As discussed in previous updates, on 31 March 2017 a change to the Construction Contracts Act 2002 will take effect to implement a trust regime that will apply to retentions held under construction contracts.
Key things you need to know about this legislative change are:
- The regime applies to all construction contracts entered into (or renewed) on or after 31 March 2017. The only exception is for contracts where a residential occupier is one of the parties. No regulations were passed specifying a 'de minimis value' so the regime applies to all contracts, regardless of value.
- Retentions are deductions from payments made to a contractor or subcontractor under a construction contract. They are generally only paid in full to the contractor or subcontractor once the defects liability period has finished and all defects arising during that period have been remedied.
- The regime applies to both principals (who hold retentions payable to contractors) and contractors (who hold retentions payable to subcontractors). It also has implications for banks and other financiers. This is because the principal or contractor may only apply retentions to remedy defects in the performance of the works. It cannot use retentions to repay amounts it owes to third parties and importantly retentions held will be outside the reach of a bank/financier under its general security agreement.
- Retentions must be put aside in cash or liquid assets readily convertible into cash and properly accounted for. However, they do not need to be put in a separate bank account and may be comingled with other assets, although a separate account or accounts appears preferable. Funds may be invested in accordance with trust legislation (which is conservative) and any returns will belong to the holder of the retentions.
- A late amendment to the regime also allows the principal or contractor to obtain a financial instrument, such as insurance or a payment bond, to provide third-party protection of retention money. It remains to be seen how practical this option will be.
- The trust over the retentions arises automatically by operation of law. So no deeds or other documents are required to create the trust.
- The legislation does not contemplate any statutory fines or penalties for non-compliance, however contractors or subcontractors will have the right to inspect records to check compliance with the regime and contractors/principals that do not comply with the regime will be liable civilly for breach of trust. In an insolvency situation, inevitably questions will be asked of directors and even financiers who may be accused of 'knowingly assisting' with non-compliance (with resulting liability).
- You cannot contract out of the regime. However, we expect to see an increase in parties (particularly principals) requiring bonds from contractors in lieu of retentions - no retentions means no trust regime requirements.