New Zealand: Eberts retention fund for subcontractors clarified

The recent receivership and subsequent liquidation of Ebert Construction Limited (Ebert) has been well publicised with significant public interest about another large construction firm in financial trouble.

One group of people particularly interested in the receivership is the group of subcontractors who have had retentions held from them by Ebert under construction contracts. This group included 152 entities / people and covered 213 separate contracts.

The High Court has recently given a judgment clarifying matters for these subcontractors in what is the first test of the retention regime contained in the Construction Contracts Act 2002 (Act).

How did Ebert handle retentions?

The group of subcontractors as a whole were owed $9.324 million (excl GST) in retentions that had been withheld by Ebert at the date of receivership. Ebert, going above and beyond the requirements of the Act, placed retentions into a separate account (Retention Account). Unfortunatly, upon receivership, that account only had a balance of $3,678,832.53.

So, what went wrong?

In practice, a subcontractor would submit a payment claim and Ebert would consider what was owing under the relevant construction contract. Once it had determined what it considered to be owing it created an invoice (to itself) showing the amount being paid to the subcontractor and the amount being retained. Ebert would then make payment to the subcontractor from the general account.

Ebert would then carry out a monthly reconciliation for retentions on contracts entered into or renewed after 31 March 2017.1 The reconciliation involved determining the net movement between:

  1. new retentions withheld from that month's invoices that needed to be placed in the Retention Account; and
  2. sums paid out of the Retention Account through payment to the subcontractor or deductions made for the remedying of defects.

Ebert had a software system that calculated this, and it then transferred funds between the general account and Retention Account depending on whether the Retention Account balance needed to increase or decrease after the reconciliation. While in theory, this system created perfect compliance with the Act – it broke down in mid-2018 with the last transfer of retention funds occurring on 22 June in relation to the May claims from subcontractors.

The breakdown of the system

The Court identified four contentious categories of subcontractors that were all factually different and resulted from the staggered deterioration of Ebert's use of its systems. These categories were:

  1. The "Reconciled and Transferred" group were those who had retentions withheld for their claims in May, which were then paid into the Retention Account by Ebert on 22 June 2018. This group comprised 131 subcontractors over 19 projects;
  2. The "Calculated but Not Transferred" group were subcontractors who made claims for work during the month of June. Throughout July Ebert did not follow its usual process. It created the invoice recording the amount owing to the subcontractor and the amount being withheld but did not:
    • pay the sum due to the subcontractor (in most cases); or
    • transfer any funds into the Retention Account.

This group totals 80 subcontractors over 12 projects owed a total of $475,000.

  1. The "Uncalculated and Not Transferred" group contains subcontractors who made claims in July. For these claims, Ebert did not complete its assessment of them, issue invoices, pay any sums to subcontractors, calculate retentions, or transfer funds into the Retentions Account. This group contains 70 subcontractors who, over 12 projects, were owed $380,000 in retentions.
  2. The "Released but Not Paid" group are subcontractors who were due under the terms of their contracts with Ebert to have retentions released to them. For this group Ebert had calculated the amount to be released and recorded them as Released Retentions in its financial accounts but had not:
    • transferred funds out of the Retention Account as part of a reconciliation; or
    • paid the retentions to the subcontractors concerned. They were recorded in Ebert's accounts as unpaid invoices.

How the Act works

  1. We have explained in a previous article the operation of the Act's retention regime but in summary:
    • all retentions must be held on trust for the benefit of the person from whom they have been withheld;
    • accounts must be kept by those holding retentions to show the amount held on trust;
    • retention monies can only be used for the remedying defects in the performance of a person from whom they are withheld; and
    • they do not need to be held separately and may be co-mingled with other funds.

His Honour Justice Churchman undertook an analysis of the legislative history of the retention regime introduced by the Construction Contracts Amendment Act 2015. His Honour noted that "there were gaps in the legislation and the language used was imprecise".

Outcome

Churchman J analysed each category of subcontractors against the three criteria required to create a trust being:

  • intention to create a trust;
  • certainty as to the subject matter; and
  • certainty as to the beneficiaries.
  1. The Reconciled and Transferred retentions meet all requirements and were therefore validly held under the Act. The subcontractors in that category, some 131 entities, therefore had a claim to the funds in the Retention Account. However, the Calculated but Not Transferred retentions and the Uncalculated and Not Transferred retentions were not entitled to share in the funds in the Retention Account. Churchman J found that these monies had not been withheld, a requirement to become retentions monies under the Act, and that there was a lack of intention to create a trust.
  2. For the Released but Not Paid retentions, the retentions had been withheld and there was an intention to create a trust. They were therefore entitled to share in the funds held in the Retention Account.
  3. The result is that those entitled to share in the fund would do so according to the size of their claim on what is called a pari passu basis. Those not entitled to share in the fund held in the Retention Account will be unsecured creditors of Ebert.

What does this tell us?

  1. The most significant learning from this decision is the confirmation of the inadequacy of the retention regime in the Act. Churchman J made several comments about the imprecise language and the fact that the regime did not necessarily do what the politicians said it would do as the Bill was passing through Parliament.
  2. With this in mind contractors and subcontractors should consider structuring more secure arrangements over and above the regime in the Act to protect any retentions being withheld under a construction contract. We have started to see this reaction already as people become aware of the issue with retentions.
  3. If you have any questions about the retention regime in the Act or how you can best protect yourself if a party holding retentions goes insolvent, then please contact us.

Footnote

1 This date is important as only contracts entered into or renewed after this date are subject to the retention regime in the Act. Of the $9.324 million owed in retentions some $4.858 million were not subject to the Act. It is understood these were withheld and kept in the general account, which had a nominal balance at the date of receivership.

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