After a lengthy gestation (the government’s consultation paper was issued in November 2013), the NSW Government has released its revised proposal for a retention trust scheme for the NSW construction industry. The consultation draft Building and Construction Industry Security of Payment Amendment (Retention Trust Money Account) Regulation 2014 and regulatory impact statement are on the NSW Fair Trading website.

Industry participants are able to comment on the draft Regulation until 8 January 2015. Despite the lengthy period of silence since the initial consultation paper and the relatively short consultation period, the proposed commencement date is 1 February 2015.

APPLICATION OF THE DRAFT REGULATION

New contracts only

The new provisions will only apply to contracts entered into after the commencement of the new Regulation. So arrangements after existing contracts are not affected, but the Regulation may apply if there is an amendment or restatement of the contract after the Regulation commences.

Head contractors only

The new provisions will only apply to retention moneys being held by ‘head contractors’ as defined in the Security of Payment Act, that is, to the contractor that is intermediary between the project ‘principal’  and any ‘subcontractor’. It will not apply to ‘principals’. It will not apply to ‘subcontractors’ dealing with secondary subcontractors unless those ‘subcontractors’ fall within the statutory definition of a ‘head contractor’. Industry participants must, once again, pay careful attention to the statutory definition of the ‘head contractor’.

Residential works

While the regulatory impact statement says the requirement for retention trust accounts applies only to ‘non-residential’ work, this is not reflected in the draft Regulation. The new provisions will apply to ‘construction contracts’ as defined in the Security of Payment Act. The residential exclusion will only apply to residential construction work on premises where the person for whom the work is being carried out will reside in (or proposes to reside in) those premises.

$20 million threshold

The new provisions will only apply to projects with a value of $20 million or more, that is, where the head contractor’s construction contract with the principal meets that threshold. The $20 million threshold includes variations to the original contract price, so whilst the provisions may not apply at the start of a project, they will apply at a later stage if head contract variations directed bring total value of the contract to $20 million or more.

The $20 million threshold may be problematic in some developments where consideration under the contract may include the transfer of land, proceeds from sale of land and work in kind. The value may not be known at the time of the construction work being performed, which in practice may create a cloud over compliance.

The government has foreshadowed lowering the threshold to $1 million if the provisions operate successfully.

Having recourse to money in retention trust accounts

The initial proposal put forward by the government in November 2013 contemplated that retention monies might be deposited with and controlled by the Small Business Commissioner. In an apparent response to criticisms of that initial proposal the consultation draft Regulation instead provides that the retention monies be held in an account with a financial institution, established and generally controlled by the head contractor.

The apparent intention of the revised proposal is to preserve the right of a head contractor to have valid recourse to retention money under a subcontract, without being required to first satisfy a third party (for example, a court, the Commissioner or an adjudicator) before doing so (as had been previously proposed). The draft Regulation would, however, benefit from further clarification of the circumstances in which funds can be withdrawn from the trust account.

Application to other forms of security

Consistent with section 12A of the Act, the draft Regulation does not apply to other forms of performance security. This includes any proceeds of such security, for example when a bank guarantee or insurance bond has been cashed. Whilst such money could be described as ‘security for the performance of obligations’, it is not ‘money retained out of money payable by the head contractor to a subcontractor’.

Application to multi-tiered and complex project arrangements

The project structure on which the draft Regulation is based is a basic construction project contracting model involving a principal, a head contractor and subcontractors. In major infrastructure and property development projects where there are multiple tiers of subcontracting beyond that basic model (such as PPPs), the ‘head contractor’ as defined under the Act may be an SPV or developer, rather than the traditional head construction contractor. Accordingly, if retention money is to be held, the provisions may require SPVs or developers in such situations to establish the retention trust rather than the traditional construction contractor. Where so, the Regulation may fail to address the objective of the Collins Inquiry to safeguard subcontractor retention money against the insolvency of a head contractor.

TRUST ACCOUNT REQUIREMENTS

The new provisions require that retention amounts be held in separate trust accounts with an approved authorised deposit-taking institution (ADI) which are identified as such with the relevant ADI. Details of the account must be notified to the chief executive of the Office of Finance and Services.

However, while the list of approved ADIs is lengthy, the additional obligations imposed on the ADIs under the legislation may result in ADIs either declining to open accounts or charging excessive fees for the service.

The new provisions allow some flexibility for head contractors in how they operate their trust accounts. They allow retention moneys from multiple projects and multiple contracts to be held within the one account. This will no doubt reduce the costs associated with holding the accounts, but will require more administration, and may cause complications when a head contractor or subcontractor enters insolvency and trust funds are commingled. Given the head contractor’s ability to access the funds autonomously, the possibility of misuse of funds remains and it is anticipated that in the case of insolvency, issues surrounding tracing funds, priority rights between the parties and preference payments will remain.

Also, there are record keeping and reporting requirements for head contractors. Accounts must be audited by a registered auditor annually, and the audit reports sent to the government with an annual fee that is yet to be determined. Also, any overdrafts must be promptly reported to the government, as must the closure of a trust account. Fines of up to $22,000 may apply.

Andrew Chew, Shaun Bailey, and David Starkoff contributed to this note.