What we know now: High Court provides guidance on the retentions regime

The High Court in Bennet v Ebert Construction Limited (In rec & liq) has provided some guidance on the retentions regime. The judgment confirms:

  1. Retentions do not exist until the payment from which they are being withheld is made to the subcontractor
  2. Failure to comply with the Regime by the Head Contractor / Principal is ultimately the misfortune of the subcontractor in a Head Contractor / Principal’s insolvency

Accordingly, we reiterate our caution for subcontractors from our previous article. Accounting records are the proof that your retention exists so it is important to exercise your rights of inspection regularly so as to increase the chances of your retention monies being accounted for, and therefore protected, in the event of the Head Contractor / Principal’s insolvency. Perhaps this is easier said than done, given the lack of penalties and enforcement mechanisms within the retentions regime under the Construction Contracts Act 2002.

Retentions and Receivers

Ebert Construction Company (Ebert) went into receivership on 31 July 2018 and liquidation on 3 October 2018. Ebert had a number of projects and a number of contracts at the time of insolvency. The contracts provided for retentions – whereby a portion of money is withheld from payment to the subcontractor and either released to the subcontractor on practical completion or appropriated by the Head Contractor / Principal to remedy defects in the subcontractor’s performance. Some of these contracts were subject to the retentions regime under the Construction Contracts Act 2002 (CCA) which came into force on 31 March 2017. For contracts entered into after this date, Head Contractors / Principals were required to hold retention money on trust for the subcontractors so that their retentions would be protected in the event of the Head Contractor / Principal’s insolvency (Regime).

PriceWaterhouseCooper (PwC) is receiver of Ebert and sought orders from the High Court as to how approximately $3.68 million in possible retention monies was to be distributed to subcontractors (Application). This amount was deposited in a separate bank account (the Fund). There are 152 subcontractors with retentions owed. 131 of these subcontractors have evidence that their retentions were deposited into the Fund (Fund Subcontractors). 21 subcontractors had contracts to which the Regime applied but the retentions were not placed into the Fund (Non-Fund Subcontractors). There are also further subcontractors with retentions amounting to approximately $4 million. However their contracts were not subject to the Regime as they were entered into prior to the Regime coming into effect – meaning there was no requirement for Ebert to hold their retentions on trust.

Orders sought and made

Last month we canvassed the orders sought from the Court, what issues are likely to arise, and possible outcomes. The High Court has now released its decision and made the following key orders:

  • PwC, receiver of Ebert, is appointed by the Court as receiver of the Fund
  • Only the Fund Subcontractors will be entitled to the Fund ($3.68 million)
  • The Non-Fund Subcontractors are not entitled to distributions from the Fund and will have to make claims as unsecured creditors
  • A further approximate $5 million of possible retention money related to contracts entered into prior to the Regime. These Subcontractors will have the same status as the Non-Fund Subcontractors
  • The Fund is to be distributed on a pari passu basis to the Fund Subcontractors, meaning distributions will be made proportionate to the amount each Fund Subcontractor is owed (the amount owed to the Fund Subcontractors is greater than the amount in the Fund)
  • PwC can deduct its fees of distribution from the Fund

Below we expand on the main orders sought and the result as ordered by the Court.

1 – Can PwC take control of and distribute the Fund?

Yes

The Court had to decide if it was appropriate that PwC be appointed as distributor of the fund given that PwC acts in the interests of the secured creditor, not the subcontractors. The Court held that by stepping into the shoes of Ebert as trustee, PwC has legal title to the Fund. The subcontractors, on the other hand, have an equitable entitlement to the Fund by virtue of the Regime.

The Court recognised a potential conflict of interest arising from this situation, however directed that the Fund could only be distributed to the subcontractors (not creditors of Ebert) – and PwC would be carrying out its role as an officer of the Court, rather than a representative of the secured creditor.

2 – Which subcontractors have a basis to claim from the Fund?

Only the Fund Subcontractors

The Application grouped the subcontractors into three categories each with a different method of establishing its entitlement to a distribution from the Fund:

  1. Subcontractors with retention amounts invoiced, calculated, and then placed into Ebert’s retention account
  2. Subcontractors with retention amounts invoiced and calculated but not withheld and not transferred into Ebert’s retention account
  3. Subcontractors with retention amounts not invoiced, not calculated and not transferred into Ebert’s retention account

The first category of subcontractors are the Fund Subcontractors; the second and third categories of subcontractors are the Non-Fund Subcontractors. In order to determine which category of subcontractor was entitled to a distribution from the Fund, the Court considered conventional trust law and the requirements under the Regime.

Conventional trust law

First, the elements required for a trust to exist on conventional trust principles is based on the concept of the “three certainties”:

  1. intention to create a trust;
  2. subject matter of the trust; and
  3. object (or beneficiaries) of the trust.

Requirements under the Regime

Second, the Court highlighted that the Regime requires (under section 18A) for retention money to be withheld by a party. Importantly, a would-be retention holder cannot say it is entitled to retention money unless it has been paid for its invoice and retention money has been withheld from this payment.

Subcontractors entitled to claim from the Fund

  • Fund Subcontractors with retention amounts invoiced, calculated, and then placed into Ebert’s retention account.

