Construction Contracts Act changes - is the tail wagging the dog?

This article first appeared in Infrastructure Magazine.

No-one who undertakes architectural, design or surveying work can afford to ignore the Construction Contracts Act (CCA) Amendment Bill - and neither can their insurers.

The Bill also changes dramatically the law relating to retentions.  Views will differ on whether the changes are  pretty.  We sketch that picture below, but note a strong sense of unease that the issues relating to retentions have not been properly understood or evaluated.

So why is the Bill doing what it is doing?  How did we get here?  A large part of the answer seems to be that consumer-focussed thinking, which might be appropriate for residential or smaller construction contracts (the “tail”), has driven reforms which will apply uniformly across the entire construction industry (“the dog”) - no matter how large the project or how sophisticated the industry participants who are making it happen.

A brief summary of a short Bill

The Bill was introduced in January 2013 after several years’ gestation.  The Commerce Select Committee considered it later that year but further progress was delayed by the elections and three Supplementary Order Papers (Labour, Greens and finally National) which targeted the vexed question of whether retentions should be held on trust.

The key changes proposed by the Bill:

  • bring consultants into the fold, by amending the definition of “construction work” to include design or engineering work and quantity surveying work, so that disputes regarding such work can be dealt with under the CCA’s fast-track, “rough and ready” adjudication process 
  • remove the distinction between residential and commercial construction work for most purposes
  • amend section 73 to allow all adjudicator’s determinations to be enforced by entry as a judgment, so “rights and obligations” determinations will be enforceable and not just determinations regarding payment, and
  • amend adjudication timeframes – but not significantly.

Consumer driven?

The strong consumer focus was expressly acknowledged by the Commerce Committee, which stated it “would benefit consumers” if consultants were covered by the legislation. 

The November 2013 Report on the Bill by the Ministry of Business, Innovation and Employment was even clearer, stating that: “The policy intent of adding design, engineering and quantity surveying work is primarily to benefit consumers by enabling them to use the [adjudication] processes under the Act to hold building contractors and professionals to account for their work”.

The Government’s sector wide push to improve quality, productivity, efficiency and accountability is admirable, but important questions remain.

  • How strong was the demand to include consultants in the adjudication process, if you put to one side demand from consumers involved in the residential or small scale construction sector?
  • Does the “one size fits all” approach to dispute resolution actually fit the reality of consultants’ terms of engagement and insurance arrangements and the nature of the services they provide?
  • Will including consultants and allowing “rights and obligations” determinations to be enforceable, immediately, be “best for project” and deliver the desired quality, efficiency and other gains?

Bringing consultants into the fold

The first question takes us back to the fundamental objective of the CCA, which was to facilitate regular and timely cash flow within the contractor chain.  The focus was not on cash flow between clients and consultants and there were no consultancy firm collapses to trigger reform.  Has there really been a groundswell of support for a broader focus?  And if so, has it come from the “big construction” sector or from the residential sector, “small construction” or from small consultancies seeking to use the CCA’s payment mechanisms?

The question surfaces because, like it or not, disputes between clients and consultants are inherently different in key respects to disputes between clients and contractors, or between contractors and sub-contractors.  Arguably those differences mean that the kinds of natural justice compromises which are justified under the fast-track adjudication process in the name of unblocking cash flow are no longer meritorious.  “Rough and ready” justice might just become too rough and not very ready.

The key differences referred to include:

  • claims against consultants will inevitably be similar to claims in tort, as terms of engagement routinely require the exercise of reasonable skill and care, not a guaranteed outcome
  • as a result, determining liability triggers an assessment of matters of professional judgement
  • that assessment requires a high degree of reliance on the views of specialist independent experts
  • there is a greater risk of technical complexity (arising from specialist fields), and
  • an inherent risk that there might be a significant time gap between the period when the relevant work was done (in the case of design and engineering work) and when the defect or other issue giving rise to the claim surfaces – normally after the physical work has been completed and possibly years after practical completion.

Further, it is highly likely that the consultant will have professional indemnity insurance, so the interests of a third party (the insurer) may be vitally affected and the ability of the consultant to manage the claim within fast timeframes may be virtually non-existent

The last point isn’t fanciful.  In addition to the time it may take an insurer to decide whether the policy even responds, conditions of insurance inevitably contain requirements governing such things as the selection of legal counsel, the appointment of experts, general conduct of the case and the taking of steps which might prejudice the defence. 

To illustrate that the concerns are real, a Client Briefing published on Marsh’s website in March 2015 notes that although the insurance industry has yet to take a position on the issue there is a “distinct possibility” that an adjudicator’s determination may not be covered by a PI policy due to non-compliance with policy conditions and inadequate timeframes.  Such an outcome is poor for both parties to the dispute.

