Construction industry and its retentions scheme
High Court provides useful guidance for subcontractors
The collapse last year of Ebert Construction Limited took many in the construction industry by surprise, particularly its subcontractors who were owed retention moneys. In our Spring 2018 edition (No 50) we published an article on Ebert Construction and subcontractors which had a section on retention moneys. Since then, the High Court decision has provided some guidance on the retentions scheme under the Construction Contracts Act 2002. We explain the main aspects of that decision and how subcontractors can help manage their risk.
The retentions regime
The retentions regime was created under the Construction Contracts Act 2002. It requires all principals/head contractors to hold moneys they retain on trust. The regime aims to protect retention funds if the principal/head contractor becomes insolvent. While Ebert was not legally required to establish a separate bank account to hold the retention money, it did so.
In July 2018, the Ebert Construction Limited receivers applied to the High Court for directions around Ebert’s retentions scheme. The receivers wanted guidance on:
- Whether they could manage and distribute the funds held in a retention account
- Which subcontractors had a right to receive those funds, and
- How those funds were to be distributed.
Useful guidance from the court
The High Court case provides useful guidance to all stakeholders in the construction industry, including subcontractors.
Can receivers manage and distribute the retention fund?
Yes, if the receivers have been appointed by the court. While a receiver has legal title to the retention funds, subcontractors also have an entitlement as beneficiaries under the regime. The Ebert receivers could distribute the company’s retention fund to entitled subcontractors, but not to Ebert’s creditors.
Which subcontractors have a claim?
The court confirmed the Act does not create the trust. The principal/head contractor must do this. There must be an intention to create a trust, and the trust must have a subject matter and an object (or beneficiaries). The Act also requires that retention money is actually withheld.
The Ebert subcontractors’ retentions were categorised as follows:
- Retentions invoiced, calculated and actually transferred to the retention fund
- Retentions invoiced, calculated but not transferred to the retention fund, and
- Retentions not invoiced, calculated or transferred to the retention fund.
The court held that only Ebert subcontractors with retentions invoiced, calculated and actually transferred to the retention fund had a claim. In these cases, there was an intention to create a trust because money was withheld and deposited into the retention fund. The subcontractors were the beneficiaries and the subject matter was clear (retention money). Ebert had also complied with the regime because the retention money was actually withheld.
This decision, however, highlights a disparity in the regime in that many of Ebert’s subcontractors only missed out due to the company’s failure to comply with its legal obligation to withhold retention money. These subcontractors have no recourse against Ebert; this is a risk to subcontractors that needs to be managed.
How are retention funds to be distributed?
The court held that the retention fund can only be used to repay a debt owed to eligible subcontractors. It also confirmed the Ebert receivers could deduct their fees from the retention fund.
Managing your risk
If you are a sub-contractor in the construction industry, there are some steps you can take to better protect your hard-earned money:
- Try and avoid giving retentions as your ability to recover those funds depends solely on the principal/head contractor having complied with the Act. Receivers are also entitled to have their fees paid from the retention fund, which dilutes the amount available to subcontractors. You could consider offering a performance bond as an alternative.
- Seek evidence that the principal/head contractor is holding retention money on trust. The Act requires principals/head contractors to maintain accounting records of retentions and, as a subcontractor, you have a right to inspect them; you should exercise this right regularly.
- Require retention money to be held in a separate bank account. This ensures the money is not mingled with other principal/head contractor funds and used as working capital. You should be aware that the law does not require principals/contractors to open a separate bank account. You would need to negotiate this point.
While the court has provided further guidance on the regime created under the Act, there are still risks for subcontractors that you must manage either through the construction contract or by taking other protective measures.
Bennett v Ebert Construction Ltd (in rec and liq)  NZHC 2934