Construction Contracts Amendment Act (2015) Update.
Law change:
The new retention regime under the Construction Contracts Amendment Act 2015 (Amendment Act) came into force on 31 March 2017. It provides that retention money withheld under commercial construction contracts must be held on trust in the form of cash or other liquid assets readily converted into cash, unless a ‘complying instrument’ (see point 2 below) is obtained. The new requirements only apply to contracts entered into, or renewed, on or after 31 March 2017.
Likely impact:
Before the Amendment Act came into force, it was common for developers and head contractors to use retention's as working capital, effectively treating these funds as unsecured interest free loans. A recent ANZ paper commented that there would likely be a meaningful impact to the working capital cycle of construction businesses as a result of this law change. Their research showed that 50% of developers and construction companies have a Net Profit After Tax margin of less than 2%. They estimate that companies captured by the retention's regime will require on average 2-3% of total revenue in additional working capital. Companies will need to consider carefully where replacement working capital will come from.
What must be held on trust?:
Payers (e.g. clients and head contractors) who choose to withhold retention money have two options:
Hold retention money on trust in the form of cash or other liquid assets readily converted into cash – this is the default option. No definition of “liquid asset” is provided in the Amendment Act and there is debate about whether it could be interpreted to cover such assets such as accounts receivable, retentions receivable or trading stock. If a company intends to hold retention money in a form other than cash it is recommended that they seek professional advice to ensure compliance with the Amendment Act.
Obtain a financial instrument, such as insurance or a payment bond, to provide third-party protection of retention money. There are strict requirements of the financial instruments to ensure repayment of retention money:
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Financial instrument providers are limited to registered banks and licensed insurers;
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Financial instruments are required to be issued in favour of payees and allow them to directly enforce the ‘promise to pay’ against the financial instrument provider
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Records of financial instruments are required to be kept and made available to subcontractors at all reasonable times and without cost.
Further requirements:
Some of the other requirements set out in the Amendment Act are to:
- Make accounting records of retention money available for inspection by the payee at all reasonable times and without charge;
- Not use the retention money for any reason other than to remedy defects in the performance of the payee’s obligations under the contract; and
- Ensure the retention money is not made available for the payment of any debts or creditors, other than the payee
Although the Amendment Act does not require the retention money to be held in a separate bank account, it is advisable that a payer do so to prevent those funds inadvertently being used for any purpose other than securing performance of the payee’s contractual obligations. In addition, if the payer is asked to make accounting records of its retention's available for inspection, a separate bank account may be beneficial as this would not require them to disclose unrelated accounting information to the payee.
If you feel you could use some specialist advice, don’t hesitate to contact the Commercial Team.
