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High Court decision on construction contracts retentions

Home Insights High Court decision on construction contracts retentions

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Contributed by: Matt Kersey, Polly Pope, Anna Crosbie, Michael Taylor and Michelle Mau

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Published on: November 16, 2018

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Construction Disputes Update – 16 November 2018

The High Court has given greater clarity this week as to legal obligations relating to retention sums in construction contracts. The Construction Contracts Act 2002 requires that, for construction contracts entered into after 31 March 2017, all retention money must be held on trust. However, the practical implications of this obligation have been seen as somewhat uncertain.  

In July 2018, receivers were appointed by the Bank of New Zealand to Ebert Construction Limited.  At that time, Ebert had a retentions account for retentions covered by the Act with a balance of $3.7 million. However, it owed $9.3 million in subcontractor retentions. The receivers applied to the Court for directions as to how the funds held in the retentions account (Fund) should be distributed.

The main points arising from the judgment are:

  • the Act does not create a "deemed trust". Parties holding retentions must take steps to create a trust;
  • for a trust to arise the traditional three "certainties" are required, namely intention to create a trust; subject matter (ie what funds are part of the trust); and object (or beneficiaries) of the trust;
  • money does not become subject to the Act unless it is actually withheld from the contractor. Where the contractor has not been paid for certain work at all, no retentions are "withheld", or therefore subject to the Act;
  • the receivers needed a court order to be entitled to administer the Fund. On the facts, the Court was willing to grant them such an order and to allow their reasonable fees and costs to be met from the Fund; and
  • once a trust is in existence, the money held must not be used for the payment of debts owed to any person other than the contractor from whom the money was withheld. This meant that contractors whose retention money was not paid into the Fund were not entitled to a share of it, as the money held there was only to be used for the payment of debts owed to those who had contributed to it.

Key points for insolvency practitioners

  • Careful analysis is required to ascertain whether or not there is a trust – the Act does not create a "deemed trust".
  • Where retentions have been held on trust you will require separate court orders to be appointed as a receiver of that trust fund (as this is the trust property of the subcontractors, not property of the insolvent company).
  • The Court may allow you to recover your reasonable fees and costs of administering the fund.

Key points for parties holding retentions

  • As no "deemed trust" arises, it is important to proactively set up and maintain a trust to hold retention money.  
  • While it is not necessary to hold retention money in a separate account, if the funds are intermingled it is important to keep the account in credit to at least the value of retentions, to avoid breaching the Act by using the funds other than the very limited purposes for which they may be spent.  

Key points for parties owed retentions

  • The Act does not create a "deemed trust" – make sure the party owing you retentions has taken steps to create and maintain a trust. You can do so by exercising your right to inspect trust instruments and accounting records pursuant to section 18FC of the Act.
  • If a company owing you retentions goes into receivership, it will not necessarily be quick or straightforward to obtain payment.
  • Receivers appointed by a secured party will require a court order allowing them to deal with funds that have been held on trust, and may be allowed by the Court to deduct their fees and costs out of the funds.

 

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