The NSW Government this week released draft regulations for public consultations, which if approved, will require head contractors on large projects to hold any cash retentions on trust for subcontractors in new Retention Money Trust Accounts.
With the detailed review of the Security of Payment legislation in 2015, the Government had previously intimated that this reform would be bundled into that review. Instead, subcontractors and industry stakeholders now have an early Christmas stocking-filler to mull over in time for the close of submissions on 8 January 2015.
Interested parties should review the following documents:
- The Building and Construction Industry Security of Payment Amendment (Retention Money Trust Account) Regulation 2014 – Public Consultation Draft (Draft Regulations)
- The Regulatory Impact Statement – December 2014
- The media release from the Minister for Fair Trading, Mathew Mason-Cox, 8 December 2014
These can be accessed by clicking on the Security of Payment link on the NSW Fair Trading website here.
The key aspects of the proposed model for Retention Money Trust Accounts are as follows:
Initial application to large projects only
- It will only apply to:
- constructions contracts entered into after the commencement of the amending Regulations; and
- projects where the contract between a head contractor and Principal has a ‘value’ of $20 million or greater.
- The ‘value’ will be determined including variations, such that projects may not initially be caught at the time of contract execution, but could exceed the threshold during the project.
- The NSW Government will later consider widening the net to apply to all commercial subcontracts of $1 million or more.
Retention Money Trust Accounts and the increased role of banks
- In a departure from the initial intentions of the Government (see our previous article here, the Regulations do not provide for an overarching retention trust scheme to be administered by the Office of Small Business Commissioner. Instead, the Draft Regulations avoid direct Government involvement (save for in a supervisory and enforcement capacity) and instead implement a system where banks and other approved financial services providers will be the direct players with head contractors in the new scheme.
- Retention Money Trust Accounts will need to be established by head contractors with an approved authorised deposit-taking institution (ADI)
- Banks and other financial institutions with approved ADI status are largely custodians of funds, with no obligations to control or supervise the transactions or the use of disbursed funds. However they also face fines of up to $22,000 if they:
- fail to inform the Chief Executive of the NSW Office of Finance and Services (Chief Executive) of certain matters, as soon as reasonably practicable after becoming aware of the overdrawn trust account; or
- fail to inform the Chief Executive of certain matters, as soon as reasonably practicable after becoming aware of a dishonoured cheque.
- In this respect, the scheme appears to borrow from the existing legislative framework for real-estate agents to open and administer trust accounts with banks under the Property, Stock and Business Agents Act 2002
- Interest earned in a retention money trust account will also be held on trust unless otherwise agreed in writing between the head contractor and the subcontractor.
- Separate trust accounts can be created in respect of each subcontractor, each project or each head contractor, however, head contractors should be wary of creating multiple accounts given the audit and reporting requirements apply to each account (along with a yet-to-be-confirmed lodgement fee).
Protection of retention money in the event of insolvency and preserving rights of recourse by head-contractors
- If the head contractor becomes contractually entitled to have recourse to the retention money, then it ceases to be ‘retention money’ for the purpose of the Regulations and the requirement for holding this amount on trust ceases.
- Except for any ‘just claim’ (ie contractual entitlement to have recourse as described above) the head contractor cannot utilise retention money to pay its debts. The Minister’s media release justified the amendments as follows:
“This will end the widespread industry practice of using subcontractors’ trust money for the head contractor’s working capital purposes. At the end of the day, this money belongs to subcontractors and it’s about time it was protected as such.”
- Banks and other financial institutions with approved ADI status have no right of recourse to funds in the trust account for the purpose of satisfying any debt or liability from the head contractor and the retention money cannot be ‘attached’ or taken in execution for satisfying a judgment debt against the head contractor.
Head contractors as trustees with penalties for non-compliance
- Head contractors face fines of up to $22,000 if they:
- fail to establish a retention trust money account with an approved ADI and fail to provide the relevant notifications, in the form and within the times required, to the ADI and to the Chief Executive
- fail to hold retention money on trust in a retention money trust account with an approved ADI
- withdraw retention money otherwise than in accordance with the construction contract or an order of a court or tribunal
- fail to notify the Chief Executive, in the form and within the times required, of any overdrawn trust account or the closing of a trust account
- fail to keep the requisite records and maintain these records for at least three years
- fail to comply with a direction to provide specified information to the Chief Executive
- fail to provide, within 1 month after the end of each financial year:
- an Account Review Report (by a registered company auditor under the Corporations Act 2001); and
- a Retention Account Statement (in the form set out in Schedule 2 of the Regulations)
- provide a Retention Account Statement, or any other information to the Chief Executive, that is knowingly false or misleading in material particular
- The adequacy and effectiveness of these penalties will be reviewed in due course and consideration will be given to introducing directors’ personal liability for unpaid retention money.
Circumventing the new regime
The amendments to the Security of Payment legislation that were introduced in April 2014 left the door open for the Regulations to require retention money to be retained on trust. Instead, the Draft Regulations are only applicable in circumstances where the construction contract already requires money to be retained from progress payments.
In other words, it will be open to head contractors to circumvent the new requirements by imposing alternative security requirements (such as bank guarantees or insurance bonds) on their subcontractors.
The reason cash retentions are so prevalent under subcontracts is their ease of administration, negligible cost in establishment and the fact that most subcontractors won’t be capable of obtaining unconditional bank guarantees (which ordinarily require contractors to provide security over assets or working capital). The Government seems to be taking a punt that these factors will outweigh any detriment or increased burden imposed by the new retention trust scheme which would otherwise encourage head contractors to look for alternative security requirements.
The penalties, lodgement fees, audit requirements and the increased obligations on head contractors generally as trustees are likely be a key target for submissions from head contractor organisations.
It’s important that the right balance is struck to ensure that the reforms don’t backfire by effectively removing cash retention as a viable form of security, which could have the unintended consequence of subcontractors being forced to obtain more expensive means of security in order to successfully win work, to the detriment of the smaller businesses that the amendments are designed to protect.
NSW focuses on subcontractor protections in its reforms
NSW is leading the charge in respect of Australian Security of Payment reforms aimed at protecting subcontractors with the most notable changes being the introduction of the Payment Withholding Request in 2011 and the prompt payment and other reforms introduced in Easter 2014 (see our previous article here and here.
The NSW Government has also been trialling the use of Project Bank Accounts (where progress payments are also held on trust for subcontractors) on major government projects this year.
Queensland and Western Australia are following suit (see our recent article here. and look set to implement similar retention trust schemes should the NSW scheme prove successful.
The NSW Government did not support the imposition of a statutory construction trust governing all progress payments (similar to the system in several North American jurisdictions) – the primary recommendation from Bruce Collins QC in his January 2013 report on Insolvency in the NSW Construction Industry.
Should the retention trust model prove successful, it could lay the foundations for the implementation over time, of a more ambitious statutory construction trust model or the mandating of project bank accounts. Alternatively, once industry stakeholders become accustomed to the new scheme and to the extent that experiences are positive, then it could also have the effect of encouraging greater experimentation with contractual trust account arrangements for progress payments, particularly, if banks begin to market alternative products as a means of securing greater market share.
Putting the crystal-ball gazing to one side, the Draft Regulations, if implemented, will introduce a ground-breaking Retention Trust Money Scheme in NSW and one that is likely to have considerable impacts (not all of which may be favourable) on all contracting parties on large construction projects.
Industry stakeholders should be closely considering the Draft Regulations and, if appropriate, making submissions to influence the model which the NSW Government seems keen to introduce early in the New Year.