract. So, for an organisation that's not already complying with a regime, and that means we’re not setting the retentions aside in a separate account, we don't really have proper accounting, we'll sort of wait until the claim comes in, we've got to start thinking about how do we proactively manage retentions. We’re accounting now for money that is not just trust money, and there's significant consequences for not doing so. If we are already complying with the 2015 amendments that came in in 2017, we're still going to have to change bank accounts. And we're still going to have to implement the reporting. And hopefully, that will be a fairly small step for those that are complying. But we all have work to do. And I think it's also really important that we have a look at our contracts and subcontracts, the 2023 DZ3910, which is the revision that is due out in the end of this year, did have some changes. The draft that went to public comment was signed off by the committee for public comment about in the same week that this Amendment Act was passed. So even though the public comment, there's actually been a bit of revisiting of some of those provisions as well, just to make sure that it ticks the boxes in terms of no prohibited provisions, for example.

Slide 18

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Industry guidance is available

www.building.govt.nz/projects-and-consents/why-contracts-are-valuable/construction-contracts-retention-money-amendment-act-2023/

Audio

And so really, that's in a nutshell, hopefully you've received the link with the industry guidance. It's taken a lot of work to get that together. And what it aims to do is focuses on the Party As. Those that hold retention money have the work to do. But it also provides a little bit of information around, to try and assist the advisors, the accountants who may not fully understand the dynamics of a retention system. There's a section there for accountants. There's also a section here for liquidators and receivers and insolvency specialists. So if they come in to the tail end of a company or contract that's failed, there’s some guidance there that will assist them to at least get a general understanding of the way the regime is intended to work. So, you've got the links there, and hopefully you've already seen them. I'll hand back now to Graham to take any questions. And Amy or myself, or Graham, can speak to those, answer them. Thank you.

Slide 19 - end of presentation

Visuals

Thank you. Questions?

Audio

Graham Burke: Thank you, Peter. And, Amy. Very thorough, and yes, we have got a heap of questions here. Just a reminder to everybody that we can't provide you with specific legal advice, that you should actually seek advice from an appropriate professional.

Questions and answers session

Visuals

Amy Moorhead and Peter Degerholm appear on screen as they answer questions submitted throughout the webinar, as read by Graham Burke. 

Audio

Graham Burke: Can you please confirm how the interest earned on retention money is treated?

Amy Moorhead: So generally, that's one of the things that isn't changing. Generally, that interest earned on retention money would go to Party A.

Graham Burke: What happens if the main contractor goes into liquidation?

Peter Degerholm: The receiver or the liquidator in that case becomes the trustee for the retention money and has the authority to distribute the retention money. But if their retention money is short, there's also provisions for prorating the retention money. The only deduction from that is the reasonable cost of the liquidator that they can recover from the fund. The fund will pay their costs but they would have to be very careful in allocating and the guidance actually sets it out fairly explicitly, that they don't just charge the cost of the liquidation to the retention fund. They can only charge to that the cost of distributing the retentions.

Graham Burke: Amy, how would the law treat a creditor who hasn't had sufficient funds or net liquidate in their retention fund? Should they go into receivership?

Amy Moorhead: I think that would probably be a question that the liquidator or the receiver would consider. But you know, if it's a contract that's entered into after these new provisions come into effect, they may also be liable for some pretty hefty fines. Noting of course that if you're in a receivership or a liquidation situation, there may not be any money available. But that's really one of the reasons that we included some of the offence penalties directly to directors and their personal capacity in some instances.

Graham Burke: How much liaison has there been with the banks regarding the new requirements? We have been talking to a main trading bank who cannot easily name the account as retention money account. Also interested in how the accounts are designated within the banking system so they are differentiated as trust money and not subject to the bank's usual rights to say, put a lien on the account?

