A cautionary tale about retentions

Brendan Cash (Partner), Madison Dobie (Senior Associate) and Caitlin Hogan (Solicitor) Dentons New Zealand ’s Major Projects and Construction team.

In a recent case, Stevensons Structural Engineers 1978 Ltd (in liq) v McMillan & Lockwood (PN) Ltd & Anor [2024] NZHC 2415, the High Court made an important clarification about retentions in construction contracts.

This ruling provides a timely reminder of the requirements of a valid retentions clause in construction contracts and warns that if the timing of a retention release breaches the Construction Contracts Act (CCA) this could have the effect of invalidating the retentions regime as a whole.

This case is particularly relevant as it allowed retentions to be released to liquidated parties that had unfinished contract work. Amidst a downturn in the construction sector and widespread liquidations across the industry, security will be a primary concern for head contractors and principals.

The lessons learned from this case could help avoid pitfalls to mitigate the risk of losing security such as retentions.

What happened?

Stevensons, a steel fabricator, entered into subcontracts with two different McMillan & Lockwood entities for steel construction projects (the Subcontracts).

After completing only part of the work, Stevensons went into liquidation, and its liquidators sought the release of over $225,000 in retentions held by McMillan & Lockwood under the subcontracts.

When McMillan & Lockwood declined to release the funds to the liquidators, Stevensons argued that the retention clauses in the Subcontracts were prohibited under the CCA, s 18I(a). This clause prohibits terms in construction contracts that make payment of retention money conditional on something other than the performance of the party’s obligations under the Contract.

In other words, you cannot have a clause which allows one party to keep retentions beyond the point at which the other party has done all of the things it is required to do under the Contract.

Retention clauses breached the CCA

The retention clause in the Subcontracts provided for the release of the retentions in two stages. Fifty percent of the retentions would be released within 30 days after Stevensons completed its work. The remaining 50 percent of the retentions would only be released within 30 days of the ‘issue of a certificate of practical completion, or earlier, as detailed in the head contract’.

The Court found that the second limb was prohibited by the CCA because the issue of a certificate of practical completion for the head contract works was not dependent on the Subcontractor’s performance, but on the performance of others (such as the head contractor and other contractors). The trigger for the repayment therefore fell within the category of terms prohibited in 18l(a) of the CCA.

Stevensons also attempted to argue that the retentions clause in the Subcontracts was also prohibited under s 18l(b) of the CCA. S 18l(b) prohibits terms that make the date on which payment of retention money is payable later than the date on which the party has performed all its obligations.

However, the Court found that the Subcontracts did not breach this requirement because the defects liability period of the Subcontract extended to 12 months beyond the practical completion of the head contract works.

The trigger for the payment of the remaining retentions (this being, within 30 days of the certificate of practical completion of the head contract works) occurred before the end of the defects liability period.

Therefore, it did not extend beyond the date when Stevensons had fulfilled all of its obligations.

Effect of the prohibited clause

The Court determined that since the retentions clause was invalid under s 18I(a), the entire retentions regime in the Subcontract had no legal effect.

The Court considered that the retention regime was ‘an indivisible whole’ and the provision requiring release on practical completion of the head contract could not be severed from the balance of the retentions regime.

McMillan & Lockwood was not entitled to withhold retentions at all under the Subcontracts and Stevensons was entitled to immediate repayment of those funds.

However, the Court held that even though there was no right to retain the retentions, at the point at which the retentions were withheld (even though the withholding was invalid), the retentions were held on trust and all the relevant requirements that come with retentions held on trust under the CCA applied.

This was because the wording of the CCA retentions regime only requires that the retentions are withheld as a matter of fact for a trust to be automatically created (i.e., there is no requirement that the withholding is contractually valid for a trust to exist).

It is also important to note that after reviewing the purposes of the retentions provisions and the CCA overall, the Court concluded that the invalidity of the retentions regime did not make the Subcontracts “illegal contracts”.

The Court pointed out that such a finding would cause considerable disruption and uncertainty for parties involved in construction contracts.

Lessons for contractors

This case serves as a reminder for head contractors to take a critical eye to their Subcontracts and ensure that the retentions release date is contingent on the completion of the Subcontractor’s obligations.

The consequences of an invalid clause could be severe and may render the entire retentions regime in a contract ineffective.

Creating clear, enforceable retention clauses which align with the requirements of the CCA will help head contractors protect their interests and reduce the risk of their retentions regimes being invalidated.