10 December, 2014

On 8 December 2014, the NSW Minister for Fair Trading, the Hon. Matthew Mason-Cox, announced the proposed introduction of a retention trust scheme which will require head contractors to hold retention money in a trust fund on behalf of their subcontractors. The proposal is commended in the accompanying Regulatory Impact Statement as a low-impact regulatory approach which fits well with industry practice and which will impose minimum costs on the community while delivering potentially significant benefits to subcontractors.

The draft Regulation announced by the Minister involves major changes to the way in which retention sums in construction contracts will have to be handled. It requires head contractors to fulfil a number of procedural obligations, with those who fail to do so facing fines of up to AUD 22k. It also potentially affects the working capital of some head contractors – although the Regulatory Impact Statement points out that retention money does not in fact belong to the head contractor and is owed to subcontractors.

The draft Regulation is open for public comment, closing on 8 January 2015.

Background

This amendment follows previous reforms to the Building and Construction Industry Security of Payment Act 1999 (NSW) (Act) which came into force in April 2014. Those reforms were intended to redress perceived head contractor abuses identified in the Final Report of the Bruce Collins QC Inquiry into Construction Industry Insolvency in NSW and included the:

1. introduction of mandatory maximum payment periods;
2. removal of the need to refer to the Act in payment claims; and
3. requirement that a Supporting Statement (regarding payment of subcontractors) be provided with each head contractor payment claim.

The Act, as amended in April 2014, made provision for the future introduction of a requirement that subcontractors’ retention money be held in trust accounts. Although foreshadowed in April 2014, the NSW Government has only now acted on this proposal, resulting in the new draft Regulation. The NSW Government released a Consultation Paper regarding a statutory trust fund for the building and construction industry in November 2013. That proposed model has not been followed in the new draft Regulation.

The Retention Trust Scheme

The draft Building and Construction Industry Security of Payment Amendment (Retention Money Trust Account) Regulation 2014 was released for public consultation on 8 December 2014. The object of the Regulation is to compel head contractors to hold on trust, for the subcontractor from whom the money has been retained, retention money under a construction contract with a project value of $20 million or more. The proposed commencement date for this Regulation is 1 February 2015.

The Draft Regulation Is Limited In Its Operation To:

• head contractors and their direct subcontractors only for building projects worth AUD 20m or more (We note that reference is made in the Regulatory Impact Statement to the amendments applying to non-residential projects only. We understand this to reflect the existing exclusion of domestic construction work for the proposed occupant of the residence from the operation of the Act and not an exclusion of developer residential construction from the requirements of the Regulation);
• the value of a construction contract is the amount of the consideration that the contract provides is payable for performance of construction work or for provision of related goods and services, otherwise it is the market value of the work carried out,
• this value is calculated including any variation to the contract after the contract is entered into (which can result in retentions becoming subject to this Regulation once the AUD 20m threshold is reached due to subsequent variations),
• retention money only. Although retention money is defined broadly to include “money retained by a head contractor out of money payable by the head contractor to a subcontractor under a construction contract, as security for the performance of obligations of the subcontractor under the contract,” it will only constitute retention money if held as security for performance. If the head contractor becomes entitled to have recourse to the cash retention then the money ceases to be subject to the trust obligations; and
• contracts entered into on or after 1 February 2015.

Key Elements Of This Draft Regulation Include:

• head contractors must deposit subcontractors’ retention money into accounts with approved authorised deposit-taking institutions (ADIs, which are defined as an “authorised deposit-taking institution approved under s 87 of the Property, Stock and Business Agents Act 2002 or approved by the Chief Executive by order in writing”);
• the amounts deposited will only be made available for the purposes specified in the contract between the parties. This means that retention money will not be available to pay the account holder’s other costs or debts;
• account holders will be obliged to inform the Chief Executive of the Office of Finance and Services when the account is established, if the account becomes overdrawn, and will be required to lodge an annual audit review of the account;
• ADIs will have to report overdrawn accounts and dishonoured cheques to the Chief Executive;
• the Chief Executive will have investigative powers to review individual accounts and seek further information from all parties;
• penalties of up to AUD 22,000 (200 penalty units) will apply for breaches of the Regulation; and
• nothing within the Regulation interferes with a contractor’s rights under the Building and Construction Industry Security of Payment Act 1999 with respect to adjudication, private negotiation and the process for making retention claims.

Future Expansion Of The Regulation

If the draft Regulation successfully implements the above measures, pending further industry consultation, its operation may be extended to apply to subcontractors performing work on projects with the value of AUD 1m or more.

In addition, potential further reforms could include the introduction of directors’ personal liability for unpaid retention money. The constitutional implications of such a reform on the insolvency provisions of the Commonwealth Corporations Act 2001 would need to be carefully considered and may prove difficult to implement in NSW alone.

A review of the penalties under the Regulation has also been flagged.

What You Need To Do

Although the draft Regulation is not yet in force and remains subject to industry consultation, prudent head contractors should now consider their options in relation to acceptance and treatment of retention money and any consequent impact of the Regulation on working capital requirements. Head Contractors should also pre-emptively consider how they propose to create a retention trust fund with an ADI.

The draft Regulation provides the following options for a trust account to be established:

• as a standalone trust account for retention money held in respect of a particular subcontract, or
• as a single trust account for all retention money held in connection with a particular construction project by the head contractor; or
• as a trust account for all retention money held in connection with two or more (or even all) construction projects of the head contractor.

It would also be prudent to become familiar with the following aspects of the draft Regulation which require action by head contractors:

• the name of the account and its description in the head contractor’s records must include the name of the head contractor and the words “Trust Account”;
• the approved ADI must be notified in writing that the account is a trust required to be established by this Regulation;
• the head contractor must within seven days of establishing a retention money trust notify the Chief Executive in writing of the particulars of the account;
• the head contractor must also inform the Chief Executive if the account becomes overdrawn;
• withdrawals must not be made from the trust account except for the purpose stated in the relevant construction contract, by agreement between the head contractor and the relevant subcontractor or in accordance with the order of a court or tribunal;
• interest earned on the retention money held in trust is to be held on the same trust as the retention money; and
• the head contractor must also keep records in relation to a retention money trust for at least three years after the account is closed.

Conclusion

The public consultation period closes on 8 January 2015.

The Regulation will impose a number of procedural requirements who may cause head contractors to incur additional cost and will prevent the use of retention amounts as working capital. A likely consequence is that head contractors who currently take security in the form of cash retention will demand provision of unconditional undertakings (i.e. bank guarantees) as a simpler alternative. We note that subcontractor demands for return of bank guarantees are not capable of being pursued by way of payment claims under the Act, unlike claims for release of cash retention.

This proposed amendment is part of the NSW Government’s overhaul of the security of payment regime, which is set to be reviewed in 2015. It is likely that developments in this area will continue.

For further information, please contact:

Alex Hartmann, Partner, Baker &  McKenzie

[email protected]

Geoffrey Wood, Partner, Baker & McKenzie

[email protected]

Baker & McKenzie Construction & Real Estate Practice Profile in Australia

Homegrown Construction & Real Estate Law Firms in Australia