In the current climate, Baker Love Lawyers’ Partner DEAN FRITH believes it is more important than ever to consider the risks surrounding cash retentions and how subcontractors and builders can afford themselves the best opportunity to recover any cash retentions in the circumstances of an insolvency event affecting a property owner or head contractor.
This article was first published in the MBA’sMaster Builder members-only magazine in September 2012.
The provision of cash retentions, or some other form of performance security, by a contractor has always been a contentious issue in the building industry and one that is often the subject of dispute between contracting parties. Since the GFC the level of insolvency and bankruptcy both in the industry and in the public at large is increasing. As a result, a growing number of contractors and subcontractors, small and large, have suffered considerable losses due to a property owner or head contractor going under. Often a large chunk of the losses suffered is in retentions, specifically cash retentions. First, let’s clarify the meaning of ‘cash retentions’. Cash retentions under a building contract involve the deduction of an amount (usually in the order of 5%) from each progress payment from the commencement of the works up until practical completion. At various stages, such as at practical completion and at the end of a defects liability period, the retentions are to be paid to the Contractor subject to the Principals’ contractual rights to have recourse to the retention monies in certain instances.
One Alternative to Cash
While the focus of this article is on cash retentions, and the alternatives shall not be considered in detail, it is important to note that it is a vital step in the contracting process for a contractor to consider offering an alternative to cash retentions such as a bank guarantee. The most common standard contracts in the building and construction industry have varied approaches to retentions, but most standard contracts do have provision to allow for a range of types of security to be provided (such as AS 4000-1997 and AS 2124-1995). As profit margins become smaller and cash flows tighten a trend has emerged within the building and construction industry away from withholding cash retentions to the provision of bank guarantees. This form of security may be advantageous for the Contractor. It will satisfy the head contractor or property owner’s insistence for some form of security over the work that is being performed. However, for a Contractor to be able to take advantage of this facility, it will need to be able to offer alternative security to the bank. The use of a bank guarantee also eliminates the risk of losing retention monies should the property owner or head contract enter into administration or liquidation. If a bank guarantee is used it is preferable that the bank guarantee be for a specified period of time rather than be open ended, thus eliminating the difficulty in having the bank guarantee returned.
No Retention?
There is an old saying in business that ‘cash is king’. Every opportunity that a contractor has to negotiate out of providing cash retentions should be taken. The advantage of no retention is that the contractor will have access to the full payment to which it is entitled to for the work it has completed up to that progress payment. This improves cash flow and the ability to meet trading obligations to other sub-contractors and suppliers. It is not uncommon for standard contracts to not provide for any retention, for example, the standard contract BC4. It could be argued that retention is redundant in residential building works as the home owner has the benefit of Home Warranty Insurance and as these contracts are overseen by the NSW Department of Fair Trading, contractors could face severe consequences, including the risk of losing their licence if they fail to adhere to their obligations under the contract. Therefore it is arguable that home owners do not need the protection of retention moneys.
Safeguards
Where the property owner or head contractor insists on the form of retention to be in cash there are a number of things to consider. Time Limit If the contract does provide for retention money then it is important to consider the contract closely as to the timing of release of the retention monies. Commonly the contract will allow for half of the retention money to be released upon practical completion, with the remainder paid out after the defects liability period. One major pitfall would be to attach the release of money to another contract, or a contingent event outside of the contractor’s scope in the contract. For example, if the contract specifies that the release of the retention is not until practical completion and the contractor has satisfactorily completed its contracted work but a dispute erupts between the property owner and another contractor over defective work, which postpones practical completion, then the money could take a long time to be released. Joint Account/Trust Account Often a contract can be vague as to the establishment and maintenance of the retention monies. If a contractor is not diligent in defining the specifics the property owner or head contractor could take full advantage of the retention monies and associated benefits, such as interest earned. Most commonly the retention monies are not deposited into a separate account but are monies withheld by the property owner or head contractor in its general trading account. If the contract is silent on who is to benefit from the interest earned on the account, it is usually kept by the principal. Sometimes the interest can be a considerable amount. It would be prudent to deposit the money in a separate interest bearing account and a special condition be inserted into the contract as to the division of any interest earned. If a contractor allows the principal full control of the retention money the principal also has the ability to mismanage it without the contractor’s knowledge. To maintain the security of the retention monies, the contractor should insist on, if it is not already specified in the contract, the money to be kept in a joint bank account or trust account. If the money is placed into a joint account it will provide more protection in the event that a head contractor or property owner is placed into administration or liquidation. A joint account requiring authority from both parties is preferable to a trust account, as the head contractor or property owner will often be the only signatory to a trust account and although it would be a breach of trust and the contract, it would still have the ability to access the funds without the contractor’s knowledge. Some building contracts do specify the use of joint or trust accounts due to the added protection these accounts provide. However, it is not uncommon for the property owner or head contractor to not comply with the obligation, particularly if it is having financial difficulties. Therefore it is prudent for a contractor to request evidence of the account and monitor it to ensure that it complies with the mutual obligations (e.g. joint signatories and a share of the interest). Personal Property Securities Act 2009 Another advantage of ensuring that retention monies are held in a separate account is that the contractor may be able to take advantage of the provisions contained in the recently enacted Personal Property Securities Act 2009 by registering a security interest over the monies held in the account. Such a registration would afford the contractor the advantage of having priority over other creditors in respect of the monies over which the security interest has been taken in the event of the property owner or head contractor going into administration or liquidation. As the legislation and associated register is rather new, we are yet to see many contractors considering this option, but it certainly is something that each contractor should seek legal advice upon.
Conclusion
In the past the NSW State Government has floated the prospect of establishing a statutory scheme, based on the NSW Rental Bonds Scheme, whereby retentions would be held in trust for the contractor until such time as entitlement to those funds arises. In theory this would solve some of the current issues set out in this article, but the cost and complexity of establishing and administering such a scheme has resulted in no action. In view of the current economic conditions facing contractors and anecdotal evidence of a rise in contractors losing retentions as a result of an event of insolvency it may be time for the Legislature to reconsider this option. The recently announced NSW government inquiry into insolvency in the building and construction industry may provide such an opportunity. But until such time it is now more vital than ever for contractors to be mindful of the risks around retention monies and take whatever steps necessary to protect their position.
