Retentions Must Be Returned - The High Court Confirms

Retentions under a subcontract are held on trust by the head contractor for the benefit of the subcontractor. If retentions are withheld, contingent on anything other than the subcontractor’s performance, they must be released immediately, as this is considered void and unenforceable.
In Stevensons Structural Engineers 1978 Ltd (in liq) v McMillan & Lockwood (PN) Ltd & Anor [2024] NZHC 2415, the High Court held that withholding retentions based on practical completion of the Head Contract was prohibited by sections 18I and 13 of the Construction Contracts Act 2002 (“the Act”). The "pay when paid" nature of the clause rendered the retentions clauses void and required the immediate release of the retention money to the subcontractor.
This article will cover the key points of the decision, including explaining:
- What are pay when paid clauses and why are they void and unenforceable.
- Why the retentions clause in this case was prohibited.
- How pay when paid provisions render entire retentions clauses void.
- Why head contractors cannot use retention money to set off costs incurred in contract cancellation.
This decision highlights the importance for all subcontractors to review their subcontracts for pay when paid provisions, and cautions head contractors to be careful when drafting their subcontract agreements.
Background
Stevensons Structural Engineers 1978 Limited (“Stevensons”) was subcontracted in 2020 and 2021 to carry out steel fabrication and installation works on two projects. These projects were for McMillan & Lockwood (PN) Limited, and McMillan & Lockwood Central Limited (together, “McMillan & Lockwood”).
Stevensons went into liquidation when the works were only partially performed. This resulted in McMillan & Lockwood cancelling the subcontracts on the basis of an act of insolvency. The liquidators of Stevensons sought the immediate release of the withheld retentions. This was rejected by McMillan & Lockwood.
McMillan & Lockwood argued the retentions clauses were not prohibited, and it was entitled to withhold the retentions until practical completion of the head contract.
Conditional Payment provisions
Conditional payment provisions are clauses which make payment to the payee conditional on the payer receiving a payment from another party. This is referred to as a ‘pay when paid’ clause. For example, a clause stating a subcontractor will be paid once the head contractor has received payment from the Principal is a pay when paid clause.
Section 13 of the Act expressly prohibits conditional payment provisions.
Accordingly, pay when paid clauses have no legal effect and cannot be used as a basis for withholding payments which are due and payable (section 13(1)). This is to ensure subcontractors receive regular and timely payments.
Why McMillan & Lockwood’s retentions clause was prohibited under the Act
Clause 12.4 of McMillan & Lockwood’s subcontract general conditions provided that:
- McMillan & Lockwood would release 50% of the retentions within 30 days of Stevensons completing the works and providing QA documentation and a PS3 Producer Statement.
- The remaining 50% was to be released within 30 days of the issue of a practical completion certificate under the head contract (“the conditional provision”).
The Court held that withholding the remaining 50% of retentions by way of the conditional provision was prohibited because the release is contingent on “anything other” than Stevensons performance of its contractual obligations (at [44]), i.e. it is conditional on McMillan & Lockwood carrying out all of its obligations. This is prohibited under s18I(1)(a) and s13(2)(ca) of the Act, which renders any conditional payment provision void and unenforceable.
Consequence of the conditional provision being prohibited
The consequence of the Court’s finding was that the entire retentions clause in the subcontract was void and has no legal effect (at [58]). McMillan & Lockwood was not contractually entitled to withhold retentions under the subcontracts and must release those immediately.
[78] … The defendants (McMillan & Lockwood) had no contractual entitlement to withhold the retention money or retain the retention money. The plaintiff (Stevensons) had an accrued right to payment of the retention money under the subcontracts prior to being put into liquidation and prior to the disclaimers or any cancellation of the subcontracts.
Set-off
McMillan & Lockwood argued that it should be entitled to use the retention money as set-off against the losses it incurred from Stevensons cancelling the subcontract when it became insolvent.
The Court rejected this argument and found that McMillan & Lockwood could not use it for set-off. The retention money was withheld by McMillan & Lockwood under the subcontracts as being held on trust by it as trustee, for the benefit of Stevensons under section 18C(1) of the Act (at [69]).
Recent amendments to the Act clarified and bolstered elements of retention regimes. When retentions are deducted, a trust is automatically established, requiring that these funds be held in a separate account, distinct from other non-retention funds. Since these funds are held in trust, head contractors are prohibited from using them for their own benefit; they may only be used for the purpose of rectifying defects.
Because the retention money was held on trust, the Court determined that McMillan & Lockwood could not apply the retention money as a set-off under section 310 of the Companies Act for the losses incurred when Stevensons cancelled the subcontract. Allowing this would effectively permit McMillan & Lockwood to benefit from the retention funds, which they have no right to.
What this means for subcontracts
Subcontractors frequently enter construction contracts which include pay when paid provisions or de facto arrangements arise where payment becomes dependent on the other party being paid, despite being prohibited under the Act.
This case illustrates that relief is available from the Courts and through other dispute resolution avenues, when a party relies on conditional payment regimes or excuses.
Subcontractors should be aware of their rights under the Act, so when issues arise, they can promptly resolve any disputes and maintain cash flow. Being proactive and informed about your rights means subcontractors can navigate challenges more effectively and ensures they are protected within the construction industry. This includes reading your current, or any future subcontractor agreements for conditional payment provisions such as pay when paid clauses. If your contract has one of these clauses, there are two options available:
- Seek the immediate release of your retentions, as the whole clause is void and unenforceable. Consequently, the head contractor has no legitimate right to withhold them.
- There are ways to resolve contracts that do not comply with the Act, ensuring that any current and/or future work continues. You can propose amendments or modifications to the retention clauses to make them complaint with the Act.
Head contractors need to be aware of their obligations under the Act when drafting subcontractor agreements. Retentions are an important form of security for defects. Head contractors risk releasing all the retentions withheld if they fail to carefully draft their contracts to avoid pay when paid or other prohibited clauses.
If you would like to discuss your subcontractor agreements or you have concerns regarding your retentions, contact Jaesen Sumner or Finn Hollingworth.