Statutory trusts: A cost/benefit analysis
How is government intervention in the construction industry helping or hindering?
The rise in building and construction company insolvencies in Australia over the last 2 years has focused attention on the intervention in contract arrangements by various governments. In assessing that intervention, the focus should be whether it delivers a net benefit to the industry. One such intervention is legislation for statutory trusts over money as it moves through the contractual chain. These statutory trusts particularly impact head contractors (removing money from cash flow) with the intent of providing protection for subcontractors' entitlements (should a head contractor become insolvent).
The objects of the intervention are laudable. The history of the construction industry is littered with instances of the liquidation of high-profile (and some not-so-high-profile) builders. The liquidation leaves a trail of destruction, particularly among the business and personal lives of unpaid subcontractors.
Reasonably, questions must be raised regarding the cost v benefit of a statutory trust regime.
A quick snapshot of statutory trusts
A "pin-up model" for statutory trusts in Australia is that in Queensland. It has wide-reaching application to progress payments and retention monies under building contracts over $10M and public sector contracts over $1M (with further rollout planned progressively to private sector contracts over $1M).
The statutory trust regime uses the concept of a "trust". Briefly, a trust is where a party (the trustee) is holding certain property (the trust property) for the benefit of one or more other people (the beneficiaries). For statutory trusts, the head contractor is the trustee and certain subcontractors are the key beneficiaries.
By legislation, a trust is applied to money paid to a head contractor for work on a project with subcontractors as key beneficiaries. The principal must pay money into a project trust account operated by the head contractor. This limits a head contractor's ability to siphon money away from subcontractors who performed much of the work resulting in the payment. The trust has the effect of giving subcontractors priority (to the extent of trust money) if a head contractor becomes insolvent.
The head contractor must not withdraw money from the project trust account other than for paying a subcontractor beneficiary, paying the head contractor itself (if not liable to pay a subcontractor beneficiary) and depositing retention money (held as security for the subcontractor's obligations) into a retention trust account. The money in the retention trust account is held until paid to the subcontractor beneficiaries in accordance with each subcontract (eg. at the end of the respective defects liability period) or needed as security for the subcontractor's obligations.
Impact of statutory trusts regime
That high-level overview of the regime highlights a number of impacts:
- Holding retention money in a retention trust account removes that money from a contractor's critical cash flow (assuming most subcontractors do not have a balance sheet which would allow access to bank guarantees/insurance bonds). The industry norm for retention money withheld from subcontractors is 5% of each subcontract sum.
- The cashflow impact is exacerbated if a head contractor elects to or can only provide security (under the head contract) in the form of retention money (rather than a bank guarantee/insurance bond). The effect is that retention money is held twice (once in the principal's retention trust account and secondly in the contractor's retention trust account).
- The legislation was amended in April this year. Among other things, it attempts to clarify that the amount to be deposited in a retention trust account must include goods and services tax (GST)[1] on the retention money. An Australian Tax Office Ruling[2] records that GST on retention money is payable when invoiced or paid. If effective, the amendment means that another 10% of all retention amounts are removed from the contractor's cash flow.
- The regime (with its attendant accounting and auditing requirements) creates a significant administrative burden for contractors (particularly given hefty fines and potential imprisonment apply for non-compliance and executive officers of companies are personally exposed for some non-compliance).
- Not all banks have opted to provide a statutory trust account service. The incidental impact is that a head contract must operate from at least two different banks or change banks (problematic where there are existing debt facilities).
Are the benefits of statutory trusts real?
If the primary purpose of statutory trusts is to secure payments to subcontractors, anecdotal evidence suggests the purpose is not met. Head contractors can clean out the project trust account each month. That is, subcontractors are paid the amount owed (as perceived by the head contractor[3]) and the balance can be paid to the head contractor. Payment to the contractor is permitted with the caveat that, if at a later time, there is insufficient money in the trust account, the contractor must pay into/re-pay to the project trust account the amount of the insufficiency. By comparison, there is little prospect of validly manipulating the monies in the retention trust account.
In a recent head contractor's insolvency, it was revealed[4] that a Queensland company of a corporate group (in liquidation) held less than $38,000 in two project trust accounts. While it is not clear what the debts on those two projects were, the Queensland company had debts of more than $4M leaving many subcontractors unpaid. Even where a head contractor is scrupulously honest in its assessments, the regime offers no guarantee that trust money will be in the project trust account for distribution to subcontractor beneficiaries. By comparison, there was close to $353,000 in the retention trust account.
Additionally, any shortfall between project trust account money and the amount owed to each claimant is managed by reducing the payments in proportion to the "amounts liable to be paid to each". It is difficult to locate any published instance of a shortfall. However, logic suggests that in the event of a dispute, it will be for a court to determine the amount of each subcontractor's entitlement. For a project where there are many subcontractors, attempts to prove each subcontractor's respective entitlement (and the respective share of the available trust money) will be a lengthy and expensive exercise.
In those circumstances, it must be doubtful whether, after all of the cost and administration of the statutory trust regime, any real benefit is delivered.
Finally, and paradoxically (for the purpose of securing payments to subcontractors), removing money from a contractor's cash flow to secure payments to subcontractors could contribute to causing a contractor's insolvency.
Conclusion
The jury is still out on whether project trust accounts while having a laudable object, will deliver any real benefit (particularly when taking into account the costs). By comparison, retention trust accounts (which could be standalone) are more likely to have a practical benefit.
[1] 10%.
[2] PAR2017/2
[3] If there is a dispute between a head contractor and subcontractor on the amount owing, it seems that the subcontractor's entitlement is not protected until that dispute is resolved.
[4] Article by Kathleen Skene dated 18 April 2023 in a Newscorp Australia newspaper publication.
