Brendan Cash, Partner, and Isaac Nicholson, Summer Clerk, Kensington Swan’s Construction and Major Projects Team.
In March last year, the law governing retentions was changed with amendments to the Construction Contracts Act 2002 (the Act) coming into force.
The new legislation dictated that retention money was now to be held ‘on trust’ for the party to the Contract it is being held for, with the aim of conferring greater protection over that money.
The recent case of Bennett & ORS v Ebert Construction Limited (in receivership and liquidation) [2018] NZHC 2934 came about due to the receivership and liquidation of Ebert Construction Limited. The case concerned the receivers applying to the court for directions on the management of the retentions fund and has given us our first example of how this new regime will be applied in practice.
As to the High Court’s decision as to how the retentions held on trust by Ebert were to be distributed; it is useful in demonstrating what is required of those withholding retentions, and what parties can do to protect their interest in that withheld money.
Background
A trust is a legal arrangement in which one party holds property on behalf of, and for the sole benefit of, another party. The legislation created a trust obligation on the party withholding the retentions and restricts the ways in which that party is allowed to use the money until it is due to be paid.
The party withholding the retentions is entitled to keep any interest earned on the retentions while they are holding them, but the retentions cannot ultimately be used for anything other than either payment of the retentions or to meet costs that the retentions were held to cover.
Ebert had created a specific trust account where retentions were held, in an effort to comply with the new requirements. However, problems arose as some contracts were not properly dated when entered into Ebert’s accounting system, and so the accounting software did not recognise these subcontracts as being subject to the new laws and did not transfer the retentions held for these subcontracts into the trust account.
In addition to this, a clerical error in the software use resulted in retentions from some of the June subcontracts not being transferred into the trust account.
The issues compiled as Ebert’s solvency issues began to emerge and payment claims started to go unpaid up until their eventual receivership on 31 July 2017. On this date, the trust account held $3.678 million and was the only significant cash asset Ebert possessed.
The questions became:
• what was the receiver entitled to do with the retentions trust account (given that it was not technically owned by Ebert)? and
• who was entitled to the money in the retentions account?
The decision
The retentions in the trust account were being held on trust, and were therefore not Ebert’s property. The receivers were not entitled to administer the account without an order from the Court. The order was granted by the Court in the interests of efficiency; the receivership was seen as likely to come to an end and to not make the order would have resulted in duplication of costs and delay if the liquidators had to subsequently handle this issue. The receivers were appointed administrators of the account, and the court held that the receivers were also entitled to recover their costs from the account.
During the Select Committee phase the then Minister for Building and Housing, Dr Nick Smith stated that the intended effect was for the legislation to create a deemed trust for retentions. The Court, however, found that the ultimate wording of the legislation did not create a deemed trust. The Court, therefore, held that the legislation was to be read in conjunction with established trust law.
As a result, the critical consideration was whether the funds were “withheld”. This meant that for any contract that had not been paid at all, nothing could be said to have been withheld and those contractors had no entitlement to the money in the trust account.
The Court then discussed how there are three requirements for creating a trust:
• certainty of an intention to create the trust,
• certainty of the subject matter of the trust (in this case the retentions), and
• certainty of who the property is being held on trust for.
In the instances where the money was recognised as needing to be withheld but was not transferred into the trust account, or where the incorrect date was entered into the system, the court held that the retentions were not sufficiently identifiable to give rise to any trust arrangement.
It could not be said in these cases that any of the money in the trust account was being held for those specific subcontractors.
This resulted in the above classes of subcontractor having no claim to any of the retentions in the account.
Where this leaves us
Entitlement to mix vs. requirement of identifiability:
The legislation allows the party holding the retentions to mix that money with their own and to invest it for their own benefit, provided it was readily convertible into cash to pay when the retentions fell due. While this allows the money to remain productive while it is withheld, it creates difficulties because the retention still needs to be clearly identifiable as the subject of the trust obligation.
How you should be handling retentions – easiest to create a separate account:
The bottom line is that the legislation does entitle contractors holding retentions to utilise that money in a productive manner and does not require them to keep it separate from their own affairs.
Parties will, however, need to be very careful and explicit in their bookkeeping so that those assets are recognisable as trust assets, or they risk not complying with the Act.
The 131 subcontractors in Ebert who were found to have claimed to the trust account demonstrates that a properly administered separate account holding retentions will be the easiest way to comply with the Act and will protect those entitled to the retentions.
What you can do to protect your interest in withheld retentions
Another lesson from Ebert is how easy it is for a subcontractor to lose retentions they are entitled to through no fault of their own. The legislation does entitle a contractor to request accounting records be made available to inspect how their retained fees are being held, at no cost.
While not the most efficient check on compliance, it may be an effective means of ensuring your money is held appropriately and safely.
• Kensington Swan offers 15 minutes of free advice on construction issues to CCNZ members.
The party withholding the retentions is entitled to keep any interest earned on the retentions while they are holding them, but the retentions cannot ultimately be used for anything other than either payment of the retentions or to meet costs that the retentions were held to cover.
Rising from the ashes