Construction Contracts (Retention Money) Amendment Bill

Members, the House is in committee on the Construction Contracts (Retention Money) Amendment Bill. We come first to Part 1.

I seek leave for all provisions to be taken as one question.

Leave is sought for that purpose. Is there any objection? There is none. The question is that Parts 1 and 2, the Schedule, and clauses 1 to 3 stand part.

Thank you, Mr Chair. It’s a pleasure to take a call on this particular bill, and there’s an aspect within this that I want to raise with the Minister, because, broadly, the intent of the bill is good. We absolutely support that. We’ve supported it so far, and, in fact, it’s looking to enhance a piece of work that was put in place under the previous National Government to try and better protect participants within the construction sector, particularly at the lower end of the contract spectrum, subcontractors, and the situations where we have seen unfortunate cases of a head contractor or one of the larger participants falling over and then those subcontractors or other participants further down the contract ranking being left out of pocket. So the retention money process was to ensure that that money being retained by the head contractor, for example, was set aside for those subcontractors.

So we’ve supported the bill to this stage. The amendments made through the select committee have been relatively straightforward, and in the Minister’s Supplementary Order Paper (SOP) there are technical changes that we support but I have proposed an SOP that I want to speak to, because an issue’s been raised with me off the back of this piece of legislation going through its stages so far, and that’s around the potential and, I believe, unintended consequence tying up additional retention money that could be used in cash flow.

So I’ll run through an example, because I think it’s important to give context to how it could play out in a particular construction contract scenario where you have, in this legislation, currently proposed, a party A being the client or head contractor, and a party B, being a subcontractor, and party A withholding money from party B that needed to be kept in trust for the period when it is subsequently released or any remediation work deducted from it and the remainder released. That all makes sense. The challenge arises in the situation where there are more than those two parties, and indeed that’s quite a frequent scenario. It’s a situation where you have a client that engages a head contractor to carry out the contract. The example I’ll use, to try and keep the maths a bit simple, is you might have a $10 million contract where a client engages the head contractor to deliver that project for $10 million. So the client then is eligible to retain $1 million as the typical 10 percent retention threshold, and put that in trust. So that’s 10 percent of the total contract put in trust.

That head contractor then engages a subcontractor to do, often, the majority of the work. So the head contractor might do, say, 20 percent of the work—$2 million of the contract—and the subcontractor does $8 million. So that head contractor then retains 10 percent of the $8 million—$800,000. And then you can get the scenario where the subcontractor engages a sub-subcontractor, so maybe they do $5 million of the work and they pass on $3 million of the work, so they retain a further $300,000 of retention money. The issue there arises because you have 10 percent of the retention money held by the client. You have a further 8 percent, so $1 million held, another $800,000, and another $300,000. So you end up, actually, with $2.1 million of retention money held on that $10 million contract, which is well above the 10 percent that is eligible to be retained. And this only arises in a situation where you have multiple participants within a construction contract, which, actually, is quite frequent.

So the issue there then becomes that you’re tying up a significantly higher amount of working capital than should be the case. So each of those steps within the chain then has to have that money sitting aside, and indeed, in some cases, they may be paying out retention money at the end of a contract, before they’ve, potentially, received all that money down from the tier above them. So what I’ve proposed with my Supplementary Order Paper is to try and address that issue by making an amendment to section 18 (FB), in clause 7, which is the section around complying instruments, to, effectively, enable multiple parties to become part of one complying instrument.

So what I’ve proposed there is new subsection (3A), “Where there are multiple construction contracts for a single construction work [or project], any 2 or more of the party As or party Bs who are a party to one or more of these contracts can agree to issue a single complying instrument for the whole of the work covered by their collective contracts.” So what that would enable us to do with this legislation is then to capture that unintended consequence and enable all of those parties to agree on a collective complying instrument—for example, a bond held at the top level by the client issuing that main contract to the head contractor. In the example I used, the $10 million contract, they would hold a $1 million bond, being 10 percent, and all subsequent parties can then connect into that same retention. So you achieve the outcome of securing the retained funds in a safe environment so that they are protected irrespective of the solvency of the head contractor down the track. That’s the issue we’re trying to address here—to ensure that money is available to be paid out to subcontractors and the likes once they have completed their works. But it gets away from that additional cost that we are adding into the industry by seeing, effectively, a doubling of the retention money being held.

