Law Change To Protect Subcontractors – What Is The Impact On Head Contractors?
On 30th March, Minister for Building and Construction Megan Woods announced a new law to protect subcontractors. The changes have been made to give subcontractors the confidence they will be paid the retention money they are owed should the head contractor’s business fail.
“These changes passed in the Construction Contracts (Retention Money) Amendment Act safeguard subcontractors who are often the first to miss out in the event a construction company becomes insolvent,” Megan Woods says.
“While it is not a requirement to hold retention money, many head contractors choose to withhold part of their payment to specialist tradespeople for up to 12 months. This is one way to help ensure building work is done right first time and acts as an insurance that the subcontractor will return if there are any defects.
Companies and directors who choose to hold retention money against subcontractors will now be required to hold retention money on trust in a separate bank account, which is unable to be mixed with other company money or assets. Information about the retention money held must be reported to subcontractors on a regular basis, at least once every 3 months. Where retention money is kept, there will be a strict liability offence for failing to hold retention money properly: for every breach of the retentions regime directors will face fines of up to $50,000 and companies will face fines of up to $200,000 (MBIE, 2023).
While this law change protects subcontractors, it does tend to bypass the fact that retentions held against sub-contractors are often similar to the retentions held on the main contractor by their clients. “This can lead to a situation where a main contractor could have $3m of retentions held against them on a $30m project, and no longer have the ability to balance this with cashflow from sub-contractors says Richard Johnstone, Director of Amalgamated Builders Limited.
Where main contractors may have used this cashflow in the past, they will now need to ensure that they have enough funding from elsewhere, and ensure that the cost of this capital is taken into account in their pricing. When gross margins in the industry are typically around 5%, there is a concern that this additional burden could put more main contractors under-pressure in an increasingly difficult market.
“The practice of retentions in our industry ties-up cash, so is a hidden cost of construction. So while this law is intended to ensure a more robust construction industry, it is likely to place an additional strain on cash reserves for main contractors that have not done this in the past, and are not adequately prepared for it”, Warren Luxton, NZ Construction Alliance says.
While the law has just come into effect, it has been foreshadowed for the past few years and many head contractors have been preparing for it. As only new contracts from 5 April are impacted, all organisations will have time to ensure that they fully comply, so ultimately it should lead to a more robust construction industry in New Zealand.