On what basis can we be satisfied that even “rough and ready” justice can be done within what may be little more than a month, say, in complex cases?  The Bill does introduce some additional discretion for adjudicators to extend timeframes, due for example to the size and complexity of the claim, but extensions in the context of the standard timeframe of only five working days to respond to an adjudication claim are still likely to be woefully inadequate.

What happens, for example, in a claim by the client which alleges that there was a design defect in a complex structural connection in a power station, or a design flaw in a wastewater treatment plant process, which potentially triggers multiple layers of PI insurance, calls into question design decisions recorded in archived documents made several years ago, by professionals who have since left the respondent firm (and live in Dubai), and which requires independent expertise which is in short supply from very busy people? 

Sure, there is likely to be some forewarning of such a claim, but aggressive pre-commencement dialogue seldom justifies applying the kind of resources which are needed to respond to an actual claim - until now. 

Rights and obligations issues

The Bill switches determinations on “rights and obligations” issues from the status of being given “weight” in any subsequent court or arbitration proceedings to being binding and immediately enforceable by entry as a judgment.  This change is also dramatic.  Making payment obligations enforceable after a “quick and dirty” adjudication process is one thing, as money can normally be repaid if the determination is overturned in subsequent court or arbitration proceedings.  But many “rights and obligations” are either complex or incapable of being unwound downstream, either at all or satisfactorily. 

The court can only refuse to enter judgment on very narrow grounds, namely that any amount payable under the determination has been paid, that there was in fact no construction contract at all, or that a condition imposed by the adjudicator has not yet been met.  The scary bit is that there is no discretion to refuse judgment like that used in interim injunction proceedings, in which the court weighs up whether the “balance of convenience” favours making interim orders which, after a full hearing, may later turn out to have been undeserving.    

Taking three examples, consider the impact of “rough and ready” but nonetheless binding and immediately enforceable determinations regarding:

  • the purported termination of the head construction contract on a $150 million project
  • disputes over whether work was either within or outside scope, or was defective or not and must be repaired, which might lead to a determination that a contractor or subcontractor must carry out very substantial work despite lacking the resources to do so or clashes with other contractual commitments
  • a determination that the Principal can call on the performance bond.

Retention trusts in brief

The retentions part of the Bill was introduced by Supplementary Order Paper in March.  It quite easily justifies a separate article of its own, and is dealt with here only in brief.

The Bill creates a trust obligation over retention money held under any commercial construction contract.  Party A (the party holding the retentions) must hold all retention money on trust for the benefit of party B (the party from which the retention are withheld). 

Proper accounting records must be kept.  Party A must not appropriate any retention money to its own use, and such money is not available for the payment of the debts of any creditor of party A other than party B, and may not be attached or taken in execution.  Party A may invest the retention money and retain the interest earned, but is liable to make good any loss to the retention money if the investment is unsuccessful.

Contractual provisions aimed at delaying the payment of retention money beyond completion of party B’s obligations are void, as are clauses purporting to make payment of retentions conditional on anything other than the performance of party B’s obligations.  Any attempt to contract out is void.

More controversially, clause 18E(2) of the proposed amendments provides that retention money subject to the statutory trust need not be held in a separate bank account, and may be commingled with other moneys – presumably party A’s own money.  This is contrary to the usual trustee obligation to hold trustee assets separately from its own. 

While possibly attractive on the surface, there are serious questions about whether the impact of this reform has been adequately assessed, and whether the drafting matches officials’ intentions as indicated in the accompanying Regulatory Impact Statement. 

Officials’ intention is apparently that each party should only be required to hold a “net” amount of retentions – the difference between retentions held by it and retentions held against it.  But this does not appear in the drafting.  On its face, the amendment requires gross retention sums to be held at all levels of the contractual chain, effectively “sterilizing” multiple trust amounts in order to protect what is ultimately a single cascade of funds through the chain. Similarly, the application of the trust regime to parties funding their activities from bank debt facilities is unclear.  Again, the intention is apparently that debt-funded owners will be exempt.  But it is unclear how the legislative drafting is meant to achieve this.

Finally, the permission for commingled trust and non-trust monies seems an invitation to confusion and error, particularly in an industry unaccustomed to managing trust obligations.

So where to from here?

Though discussions with industry participants are ongoing, the Bill is likely to be unstoppable.  It should provide the relevant consultants with a 12 month transition period in which to prepare for the changes but quite what is meant to be done in that time to deal with the issues discussed above is less clear. 

As a minimum, consultants should engage on the insurance issues with their broker and insurer, as regards policy wording issues and expectations around communication and decision making, and establish unequivocal internal protocols for spotting and dealing with adjudication claims seamlessly and swiftly.  Similarly, industry participants will need to consider how their balance sheet will manage the elimination of retention funds required to be held on trust.  In either case, delay will not be your friend.     

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