This, when we look at the Ministry of Business, Innovation and Employment’s (MBIE’s) figures saying, right, there’s $31 billion - odd of contracts—in the scenario I gave, where we saw $2.1 million, so, effectively, an extra 110 percent over and above what we should be retaining is being retained, we’re looking at about $3.5 billion dollars’ worth of working capital being constrained through the construction pipeline, going on MBIE’s figures, and that’s a pretty significant level.

So what I’m proposing to do is to create a scenario to help us alleviate that pressure, and we’ve looked at a few potential SOPs over the last few weeks to try and address this, potentially having all party As and Bs retaining in a single trust model. That was considered to be out of scope of the bill by the Clerk’s Office. So we’ve ended up with this scenario, which is imperfect but, I believe, can achieve the intent of unlocking that potential working capital by enabling all of those parties A and B to convalesce to agree to the single complying instrument—for example, the bond—and to therefore create the capacity to get on and do the project, achieving the intent of the legislation, i.e., protecting those retention funds, but unlocking that working capital that is, I believe, unintentionally captured as the legislation is currently proposed.

So I’d be really interested in the Minister for Building and Construction’s insights around that and whether they’re aware of the risk for potentially locking up additional capital over and above what was anticipated, and the potential cost of that for the industry. Thank you.

Thank you, Mr Chair. I would like to take the opportunity to thank the members of the select committee, who I think have given this bill some very thoughtful consideration. I think it is one of those pieces of legislation that is an incredibly pragmatic and sensible piece of legislation that makes sense, and it’s something that needs to happen. It’s good to see all members across this House getting behind it.

In that spirit, I have examined the Supplementary Order Paper that the member has just addressed in his contribution. It is talking about a scenario where you may have multiple head contractors with multiple construction contracts with multiple subcontractors beneath. So it is a complex construction contract arrangement that you are talking about, and suggesting that there be one complying financial instrument that could be used for the whole of that job.

As I said, I have looked at it, and I have sought advice on it. One of the things that I keep coming back to is that we won’t be supporting it because it is not a necessary amendment. There is nothing in the legislation that precludes anyone from doing that; they would need to find someone to issue them a complying financial instrument in order to be able to do it if they were to use the bond mechanism in order to do it. It simply not good legislative practice to provide for something in the legislation that can occur anyway. So the fact that there is nothing to stop this happening does mean that we won’t be supporting that Supplementary Order Paper.

Thank you, Mr Chairman. I appreciate the Minister’s consideration of that, and I wanted to come to the section around complying instruments because, to me, it’s not clear that it is possible to do that currently under the current section on compliant instruments, section 18FB. It makes it clear that the complying instrument must be issued in favour of party B or endorsed with party B’s interest, and it must require the issuer to pay the retention money to party B if party A fails. So nothing in this—and there’s a couple of other aspects—gives any indication that it can apply to multiple party B participants within a construction contract.

That’s the real challenge here—that in most construction contracts, there are more than one party B layer. So when you have a subcontractor and then a sub-subcontractor, which is quite normal, then you are—I believe—not allowing for that under the current legislation around complying instruments. That’s why my Supplementary Order Paper seeks to clarify that multiple parties, who all have an interest in some aspect of the overall project, are able to then come together around one individual complying instrument because, as I say, the complying instrument currently must be issued in favour of party B or endorsed with their interests. That doesn’t, in my mind, refer to multiple participants being able to attach to the same complying instrument. So I’d be interested in the Minister’s view on that.

I direct the member to clause 7 of the legislation, which says that section 18FB will be amended. This is, of course, the complying instruments, replacing section 18FB(3)(a) with “(a) be issued in favour of, or endorsed with the interests of, (i) party B; or (ii) party B and 1 or more other persons (each being a party B under a construction contract); or (iii) a class of persons (all being party Bs under construction contracts) of which party B is a member”. That is the clause that allows what is outlined in the Supplementary Order Paper to occur.