Amy Moorhead: I was actually quite interested to read that comment in the chat. We had quite a lot of interaction with banks and the development of the legislation and also through the select committee process. So, I was a little bit surprised to hear that. But look, banks are dealing with trust accounts all the time. They have to do this in a number of other areas, the legal profession would be one that immediately springs to mind. So, I would be very surprised to hear if there's any difficulties on that front. If it's an issue with the party that is holding the bank account or that is the name on the bank account, we have actually introduced some amendments by the 2023 Amendment Act that just specifies the sort of third parties that may hold the retentions in a named bank account. I would be very surprised to hear that there would be any difficulties on the part of banks to be implementing this. It's a very straightforward and common thing that they do.

Graham Burke: What's party B entitled to see if they want to inspect records? How do they ensure that party A has enough in trust to cover all of the retention obligations to all party B's?

Peter Degerholm: The Act requires them to provide information on the retention money that is withheld from that party. And individually and collectively, if they're giving accurate information to each party and there's some something misleading, certainly they're exposed to fines for giving misleading information. So, I don't think it would be a legitimate question to say, I want to know how much retention money you're holding from all party Bs.

Graham Burke: Re possible definitions of defects and performance obligations, could this cover late completion with retentions used to cover liquidated damages?

Peter Degerholm: I think we're going to be seeing some interesting debate around just what is a defect and the performance of the work. And late completion, I would say it's not something that can be remedied. I would question whether that actually fits within the definition.

Graham Burke: Can you only pay retentions from the specified trust account or can you transfer it from the trust account to your working 00 bank account and pay it from there?

Amy Moorhead: The Act doesn't really specify that level of detail in terms of how payments are made from the retention account. Peter, I'm pretty sure that we don't really cover this in the legislation because if you're making the payment, then you're meeting your obligation to pay the money to the person to whom it's owed, but I defer to you on any detail.

Peter Degerholm: Yes and I had significant input from the accountants on this. And it was really about it's actually the money until it's paid to party B, it’s held by party A. So, I mean you could imagine the situation that they might put it in the 00 and then the receivers move in and it's disappeared in that instant. The reality is, it's actually got to be held in that bank account, and it's got to be paid. But the mechanism for payment, I think, is, as Amy says, it's not trying to tell them how to do the accounting. It's only the liability is very clear.

Graham Burke: Can the subcontractor retention be linked to the overall practical completion date of the contract and therefore any interest payments would commence from this date?

Peter Degerholm: I would say yes. Because if the subcontractors should not have to wait until they put in a claim for their retentions. That is the late release of the retention money. If it's just 50% of the retention due on practical completion, and they're not paid when practical completion occurs, then I would expect that there’s interest provisions, noting that the subcontract agreement interest provision is 0%. It doesn't actually give them a lot of money but unless it’s regulated, if it is regulated to a certain amount, then I would say the right to interest would arise. I think that would be useful if it was clear, because it would certainly encourage a proactive release if there was a real consequence. We'll just have to watch this space.

Graham Burke: Does the legislation apply to projects we signed the contract only after October or any projects that are currently going on? So, I'm thinking they're talking about transition - do the rules apply to contracts in progress at the start date in October?

Amy Moorhead: No, they do not. The only case where it might apply to a project that's currently underway, where there's a contract already in place, is if you renew that contract after the 5th of October. In all other cases, if you entered into a contract before the 5th of October this year, the original retention money provisions will apply.

Peter Degerholm: I’d just like to add a comment to that. In discussion once again with accounting and contract, some contractors will actually start the reporting on the new contracts. The obligation to hold and keep accounting records are the same. Others will say we've got all the money there, let's put it into one account. And we're going to report to all of our subcontractors on all of our contracts. So, I think the behaviours will vary. But if we fast forward two or three years down the track, we're going to find that all retentions will eventually be caught in the reporting. It will take a little time for that transition.

Graham Burke: Is there any clarity on whether retention money can only be used by party A for actual defects as opposed to performance issues such as engaging a replacement subcontractor to complete unfinished works?

