From 31 March 2017, the common construction industry practice of withholding payments to contractors to ensure they perform their obligations under construction contracts (i.e. ‘retention money’) will be subject to new requirements.

The Construction Contracts Amendment Act 2015 (the Act) will require all retention money under construction contracts to be held in trust, and this will apply to contracts for both residential and commercial building work.

This can be illustrated by a situation where a builder contracts a plumber to do plumbing work on a building project.

If the builder withholds money that is payable to the plumber to ensure that the plumber’s work is to the standard agreed under the contract, then this would be ‘retention money’ and the builder will be required to hold that money in trust for the plumber.

As a result, the builder will owe trustee duties to the plumber in relation to that money. These duties will last until the retention money is paid to the plumber, the plumber agrees to give up claims to the money, or the money stops being payable to the plumber under the contract or through law.

We note that, while this example relates to builders and plumbers, the Act applies to all parties with retention money under construction contracts.

The Act places further limits on retention money:

  • Retention money must be held in the form of cash or other liquid assets;
  • Retention money must be kept in accordance with proper accounting practices;
  • Retention money must not be used to pay the debts of the party holding it; and
  • Retention money can only be used by the party holding it to remedy the other party’s failure to perform their obligations under the contract.

The Act cannot be contracted out of and any attempts to avoid these requirements through a contract will be void.

Where a person uses retention money to pay their creditors, for example, they may face civil and/or criminal liability in relation to breaching their trustee duties.

As a result, many builders and contractors may choose not to use retention money at all so as to avoid the associated risks and administration costs. As an alternative, builders and contractors may look to bonds and milestone payment schemes under their contracts to secure performance of their subcontractors.

We expect regulations to be adopted soon to provide further clarity in this area.

Jason Klapproth
Commercial Lawyer
Wellington