BY FRANK BROWN AND RIAIA DONALD, MINTER ELLISON
The retentions regime under the Construction Contracts Act 2002 (Act) is a significant step forward in protecting contractors’ interests.
Since March 31, 2017 principal/head contractors have been required under the Act to hold retention money on trust for contractors so that their retentions would be protected in the event of the principal/head contractor’s insolvency (Regime).
The recent High Court decision of Bennet v Ebert Construction Limited (In receivership & liquidation) highlighted some remaining issues for contractors, who have limited ways to protect their retentions. Ebert’s receiver applied to the High Court for directions as to if and how it could distribute around $3 million in retention money held in a separate bank account for its subcontractors.
The High Court held that the receiver could distribute the retentions (as officers of the Court) and provided some guidance as to how the Regime will play out in a principal/head contractor’s insolvency.
In light of the decision, the need-to-know for contractors is threefold:
1. Retentions are not captured by the Regime until the payment from which they are being withheld is made to the contractor;
2. Failure to comply with the Regime by the principal/head contractor is ultimately the misfortune of the contractor in a principal / head contractor’s insolvency; and
3. The Regime does not prescribe any penalties for non-compliance (including for while the principal/head contractor is still solvent).
Weighing up the options: The Regime, bonds, or an ‘alternative arrangement’?
In light of the recent guidance, the purpose of this article is to assess the Regime as it stands, and other alternatives available.
How it works
A portion of money (usually between 1-10 percent) is withheld from each payment to the contractor and released to the contractor part on practical completion, part at the end of the defects liability period, and part on final completion (less any amounts deducted to remedy defects or omissions in the contractor’s work).
For all contracts entered into after March 31, 2017, the principal/head contractor is required to hold this money on trust.
For those contractors who have had their invoices paid (whether the claimed or scheduled amount) and the amount of retention has been properly accounted for and set aside by the principal/head contractor, this money cannot be touched by the principal/head contractor’s creditors in an insolvency.
As the recent judgment has shown, if the principal/head contractor fails to comply with the Regime (and account for or set aside the contractor’s retention), it is the contractor who ultimately loses out – being left primarily with an unsecured creditor’s claim.
Bond in lieu of retentions
How it works
With the principal/head contractor’s agreement, a contractor can arrange a bond in lieu of retentions with a bank or insurance company and present it to the principal/head contractor. The bond achieves the same end as the Regime by covering the retention amount and expires at the end of the defects liability period.
If the contractor is able to arrange a bond in lieu of retentions, the advantages are:
• The contractor gets each of its invoices paid in full, increasing its cash-flow position throughout the entire project;
• Depending on the size of the project, the withheld amount of retention money can be substantial. The contractor does not have to be without the benefit of this money for the defects liability period (often up to 12 months after the completion of the project).
While bonds are usually not expensive (between 1 – 3.5 percent of the amount secured up front), they can be difficult for the contractor to procure. Contractors can be involved in multiple projects and may already have loans from banks.
This means banks or insurance companies may be unwilling to lend further by providing a bond.
How it works
The Act allows for the parties to agree on an ‘alternative arrangement’, which is effectively an insurance arrangement made by the principal/head contractor with a third party (Insurer).
The principal/head contractor withholds retentions from each payment to the contractor and releases payment after the end of the defects liability period in the same way as under the Regime. However, rather than having to hold the retention money on trust, the principal/head contractor can instead spend it at-will up to the amount insured by the Insurer.
The amount of premiums are usually between 1-5 percent of the amount being guaranteed. When the retention money becomes payable, either the principal/head contractor pays it or the Insurer will.
The contractor has its retentions guaranteed and need not worry that it may never see its retention money if the principal / head contractor becomes insolvent.
Additionally, it is arranged by and at the cost of the principal/head contractor (though this could be subject to negotiation and the cost being priced into the contract).
The alternative arrangement is a beneficial option for the contractor, but is ultimately at the election of and implemented by the principal/head contractor.
If the alternative arrangement or bond can be agreed, then these options arguably provide better protection to a contractor’s retentions than the Regime.
However, we recognise that it may be difficult for a contractor to obtain the principal/head contractor’s agreement to such and in particular, contractors may not be in a financial position to acquire a bond.
Therefore, in most cases, parties will opt for the default position – the Regime. If that is the case, it is important that contractors exercise their rights to inspection and we suggest that contractors consider contracting to greater protect its retention money. The following could be considered:
• Stipulate that the retention money must be held in a separate account;
• Stipulate that a bank statement must be presented after an agreed period of time following payment to show the retention amount has been set aside; and
• Provide for consequences if, following inspection, the retention monies are not accounted for, the principal /head contractor fails to provide this bank statement, or if the bank statement fails to show evidence of the retention being accounted for (such as interest provisions or suspension of works if non-compliance is persistent).
The recent court decision has highlighted some shortcomings with the Regime which will hopefully prompt the Legislature to consider how the Regime can be improved.
In the meantime, the construction industry (particularly contractors) should push for better protection of retention money, whether through contractual provisions or adopting alternatives to the Regime.