New rules for protecting retention money came into effect on the 31st of March 2017. These require developers and head contractors to hold “on trust” any retention money they’ve withheld from their subcontractors. This on trust obligation, which applies to all contracts except those with a residential homeowner, means the head contractor must hold that retention money in the form of cash or other readily convertible liquid assets, making it easier, in theory, for subbies to reclaim this money if the head contractor goes bust.
However, the legislation was not clear about whether these obligations only applied to new contracts entered into on or after 31st March, or in fact applied to any contract in place at that time. A new amendment is now working its way through Parliament to clarify that only contracts entered into (or renewed) on or after 31st March will have to comply with these new on trust rules.
The select committee also recommended an additional amendment to the Construction Contracts Act. This amendment will allow developers and head contractors to obtain an insurance-backed bond to cover the retention money they hold. So, if the head contractor failed to pay back retentions the subcontractor could claim them directly from the insurer. This benefits the subcontractor because they have a guarantee from a third party (the insurer) that they will get their money. It also benefits the head contractors because it means they don’t need to hold the retention money on trust, so they can use it and account for it within their business however they wish (as long as their insurance bond is enough to cover all the outstanding retentions they hold at any given time).
There is also another option, which is that the head contractor doesn’t demand retentions in the first place, or accepts a bond in lieu of retentions/subcontractor retention bond from the subcontractor instead. This benefits the subcontractor because no retentions are withheld in the first place, so there is no danger of losing them, and they get paid in full. A premium is payable on each bond, but this is often more than offset by the savings the business generates in cashflow by having money that would previously have been withheld as retentions in their bank account instead. It also benefits the head contractor because they have no on trust obligations. The drawback for them is that they can’t use retentions as a form of revenue to cashflow their business (which is not good practice anyway). Subcontractor retentions bonds are available now and readily accepted as part of most major construction contracts.
Finally, the Act says MBIE can set regulations specifying the minimum amount of retentions to which on trust obligations will apply. They have decided that there will be no minimum, so main contractors must hold all retentions on trust, no matter how small an amount it is.
In a nutshell
If you’re a subcontractor that has retentions withheld, for any new contracts entered into since 31st of March your head contractor must hold these retentions on trust, which means they have to account for them in cash or other readily convertible form. Head contractors could choose to insure the retentions they hold instead of holding them on trust. A subcontractor can provide a subcontractor retention bond instead of having cash retentions withheld in the first place, so they get paid in full and there’s no risk of losing their retentions.