Amended law for subcontractors lacks teeth
Lawyers Jonathan Gillard and David Dingwall ask whether new laws will do enough to protect subcontractors.
DESPITE record growth in the construction industry, cashflow problems have proved terminal for many building firms recently. One factor affecting cashflow is retentions – sums withheld from payments to the head contractor to guarantee the quality of their work, and ensure defects are fixed. Retentions are commonly 5 per cent to 10 per cent of the total contract price.
Usually the head contractor is not eligible for the retained sum until construction is complete, or until the end of the defects liability period, which can be months or even years after completion. The amount is often the contractor’s entire profit margin.
Unsurprisingly, most head contractors adopt the same process for paying their subcontractors, who are generally not as informed about the viability of a certain project. Until a subcontractor is paid, the funds remain with the head contractor. This places subcontractors at significant risk if the head contractor becomes insolvent.
In an extreme example, about $18 million of subcontractors’ retention money was lost as in 2013’s Mainzeal collapse.
If the head contractor does not separate retentions from their general account (under law there is no requirement to do so), those funds will become part of the pool available to secured creditors if the contractor goes into receivership or liquidation. Unfortunately, a subcontractor’s interest in those funds will generally be unsecured and they may miss out entirely.
Exacerbating the problem, some contractors use retentions to keep their businesses afloat (perhaps while waiting for their own retentions), which can result
in subcontractors being paid late. A New South Wales report last year said retention money was regularly put at risk, with subcontractors frequently paid late or not at all if the contractor went broke.
Because of the potential effects on small businesses, the NSW Government plans to change the law to better secure retentions held by contractors. Of the report’s suggestions, the NSW Government preferred a model of the head contractor putting retentions directly into an independent fund. As well as preventing contractors mixing retentions with other money, the model includes an independent mediator.
The state government is likely to adopt this scheme for commercial and then residential work. The New Zealand Government has also recognised the need for law change in this area. However, New Zealand’s proposed changes lack the teeth of those proposed in NSW.
Building and Housing Minister Nick Smith announced that the Construction Contracts Amendment Bill would include changes to better protect subcontractors for work done.
The proposed law change would: Require head contractors to hold retentions on trust for subcontractors. impose penalties on head contractors who use retentions for purposes other than for subcontractors’ work. provide for a default rate of interest charged for late payment; and, clarify that the prohibition of the ‘‘pay-when-paid’’ practice, a hallmark of the Construction Contracts Act 2002, will also apply to retentions. However, under these proposed changes, head contractors will not be required to put retentions into a separate account.
As a result, retentions will: Remain available for the head contractor’s use and, possibly, misuse. be very difficult to identify and protect in the event of the contractor’s insolvency; and, place third parties dealing with contractor funds (such as banks, accountants and lawyers) at risk of becoming embroiled and liable in disputes. The model favoured by New Zealand was dismissed in NSW because it did not address the root of the problem, which is the underlying need to clearly identify and separate retentions.
In response, Smith said he had not opted to require retentions go into a separate bank account or lawyer’s trust fund, ‘‘because the compliance cost is too high’’.
Time will tell whether the changes, if implemented, will provide improved certainty and stability in the construction sector.
Jonathan Gillard is a partner and David Dingwall a solicitor at law firm Wynn Williams. Jonathan.gillard@wynnwilliams.co.nz.