Thank you, Mr Chair. While we’re just digesting that—and thank you to the Minister for that response—I suppose the first question is that the first reading was in June 2021, and here we are in 2023. I seem to recall being on the committee doing the original work on this. Can she perhaps just explain to the committee and, no doubt to construction entities and organisations that may be listening to this debate—even though it’s just after 11 at night—why there has been such a delay, because this is a very significant piece of legislation and many people have been calling for it. It follows a couple of court cases, particularly the Ebert court case. So I suppose that’s the first question I’d like to understand from the Minister.

I just wonder if the Minister could tell us what quantum of money is currently subject to retentions in the New Zealand construction industry right now.

In answer to the two questions that have been put in the committee, there are two reasons why this bill has taken some time to come back to the floor of the House. One is availability of House time. Quite a lot has occurred in terms of lost time in the House over that period of time, but the other and more substantive reason is in terms of the Government Supplementary Order Paper. We’re wanting to make sure that we have the compliance regime there so that it actually did have some force.

In answer to Mr Seymour’s question that he’s put, one of the issues is the fact that there isn’t a regime around it means there actually isn’t a good handle on what money is held as retention moneys at the moment. This is the kind of regime that will allow us to have those protections in place and, because there is more of a system around it, to have more of a handle of what the quantum is.

Surely one of the effects of the bill is that it will reduce the amount of working capital available to construction firms at a time when a lot of construction firms are under a lot of pressure. Doesn’t it seem perhaps a bit irresponsible to pass legislation without knowing what the quantum of the effect on construction firms’ working capital will be?

In answer to Mr van de Molen, over the Supplementary Order Paper that he was introducing in the clauses of the bill that I read out—actually, it is possible to package up clubs of subcontractors and contractors in terms of what that can be. The whole point of this is to make sure that we do have protections for those subcontractors; that, you can argue, becomes really important at a time where there is a tight property market and they could be at more risk. But the other point I’d make is that many of our construction companies already operate this. It is good practice; it is the way in which they do already operate. But there are options to make sure that we can have the ability of our construction sector to get ahead.

Thank you, Mr Chairman. If the Minister’s unable to tell us how much money is currently subject to retention in the construction industry, can she give us an indication of the value of defaults due to companies failing to pay retention money when they otherwise should’ve?

Thank you, Mr Chair. I appreciate the Minister’s response around the clarification on that Supplementary Order Paper (SOP) she’s brought forward, and I just wanted to query that because I see the section 7 she’s referring to.

My question would be whether or not that gives enough clarity around the party Bs being in relation to one construction contract, because, looking at that, my understanding of it would be that it relates to a party A that has sought a complying instrument, that complying instrument could potentially cover multiple contracts that they have across a range of different projects, and, therefore, that would be party B or party B and one or more other persons, each being a party B under a construction contract, or party Bs under construction contracts. But nothing in that specifies that they could be party Bs of the same construction contract.

That’s the issue for me. Obviously, to me, this acknowledges the fact that one head contractor, for example, being the party A, could be working across multiple sites and multiple contracts, but it doesn’t seem to me to be entirely clear that it relates to both the subcontractor and the sub-subcontractor and any other participants within the one overarching contract. So that’s what I’m seeking to address specifically with my SOP, because I think it is really important that we do have clarity, and perhaps if the Minister is able to give us confidence that indeed it does address both, the situation where party A is operating across multiple sites and therefore multiple contracts and also the situation where party A has multiple party Bs on the same contract. If we can get clarity that both of those apply under the proposal that she’s brought forward, then that would be fantastic.

The section that the member is referring to does allow for multiple parties, if they want to do across multiple contracts, there is nothing precluding that in this legislation. That was the point I made in my initial contribution speaking to the member’s Supplementary Order Paper.

I just want to turn to the lessons out of the Ebert liquidation, which also followed the Mainzeal failure. What came out of the court decision was that it confirmed that the legislation—this is 2017 legislation—did not work as Parliament may have originally intended.

For example, in the Ebert case, the High Court confirmed that although it may have been Parliament’s intention to create a deemed trust—which clearly it was—by operation of the statutory regime, the actual effect of the language used in the Credit Contracts and Consumer Finance Act only creates an obligation on the payer to create a trust.

