Introduction

Stevenson Structural Engineers 1978 Ltd v McMillan & Lockwood (PN) Ltd, was the first substantive opportunity¹ the courts have had to consider the operation and effect of s 18I of the Construction Contracts Act 2002 (“CCA”). That provision sets the boundaries of valid retention clauses by voiding retention clauses in construction contracts that (among other things):

(a) make payment conditional on anything other than the contractor’s obligations under the construction contract (s 18I(1)(a));

(b) make the date of payment later than the date on which the contractor has performed all its obligations under the construction contract (s 18I(1)(b)); and

(c) have as their purpose (or one of their purposes) the avoidance of the provisions (s 18I(2)).

The result, in favour of the subcontractor, emphasises the vital importance of getting retention clauses right. In particular, the decision highlights the significant risks in linking subcontractor retentions to practical completion of works under the head contract.  

 

Background

The two defendants (related companies) were head contractors on two projects, the Sarjeant Gallery in Whanganui and a military project in Linton. The plaintiff, Stevenson, was the subcontractor responsible for steel fabrication and installation on both projects (under three separate, but materially similar, agreements). Stevenson went into liquidation in March 2023 with the works between 66 and 99 per cent complete and with the defendants holding $226,715.17 in retentions.

The relevant clauses of the agreements² provided that the retentions were to be released in two stages:

(a) 50 per cent on completion of the subcontract works and the provision of QA documentation and P3 producer statements, if required; and

(b) the remainder within 30 days of practical completion.

It was the clause providing for the second release period (called the impugned provision) that was the focus of the case.  Another relevant clause provided that the defects liability period ran from the date the subcontract works were complete until 12 months after practical completion of the head contracts.

 

Judgment

The liquidators of the plaintiff sought, by summary judgment, a declaration that the retentions provisions in the agreements were unlawful and judgment in the amount of the retentions.³

The Court found that the impugned provision was prohibited under s 18I(1)(a) of the CCA. This was because it made release of the retentions contingent upon the performance of the head contractors (the defendants) and other subcontractors that would be required to achieve practical completion. Therefore, the release of the retentions was conditional on something other than the plaintiff’s obligations.

The Court was not, however, prepared to find that the provision was void under s 18I(1)(b) because the defects liability period (where the plaintiff would be required to remedy defects) extended the plaintiff’s time for performance until 12 months after practical completion. Therefore, the retentions payment date (being within 30 days of practical completion) was not later than the date on which the plaintiff would have performed all its obligations.

The Court then went on to consider the effect of the finding that the impugned provision was void:

(a) First, the Court held that it did not render the construction contract illegal pursuant to the Contract and Commercial Law Act 2017. The Court considered it would be inconsistent with the purpose of the CCA if the inclusion of a prohibited provision under s 18I would render the contract illegal under the Contract and Commercial Law Act 2017.

(b) Secondly, the Court declined to imply a term into the contract that would allow the defendants to retain the retentions until the plaintiff had completed all the contract works.  This case was not a situation where the parties had left an obvious gap in their agreement, and an implied term was not required to give business efficacy to the subcontract.

The Court found that the consequence of the release clause being invalid was that the entire retentions regime under the contract was invalid – the defendants were not (and had never been) entitled to withhold payments as retentions or retain those payments. That finding was crucial in this case because it meant that the entitlement to the retained amounts accrued to the plaintiff before it went into liquidation. This meant the following did not affect the plaintiff’s right to the retentions:  

(a) the subsequent disclaimer by the liquidators of the construction contracts; and

(b) the fact that the construction contracts would never be completely performed.

Accordingly, the defendants continued to hold the retentions on trust for the plaintiff – the Court having found that the validity of the retention deductions did not affect the defendants’ obligations to hold those amounts on trust. Because the funds were still being held on trust, the defendants (as trustees) were not entitled to set off amounts owing to them (in their personal capacities) by the plaintiffs under s 310 of the Companies Act 1993.

 

Conclusion

The decision advances the aims of the amendments to the retentions regime in 2015 (of which s 18I was a part). Broadly, they were designed to protect sums held as retentions and ensure that those sums were not held for too long.

Stepping back, the particular result in this case (as between head contractor and subcontractor) appears harsh. The defendants are left with incomplete subcontract works that they will inevitably have to complete at their cost. However, it highlights why it is crucial to ensure retention clauses are compliant with the CCA.

Ultimately, the decision means that those engaging contractors and subcontractors will need to review their retentions clauses carefully to ensure they do not fall outside of the requirements of s 18I and, in particular, to consider whether any subcontracts make the release of retentions conditional on performance by other parties under the head contract. The effects of a prohibited clause can be profound.

 

Endnotes

¹ In Federal Commercial Construction Ltd v Leading Edge Fabrication Ltd [2020] NZHC 2352 at [26] the Court briefly noted that the parties were agreed that certain provisions of the contract at issue were void pursuant to s 18I, but did not consider the issue further.

² All the contracts were in materially the same terms.

³ If that primary clause failed, a secondary clause sought a declaration that any retentions held only be applied to actual defects in the plaintiff’s work.