This is our third legal update following the progress, and discussing the potential impact, of the Construction Contracts (Retention Money) Amendment Bill (the Bill). In this update, we outline the progress of the Bill following its successful navigation of the select committee review process and its second reading in Parliament and consider some of the practical impacts of the Bill in its current form - in particular, the potential for an industry shift towards bonds rather than retentions.
To recap, and as discussed in detail in our first legal update, the Bill seeks to address some of the shortcomings of the retention money regime in the Construction Contracts Act 2002 (the Act). In particular, the Bill seeks to clarify that retention money:
- Is automatically held on trust by a 'payer' (being a party withholding payment - most commonly a principal or head contractor) for a 'payee' at the time at which the construction contract allows it to be withheld from the payee
- Must be held on trust separately from the payer's other money and assets
- Must be paid into a bank account in a registered bank in New Zealand as soon as practicable after it becomes retention money or be held in the form of complying instruments (ie, an insurance policy or bond/guarantee).
The Bill also seeks to improve the reporting requirements around retention money.
Status
The Bill is currently at the Committee of whole House stage, having successfully navigated the Transport and Infrastructure Committee (the Committee) and second reading in Parliament. The Committee proposed a number of clarificatory amendments to the Bill. In particular:
- When an amount becomes retention money - it is when a construction contract allows a payer to withhold payment of an amount from a payee
- How retention money must be held and used - retention money must be deposited into a compliant bank account as soon as practicable after it becomes retention money and a payer seeking to use retention money to remediate defects must provide at least 10 working days' prior written notice to the payee
- A fine will be incurred for each offence - meaning fines will be cumulative and, potentially significant, incurred in circumstances where retention moneys have been continually mistreated
- A defence is available for the misuse of retention money in circumstances where the use of the retention money was honest, in good faith and reasonably believed to be permitted by the Act.
The Committee did not introduce substantive amendments to address the issues we outlined in our previous legal update in relation to the potential scope of regime as a result of the widely drawn definition of "retention money" or to reduce the significant administrative burden that the new regime will likely impose on payers.
Practical impact - an industry shift to retention bonds?
In our view, the consequence of the proposed reforms may be a shift towards a greater preference for bonds rather than retentions. Primarily, this is because:
- There is a risk that under the proposed section 18D(4), a payer's recourse to retention money is now limited to the application of retention money to remediation of a defect in the works only and, as a result, leaving unresolved the use of retention money for other defaults by a payee, such as (i) unpaid delay liquidated damages or (ii) as compensation for a defective or under performing asset that the payer decides to accept for commercial reasons. This uncertainty may impact on the 'bankability' of retention moneys as part of the wider performance security package
- The significant additional administrative burden that the new regime will likely impose on retention industry participants (notably payers)
- In our experience, bonds are a robust and flexible part of the principal's security package. Parties can negotiate how and when they can be called. An on demand bond provides a reliable security for the bond holder in relation to the performance of a contractor and subcontractor.
There is, of course, an additional cost for the contractor or subcontractor in providing a bond. However, in practice, these costs are typically 'priced in' to the applicable contract (ie, the principal or head contractor bears the cost of the bond) which will often significantly reduce the practical financial impact for the contractor or subcontractor. Depending on whether or not a bond is required to be cash-backed by the bond provider, there can be a cash flow benefit for contractors and subcontractors compared to retentions.
You can review the Bill in its entirety here.