So my first question is: can she give assurance to the committee that this bill actually deals comprehensively with that matter? And the second thing: there’s been many examples of situations where contractors have had their tools on site and there’s been a liquidation or receivership event overnight, and they’ve been precluded from getting access to those tools.

Can she also, in that second regard, confirm to the committee that that situation is also provided for in this bill and will be necessary, the result being that contractors will be able to get access to their tools? So two questions there.

In answer to those questions—the first one: yes. In answer to the second one—and I believe this was something that was talked about quite a lot at select committee—the issue of contractors and their tools, and subcontractors and their tools, and their ability to access on site, we all know that is a significant issue but it is not an issue that is covered off under this legislation. That is an issue that is covered off under the insolvency laws. This, in many ways, is a carve-out for a specific piece of that insolvency legislation.

Thank you for the response, Minister. I know it’s outside the realm of this particular Act, but given the relevancy of it, is it her understanding that under the insolvency laws, that arrangement, the tools and the stock that they may have on site, like an electrician, would be covered? Because it’s very relevant to this whole issue around failure and contracts of construction contractors, which is the motion we’re debating tonight.

While it’s not my role as the Minister for Building and Construction speaking on this piece of legislation to get into the ins and outs of insolvency law, essentially, yes. It is the role of the person administrating an insolvency to work out whose assets are whose, and to distribute them accordingly. But I think we should keep this to the bounds of this piece of legislation.

Mr Bayly, while we are broadly looking at the whole bill, it’s creeping outside the provisions of the bill.

Yeah, and I appreciate the indulgence of the committee. I just want to return to the Minister’s Supplementary Order Paper, which we haven’t had much time to consider, but I suppose the primary purpose of this—well, one of the one of the primary purposes—is the issue around councilcontrolled organisations and also the wider responsibility of councils, who obviously procure a significant amount of work, whether in respect of infrastructure or just procurement of other construction-related projects. The issue over the councilcontrolled organisation, which is covered under section 18E(3)(b)(va) and (vi), in clause 4, seems reasonably clear, because my understanding of it—and I’m just going to get the Minister’s understanding as well—is that where you’ve got a council-controlled organisation, there would be directors in place who could fulfil the obligations and take responsibility for failure. And we all know that the bill includes a $50,000 fine or penalties for directors who don’t conform to the requirements of keeping the retentions in a proper order and reporting on them, etc. So that bit, I get, but I suppose my question is a wider one: where councils, in their own right and not necessarily through a council-controlled organisation, procure directly, how do we know, if there is an issue where a council has failed to adhere to the retention policies set out in this bill, where the liability lies in the event of failure?

In respect to whether this law will apply to councils as well as council-controlled organisations, I can assure the member there’s one law to rule them all.

With all due respect, that was quite a serious question. So the question is: directors, if they don’t perform their duties, are subject to a personal liability of $50,000. This talks about council-controlled organisations (CCOs) where there are directors in place, so I can understand the liability. My question specifically—and I’ll just maybe repeat it for the benefit of the Minister—is: councils clearly do not have directors; they have councillors. If there was an event where councils direct procurers of a construction project and they do not account for retention, where does the personal liability lie in that situation? And I’ll just keep talking, if I may, while the Minister’s just getting an answer on that, because I think it’s a very important point. Councils are very large procurers in their own right—whether it’s for wastewater services, whether it’s for roading projects, all those types of different projects—and there will often be wider construction of buildings, and they won’t be done through a CCO; they will be done directly through the council entity.

Councils already sign contracts directly, not only through council-controlled organisations. There is direct contracting through many of our councils. So issues around liability already apply, and these differ from contract to contract, depending sometimes around the delegations of who could sign the contract, whether that’s at an officer level or whether it requires the endorsement of the table. So there is not one simple answer for that. It will depend on the contracts.

But that is my point—that is my point. The Act specifically rams home the liability for not complying with the bill provisions to directors. And, you’re right, that includes $50,000 of personal liability for each director. Why should a council be in a different situation—although it has a different structure—because councils may and often could actually not perform the duties that they should? So where in the bill does it direct me to say where those liabilities lie for nonperformance, who I would sue, and who the court would sue if there was nonperformance? Is it the councillor; is that the council officers? But I can’t see any reference in the bill. Perhaps the Minister can help me.

