Surge in construction could bring “another Mainzeal”

1 February 2014

Opinion Piece

By Graham Burke, president, Specialist Trade Contractors Federation.

It is now 12 months since construction company Mainzeal collapsed, leading to around $70m in losses for many sub-contractors across New Zealand - ranging from plumbers and gasfitters to carpenters and scaffolders.

At least $20m of those losses, hitting countless small businesses, was due to the retention system. This allows the main contractor – such as Mainzeal - to hold up to 10 per cent of the sum due to a contractor, interest free for up to two years as a guarantee of the quality of the work. Because retentions work on a sliding scale, main contractors may often end up holding up to twice the sum from sub-contractors that is being held in retentions against them.

Sub-contractors are unsecured creditors. So when a main contractor fails it can lead to devastating losses for the smaller guys. This is not good for the reputation or credibility of the New Zealand construction industry and, ultimately, can mean higher costs for customers and the public.

In practical terms, if a sub-contractor has sustained major losses or if their entire profit from a job is being held interest free by someone else, then they are likely to have overdrafts and interest costs which they have to recoup through increasing their charges. In the worst case scenario they may become insolvent.

Since the Mainzeal collapse, the Specialist Trade Contractors’ Federation (STCF) has been pressing the Government to legislate to give sub-contractors the option of providing a bond as guarantee instead of the main contractor holding on to 10 per cent of the sum owed to them.

Alternatively, if both parties agree to retentions, STCF, believes that the retention should be legally treated as being held in trust for the payee. This would require a simple addition to current legislation and would mean retentions cannot be scooped up by the bank or receiver if the principal runs into financial trouble.

Despite some very good conversations with Government officials and the Commerce Select Committee looking at the situation, nothing has changed yet.

Now, more than ever before, this absurd  situation requires urgent attention. That’s because of the surge in construction activity in Auckland and Christchurch.

Most people outside the industry might think that the situation for main contractors and, accordingly, sub-contractors would be more secure during the good times. However, history has shown that the most precarious times for companies are recessions and, ironically, during upturns.

During economic upswings, firms often grow rapidly to meet demand and may over-extend themselves. If the bank refuses to loan them money, then there is the opportunity to use the retention payments they are holding as working capital. If the company fails down then, then those retentions will be used to pay secured creditors such as the bank or IRD.

Given the unpredictable nature of the industry, there is a strong likelihood that, unless the Construction Contracts Act is amended to address this problem, we will ultimately see another Mainzeal scenario with thousands of small businesses once again suffering for the mistakes of the main contractor.

Retentions are a frankly archaic hangover from the repeal of the Liens Act in the 1980s. No other industry would accept it – you don’t hire a lawyer and pay them 90 per cent now and 10 per cent at an undisclosed date up to two years away. When you get your car repaired you aren’t allowed to hold 10 per cent back in case there are problems.

A bond effectively allows a subcontractor to provide a guarantee to the main contractor without them having to hold on to any money themselves. Currently bonds can be used in standard New Zealand contracts but only if the main contractor agrees. Most don’t, and why would they? It’s free money in their coffers earning interest.

New Zealand’s thousands of skilled sub-contractors are the backbone of the construction industry and currently they are carrying a disproportionate amount of the risk. They provide the materials, the skills and the hours and they pay their staff, with no guarantee they are going to be paid in full themselves.

It is time to legislate and reform the unfair practice of retentions with a sensible, workable and just alternative. If retentions are held, they should be held in trust for the payee.  In an election year, New Zealand’s thousands of sub-contractors will be looking for action by the Government. 

If any positive can come out of the Mainzeal collapse, it will be that the government finally recognises how important it is to reform the laws around retentions.