There was certainty of intention to create a trust (money withheld and deposited into the Fund account), certainty of beneficiaries (the Fund Subcontractors) and certainty of subject matter (the amounts deposited into the Fund account). There was also compliance with the Regime due to the Fund Subcontractors’ invoices being paid and the retention amount being withheld.

Subcontractors not entitled to claim from the Fund

  • Non-Fund Subcontractors with retention amounts invoiced and calculated but not withheld and not transferred into Ebert’s retention account

First, retentions must be withheld in accordance with the Regime. These retentions related to payments that were never made to the subcontractor. Therefore, the retention portion was never withheld and there was no intention to place the money on trust.

Second, the subcontractors in category 2 (unlike those in category 1) were not identified as having their retentions held in the Fund account – meaning they were not identified as beneficiaries.

  • Non-Fund Subcontractors with retention amounts not invoiced, not calculated and not transferred into Ebert’s retention account

Similarly to those subcontractors in category 2, the Court held that, because payments were never made to the subcontractor, the money was not withheld and no intention to create a trust was exhibited by Ebert.

3 – Can subcontractors with incorrectly dated contracts claim from the Fund?

No

Some of the Non-Fund Subcontractors’ contracts were incorrectly dated as being entered into prior to the law on retentions coming into effect on 31 March 2017, so that Ebert did not realise it was required to place these retentions on trust. The Court held that the Regime is explicit in its prohibition of the use of retention money for the payment of anyone other than those who are entitled to the retention by virtue of section 18FA. Accordingly, and by no fault of these Non-Fund Subcontractors, they cannot receive a share of the Fund. As tentatively predicted in our previous article, the Head Contractor / Principal’s non-compliance with the Regime becomes the misfortune of the subcontractor in the event of an insolvency.

4 – Are subcontractors entitled to interest for late payment pursuant to section 18G?

Interest for late payment should be disregarded for the purposes of distribution

The Court determined that the pragmatic approach would be to ignore interest for the purposes of calculating each Fund Subcontractor’s entitlement from the Fund. The Court held that, if interest were to be calculated, the cost of doing so would likely outweigh any additional money the Fund Subcontractor would receive.

As another comment, there is a distinction between the retention monies which the Regime dictates are to be held on trust, and a subcontractor’s contractual entitlement to interest which the Regime does not dictate needs to be held on trust. Arguably, another approach to entitlement to interest is to treat it as a separate matter for which the Fund Subcontractors would be entitled but as an unsecured creditor. Interest cannot be drawn from the Fund because interest is a contractual entitlement which is not subject to the Regime.

Interest earned on the Fund

The Court went on to raise a paradox where both Ebert and the Fund Subcontractors could be entitled to interest earned on the Fund. Under the Regime, the Head Contractor / Principal is entitled to retain any interest earned up until the point that the retention money becomes payable if retention money is invested under section 18F (the Fund was invested). Therefore any interest earned on the retention money owed may belong to Ebert (or be available to PwC as receiver). However, the Fund Subcontractors could argue that they are entitled to the interest on the basis that – from the date of cancellation – Ebert is no longer entitled to retain the interest because the retention money has become payable.

The Court was not required to determine this point, but indicated that the Fund Subcontractors could argue that the interest earned after cancellation belongs to them. It is unclear from the judgment, however, whether the Fund Subcontractors would take priority over other creditors in respect of these interest amounts.

5 – Can the receiver withdraw its costs from the Fund?

Yes

PwC sought orders as to their own costs, requesting they be paid from the Fund. The Court held that PwC’s costs can be paid from the Fund and these costs will be submitted to the Court for review and approval.

This Judgment’s approach to the Regime

In our previous article we anticipated that the results of the Judgment would hinge on two general approaches to interpretation of the Regime:

  1. A subcontractor’s retention will only be established and set aside from assets available to other creditors if it has been properly accounted for in accordance with the Regime. If not, and the principal has not complied with its obligations under the Regime, this becomes the misfortune of the subcontractor in the principal’s insolvency. Either the retentions were not placed or not held on trust as directed by the Act, or a trust over the monies does not exist for uncertainty.
  2. All retentions owed to subcontractors are identified and the total of these amounts is set aside on trust and excluded from the pool of assets available to creditors. The court could accordingly take the approach that those subcontractors whose retentions are not readily identifiable need to provide evidence of what amounts are owed to them before being entitled to any distribution and a timeframe to do so could be provided. If the total amount of retentions owed exceeds the assets available, distributions of retentions could be pro-rated.

As expected, it is clear that the first approach was taken. The provisions do not support the second approach, in that they do not evidence an intention of parliament to create a regime where a deemed trust would exist over whatever amount of money was the sum of all retentions owed at the time insolvency occurred.

The judgment certainly highlights some issues with the Regime as it currently stands. The purpose of the Regime is to protect subcontractors’ retentions in an insolvency. However, there are no ways in which a subcontractor can enforce a Head Contractor / Principal’s compliance with the Regime prior to insolvency. This raises questions as to how effective the Regime is at achieving its purpose. This judgment may incentivize reform or further regulations. It may also lead contracting parties to consider what alternatives to the Regime are available.

For advice on construction related matters, including in the insolvency context, contact one of our experts.

Contributor: Frank Brown, Solicitor

Who can help

Related Articles