I think what the member is getting into is what will differ from situation to situation and contract to contract. And like any other dispute that there is over a contract, the council would need to take legal advice.

Thank you, Mr Chair. Look, I’d just like to come back to the example I gave at the start, and I’m just interested in testing whether it’s the Minister’s understanding that there is the risk here of seeing significant cash flow amounts tied up through the trust process that is, effectively, one of the two options here for retention money—either being held in trust or a complying instrument being sought. So I’m interested in whether that example, as I explained it, is the Minister’s understanding too, where you could end up with, potentially, more than double the amount of retentions being held that should be held in an overall contract, and the implications of that because when I was looking at the regulatory impact assessment, I didn’t see any information pertaining to potential cash flow costs to the industry off the back of possibly having $3.5 billion dollars’ worth of constrained cash flow, and the impact that might have on those businesses.

Secondly, alongside that, I’m also interested in whether the Minister can shed some light on the potential costs of these complying instruments—whether there is any indicative range that she’s sought or obtained from insurers or banks to give some insight into the additional cost we are imposing on these participants within the building industry. Obviously, there is a cost, and we accept that, to try and better secure those retention funds—there will be a cost. I totally am on board with understanding that, but I’m interested in whether she can give an indication of what those costs might look like because that could influence a head contractor’s decision to either, potentially, look at retaining money on trust in the separate bank account, as proposed, and all the different requirements around that, or taking the alternate option of a complying instrument. So some insight into those costs, and also the impact or the example I gave around whether that cash flow could be tied up through numerous participants in having these multiple party A, party B agreements, where you end up with additional retentions.

I think we’ve dealt with the multi-party question several times. What I will point the member to—and I think that this would be well understood from the examination that I know that it did receive at select committee—is that holding retention money is voluntary here. So I think that’s one of the critical things to understand. There is nothing prescribed in the bill that has a set amount to it—that is going to be for the parties to determine themselves when they’re entering into an agreement. So I think that is one of the things that has to be understood about this legislation.

The other that I would point to—I understand the anxiety that members have around unnecessarily tying up working capital, and I think it is a good question to be asked, but we must remember and go back to the principle of why it is that we are passing this legislation, and that is because there have been times when head contractors have used retention moneys which should have been protected from their everyday business, from their working capital, and it is their subcontractors that have paid the price for that, and that is the whole purpose of the legislation.

Thank you, Mr Chair. Yes, look, I absolutely accept that, and that’s the intent here of what we are trying to achieve. But by locking up more than double the amount of retention, surely that is an unintended consequence, and that’s where I want some clarity. The Minister hasn’t addressed that yet, and I would like it if she could give some insight into whether or not that is also her understanding of it. I think it’s also important to understand that it is very normal practice in the construction sector to retain money through these contracts, and the typical level is 10 percent. So, therefore, I’m interested in some insight around the potential cost of that because I think it’s a bit flippant to say that “Oh, well, it’s entirely up to them whether they have retentions.” Yes, to an extent, that is the case but it is standard practice that retentions are held—that’s why we’re passing this legislation—because it is normal business for these retentions to occur, and so, on that basis, there must be some insight into their potential cost imposition on those businesses.

I will answer this one more time, but I think we are at the risk of repeating ourselves here. This is a voluntary system. Nobody has to enter into it. There is no prescribed amount; it is up to parties to determine how much is going to be put aside, if it is going to be put aside.

Can I just briefly comment on that answer—I guess doing construction is voluntary. You know, it’s certainly true that businesses could choose not to enter into any contract at all, but that’s kind of moot. I think the point is that under this law, if people do want to enter into construction, and if they do want to use retentions—which have been part of construction for a very long time—then there are some constraints put on them. So I’m not sure that the Minister is really addressing the question. But the question I asked earlier was if the Minister could quantify the amount that is lost by insolvency. Now, just to be helpful to the Minister, the regulatory impact statement says annual insolvency costs are $89 million. Does the Minister think that might be how much is lost from retentions that aren’t properly paid each year in New Zealand—$89 million—or is it some other number?

