Are you ready for the new construction retention rules?
The changes apply to commercial construction contracts entered into or renewed from Friday, 31 March 2017 where retention monies are required from subcontractors. Head contractors will soon have to hold retention money on trust if the funds are more than the specified ‘de minimis’ amount. This amount is yet to be set by regulations.
The aim is to protect retention monies from being used as working capital, or from being used to pay preferential and secured creditors ahead of subcontractors.
In our view, however, the lawmakers have not actually achieved this outcome. While they have imposed an obligation on head contractors to hold retention monies on trust, they have failed to put in place the substantive measures required to actually protect the subcontractor's rights to that money.The legislation still allows retention monies held on trust to remain in a head contractor's general account. Further, it does not clarify whether a subcontractor’s right to retention monies would rank ahead of preferential or secured creditor's claims in the event of a liquidation. Therefore, we believe the retention monies remain at risk, despite the change in the law.
Our advice to subcontractors
So what should subcontractors do?
Firstly, you should avoid giving retentions. There are other ways for you to secure performance such as a performance bond issued by your bank. Performance bonds ensure your money remains in your bank account and it cannot be used for working capital or to pay other creditors.
Secondly, if you cannot avoid retentions, we recommend that you leverage off the ‘right’ to have your retention held in trust granted to you under the new regime. However, to obtain the best level of protection, you will need to take additional steps rather than simply rely on the new regime. You will need to insist that retention monies are placed in a separate bank account for the benefit of subcontractors.
Then you must obtain the head contractor's consent to register a security interest over that account on the Personal Property Securities Register. Both steps should be taken before retention monies are paid to, or taken by, the head contractor. You will also need to negotiate additional clauses into the construction contract. We acknowledge that these steps will be challenging when you are working with major construction companies. However, we hope head contractors will accept these additional steps are needed to properly implement and give substance to the rights given to subcontractors under the new regime.
Our advice to head contractors
Retentions could previously be used as a source of cash for working capital purposes; this is no longer the case. In law, retentions have always been subcontractor monies provided as a security for performance, and therefore should not be used as working capital.
The new regime is simply clarifying that position. Therefore, our advice to head contractors is to accept the change and to help subcontractors protect their hard-earned money by placing funds in a separate bank account and granting a specific security interest over the account. We cannot see any downside for you.
The new regime also imposes additional administrative obligations on you to keep accounting records and report to subcontractors. Placing the retention monies in a separate account should make reporting easier.
As an alternative to a retention, you could request an alternative performance security such as a parent company guarantee and/or a performance bond.
The new regime brings some major changes to the construction sector – for the better. We believe, however, that the new provisions have some limitations.
If you need guidance in drafting or negotiating your construction contracts, feel free to contact Nicola Russ, or my team.