Subbies screwed by cash retentions
The collapse of Mainzeal Property and Construction is likely to leave most of the company's subcontractors screwed, with the mysterious practice of builders' retention payments the cause of much of the carnage.
Retentions are a portion of payments that a property's developer withholds from the money paid a builder, to cover fixing any maintenance issues which are discovered after the work is completed.
While they have a legitimate purpose, their complicated structure allows many building firms to use retentions as working capital at their subcontractors' expense, creating widespread problems for the construction industry.
There are three main groups involved in the construction of a new building: the developers who commission the project and pay for it; the master contractor who wins the building contract; and subcontractors, who usually do most of the work.
On a big building project the master contractor is usually a major building company that is responsible for the whole project, although it is common for this firm to undertake only about 20 per cent of the actual building work (by value) itself.
The remaining 80 per cent of the work is done by subcontractors. Often these are individual tradespeople or smaller owner-operated businesses that specialise in particular building tasks, such as roofing or concreting or plumbing. There can be dozens of subbies working on a large project.
The money flow on a building project is that the developer pays the master contractor for all of the work that is undertaken every month and the master contractor is responsible for paying the subbies for their work.
The standard contract used for most building jobs allows the developer to retain a certain amount of money from these monthly progress payments to cover remedial work, referred to as retentions.
Retentions are calculated according to a formula which is at the heart of the problems subbies face. In standard contracts, the maximum amount a developer can retain is 10 per cent of the first $200,000 of any work, plus 5 per cent of the next $800,000 of work, plus 1.75 per cent of work above $1 million.
The maximum aggregated amount that can be retained from any contractor, whether they be the master contractor or a subbie, is $200,000.
So how does that work in practice?
Say a building contract is worth $25m (the amount due to the master contractor).
The maximum amount of payment the developer can withhold from the master contractor as a retention is $200,000. On a $25m job, that is just 0.8 per cent of the money due to the master contractor.
But the master contractor can apply the same retention formula to his subbies, most of whom will be completing small portions of the building work.
Many would be undertaking less than $200,000 of work and most if not all would be undertaking less than $1m of work.
That means that, if the subbies have performed 80 per cent of the work on a project, the master contractor would be entitled to withhold up to 10 per cent of their money as retentions.
Assuming none of the subbies undertook more than $200,000 of work, that would mean the master contractor could retain up to $2m from the subbies.
Quantity surveyors contacted by Sunday Star-Times, who asked not to be identified, said it would be likely that several subbies on a $25m project would have contracts worth more than $200,000, and around $1.2m would be a more realistic figure for the total amount the master contractor would typically retain on such a job.
So in the example above, the developer could withhold $200,000 in retentions from the master contractor, but the master contractor could withhold around $1.2m from its subbies.
Half of the retention money is supposed to be released when a practical completion certificate is issued for the building, and the rest when any problems which have been identified with the contractor's work have been resolved.
Reputable building companies play by the rules and pay their subbies what they are due. But, unfortunately, there are many that do not.
The quantity surveyors say the downturn in the building industry has resulted in margins being trimmed to the bone as companies undercut each other for work.
Most master contractors are getting margins of just 3.5 per cent, so, on a $25m contract, that would be $875,000. For subbies, the situation is even worse, with most getting no profit margin and making just enough to cover their costs and pay themselves a wage.
If a master contractor is facing financial difficulties, holding on to $1.2m in retentions from subbies on a $25m job and using it as additional working capital could be very tempting and some simply treat the money as though it was an unsecured, interest-free loan.
That leaves the subbies in an unenviable position.
Many are reliant on the same master contractor for future work and, if they make too much fuss, they risk being stigmatised in the industry as troublemakers.
Legal action is probably not an option because lawyers will argue about whether a job was completed satisfactorily or not forever and a day and the big building firms aren't afraid to use them.
So when things go wrong in the building industry and there's not enough money to go around, one thing is certain. The subbies are screwed.
- © Fairfax NZ News
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