I’m aware that the regulatory impact statement puts that insolvency cost at $89 million, but one of the issues that I addressed as an answer to an earlier question is because there isn’t a regime around recording all of this in terms of the flow of retentions, you cannot just extrapolate from that and say that that is the amount it could be. But with having this framework around the retention moneys and the fact that we will have a structure around it, we will be able to have more of an idea around what that will be.

I move, That the question be now put.

Thank you, Mr Chair. I think this is a really important point. There is a cost and a benefit to this. There is the cost of having what could be working capital ring-fenced and not able to be used by the business. That’s a cost, but the Minister doesn’t know what the quantum of that working capital or that retention money is. But then there’s also a benefit that there’s less insolvency. But the Minister said they don’t know what the benefit is. So am I correct to think that this Government has brought a piece of legislation to the House and the Minister responsible doesn’t know what the costs or the benefits are?

No, the member is not correct.

I move, That the question be now put.

I just want to ask the Minister a question to clarify. So if the cost of insolvency as a result of construction businesses going under is in that region of $89 million a year, under the amendments to the Construction Contracts Act, the impact summary, it says that retention moneys held are between 2 and 10 percent of the contract price. Now, let’s assume, generously, that $89 million - odd is lost to insolvency, 10 percent of that being the contract price—is all of this legislation, all of this compliance requirement, really for $8 million, $9 million, $10 million or, potentially, $1 million or $2 million a year? Is that the net quantum of the amount of money that we might be protecting for subcontractors who have performed work, who may well have been paid for the work they have done, apart from that 2, 5, or 10 percent withholding, which is genuinely withheld because of the risk of defects or quality issues being found with their work or their work being found to be incomplete or not conforming, or some aspect of the contract?

So is all of this legislation intended to protect, on an annual basis, maybe, I don’t know, $1 million, $2 million, or $5 million worth of payments that would otherwise be due to subbies? And that’s assuming, of course, that, actually, those retentions weren’t going to be used for dealing with quality issues or withheld by the head contractor because of a failure to deliver to the quality standard.

Again, I have already covered this question off in previous contributions. The extrapolations and assumptions that members are making to draw from that are simply not correct.

I move, That the question be now put.

Could I ask the Minister if it’s true that I’m incorrect, that the extrapolations that every other member on this side of the Chamber is making is incorrect? One last chance: can the Minister just tell us, what are the costs in terms of tied-up working capital and the costs of tying that working capital up versus the benefits of insolvency that won’t happen? Because if the Minister responsible can’t tell us what the numbers are for the costs and benefits, then it’s not really fair for her to tell everyone else that they’re wrong when she doesn’t know, herself.

I’ve been over this several times, in terms of not being able to extrapolate that out. But let’s actually get back to what this is. This is the retention money that is there for the subcontractors. It is put aside because this is money for people who have done work and should be, and deserve to be, paid out. That is the whole point that is occurring in this legislation.

In terms of the wanting to extrapolate from those numbers, I’m not going to be ruling in or ruling out. It could be, but, as I have said, you cannot draw the assumptions that members are trying to. But let’s think about some of the high-profile cases where we have had businesses go under, where we have seen contractors and subcontractors that haven’t been paid out. We have seen a number of small businesses who have worked incredibly hard on projects not get paid and—I take the point that was raised by members in the National Party around that—not get access to their tools. In the case of Mainzeal, that meant their business couldn’t operate, but that is covered under a separate piece of legislation.

But the point of this is the fact that even if we’re talking about a couple of dollars here, this is money that people have worked hard for, and they deserve to be paid and not for people to use that in an irresponsible way. What we know is the best practice in the building industry is already to do this.

I move, That the question be now put.

Motion agreed to.

The question is that Tim van de Molen’s clause 7 amendment to Supplementary Order Paper 278 set out on Supplementary Order Paper 328 be agreed to.

The question is that the Minister’s amendments set out on Supplementary Order Paper 278 be agreed to.

Amendments agreed to.

Parts 1 and 2, the Schedule, and clauses 1 to 3 as amended agreed to.

Bill to be reported with amendment.

House resumed.

The committee has considered the Construction Contracts (Retention Money) Amendment Bill and reports it with amendment. I move, That the report be adopted.

Motion agreed to.

Report adopted.

The Construction Contracts (Retention Money) Amendment Bill is set down for third reading immediately.