Peter Degerholm: My interpretation of that is if engaging another subcontractor was due to a failure to perform contractual obligations, and that was a cost in fulfilling those contractual obligations, then arguably the retention money could be used for that, but not just kicking a subcontractor off and getting another one on board. There would have to be the contractual processes. This does not overtake contractual processes.

Graham Burke: I think you've actually answered this question, but I'll ask it again because it obviously needs clarifying. Does that mean there is no way to link the subcontractors performance to the practical completion of the head contract? I understand that, in theory, subcontractor work should be defected as the work is completed, but in reality, it is often the case that defects aren't identified until near completion of the project, which can be some time after the subcontractor has completed his work.

Peter Degerholm: The guidance was actually around a demolition company, because that's pretty obvious. They've demolished the work and have provided all the certification of disposal. They’re not likely to find any defects in the demolition work so it's an extreme example. There's some where it's not entirely clear. But there are some, for example, when they actually commission the system on and that is practically complete. They also will have a defect period, because the work that they've done needs to have, it's legitimate as their obligations are not completed until it’s signed off after the end of any defects notification period. So, all of those provisions remain in place. But it's more that some sub trades will not fit that definition and will clearly fall out of it. There will be some where it might be argued, well I finished the roof six months before and there will be some question marks around whether in fact practical completion is the proper time to sign it off. So, there are some question marks that just won't be able to get a precise answer on some trades.

Graham Burke: How's it envisaged that a Council manages this? I don't believe many, if any councils have separate bank accounts for retentions, but retentions are typically recorded in their accounting system.

Amy Moorhead: So that would probably be a question that I'd put back to Councils. There's no exemptions from the retention money provisions. They apply to anybody who's holding retentions regardless of whether it's central government, local councils, or anybody else. So, you know, it's really for the various party As, or the holders of retention money, to have a really good look at the way that they’re operating. It's going to be probably a little bit different for everyone. You might have different considerations, but I'd really encourage everybody who's holding retention money to have a good look at what they're doing and what they need to do to comply.

Peter Degerholm: And just to add to that, there is provision for our Government, is subject to the Public Finance Act, there's specific provisions. Also, it also refers to a trading enterprise or local authority can put their money into the Council's account. So, ownership of the account is clarified quite clearly, but no one is, as Amy said, immune from complying with those obligations, and most importantly, with the reporting obligations.

Graham Burke: Somebody's made a comment here, I see a great future for bank guarantees with those penalties and the administration involved. I'm not exactly sure what's meant by that. But I invite comments from Amy first, and then Peter.

Amy Moorhead: As we always say, retentions is a voluntary practice. Where people choose to use retention money, it must be as per the Construction Contracts Act. And the reason behind that is really to protect people from the financial failure of the people holding that retention money. If people want to start moving towards other forms of holding retention money, those things offer equal protections I would argue. It's really up to the people who are holding retention money, using those as part of their contracts, to decide how to go forward from here.

Graham Burke: You have anything to add to that, Peter?

Peter Degerholm: I certainly hear some indications that some are not going to have retentions, will just insist on performance bonds, for example. We sort of think as an industry there is a need for surety for performance, but I still don't have an answer as to why do we need retentions plus bonds. Maybe we need to rethink the equation. One thing I am hearing is that a lot of contractors talking to the subcontractors and some clients talking to their contractors and saying, look we held retentions on you and a whole lot of contracts. What about giving us an overarching bond to a surety for your performance? So, I think we started to get some adult conversations around what real surety looks like without adding a lot of cost. So, it will be really interesting just to see what influence it has on behaviours. I would hope it's a positive influence rather than just demanding more performance bonds. It just takes so much cash out of the industry.

Graham Burke: What add-on do organisations use with Xero to track and report on these retentions? We had a question before the webinar asking do we have suggestions for accounting packages that account for this? Just bear in mind that the Accord's not going to actually recommend or nominate a product. Are you able to give a reasonably simple answer to the Xero question, Peter?

Peter Degerholm: I think Xero, if they've seen this coming, they will have developed some sort of app or encouraged an organization to develop some sort of app. I have during the drafting of this guidance, been talking with a couple of companies that have actually been looking ahead. And I'm sure all of those construction accounting organisations have. So, it's probably relatively straightforward for those that are construction specific accounting, and I would expect their accounting systems would be fairly easily tweaked. As to the Zero type of basis, it certainly wouldn't reside in Xero but it may be that there's an app that will or should talk to it. It will take some time.

Graham Burke: Will the format document be updated to reflect these changes?

Peter Degerholm: Personally, I don't see any need to because the form one document is only about the obligation to respond to a payment. One of the things that a payment schedule needs for retention money is one of the deductions or adjustment shown in the payment schedule. No payment schedule has the same effect. I don't think the form one needs to be tweaked, but Amy, you may have a different view.

Graham Burke: Most of our clients already hold retentions and a separate bank account. Does this mean a liquidator will only recognise retentions held on trust on new contracts post-October 23?

Peter Degerholm: No, because if the contract was entered into after the 31st of March 2017, that retention money should be in a separate account. And the specific provision is that the liquidator has control over those accounts, the retention money that is withheld. So, anything prior to 31 March 2017 would be all bets are off. But anything then would be similar to the Ebert situation except that it now clarifies that the liquidator has the same powers in the event of insolvency. The ones that should have been available to its liquidator, they are there now in respect to those earlier contracts.

Graham Burke: What prevents party A from drawing monies from the trust accounts?

Amy Moorhead: There's a few penalties for doing that, I believe. I mean, the obligations and the Act dictate how party A needs to treat that money. And then what I would point to is there are penalties available for not doing that. As Peter said, with the penalties applying for each instance of non-compliance, that's going to stack up. Peter, do you have anything to add to that?There's a few penalties for doing that, I believe. I mean, the obligations and the Act dictate how party A needs to treat that money. And then what I would point to is there are penalties available for not doing that. As Peter said, with the penalties applying for each instance of non-compliance, that's going to stack up. Peter, do you have anything to add to that?

Peter Degerholm: I would just think perhaps ask Jenny Shipley and her colleagues whether it really matters taking, not following the rules. We have speed limits and people speed. So, some people might take shortcuts, you just don't want to get caught in the crosshairs. I would actually say it will certainly reduce the likelihood of that. The other thing that's important in the guidance, there was also a suggestion there about setting up some management reports because it's the Directors who are accountable and they should actually have a window into their accounting system. And one of the things is suggesting a report, for example, that the money held for retentions is offset by a dedicated bank account, and for an instrument, and so that they should actually get a one page report that satisfies them every month. That's in the guidance, as well. Directors should take an interest in what your quantity surveyors are doing and what your accounting people are doing.

Graham Burke: Can the final penalty be covered by insurance? Or is it not insurable? Like health and safety fines?

Amy Moorhead: I'm not entirely sure I know the answer to that. I think that's probably a question for your insurer. Peter?

Peter Degerholm: Health and safety was specific that it can't be insured so there's no reference in there. I would agree with Amy, it's a matter for the insurer. But it doesn't look good on the six o'clock news.

Graham Burke: I'd say good luck getting insurance if you're likely to default on it.

Amy Moorhead: I was just about to say that.

Peter Degerholm: I know Warren Tucker from Aon Insurance has just put up a note that just popped up on screen. I didn't read it at all.

Graham Burke (reading Warren's note): At this time, the policy wordings there is nothing to exclude the payment of the fine. It is possible that the insurance companies will amend their wordings to exclude these fines for the same reason as health and safety and employment, not in public interest.

Conclusion

Graham Burke: I think that's a pretty good note to finish on. It's been a really informative session. Thank you very much, Amy and Peter. I think we've had, I looked at one point, we had 235 people on the call. And I think we've got that number pretty much right to the end. So, thank you very much for listening. I believe this will be available on our website shortly. And just a reminder that you should seek professional advice for any specific legal questions. Again, thank you very much, Amy and Peter, and we will see everybody soon at the next webinar.