Protecting against a building company collapse – what you can do to minimise your risk if your builder goes bust

Author:Mr Jeroen Vink
Profession:Cavell Leitch
 
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As an owner (or principal) one of the biggest risks on a building project is the builder/ main contractor 'going under' during construction. There have been a number of recent high profile building company collapses and this is not an uncommon reality across the building industry. Whether you are engaging builders for a large commercial project or for your first home there are security protections that you can employ in order to help mitigate some of the risk.

This article explores some of the more common mechanisms and practical tips that owners can use to help give them some piece of mind.

Retentions.

Retentions are sums of money withheld by the owner on each progress payment. These retention monies are normally held for the duration of the project and can be used by the owner to rectify defective or non-completed work. Generally, the amount retained is applied on a scale. For example, the standard building contract, NZS3916 uses a scale that is 10% on the first $200,000 then 5% on the next $800,000 and 1.75% on the balance, up to a total aggregate amount of $200,000. One half the retention amount is released on practical completion and the other is released at the end of the defects liability period. Retentions are widely used on commercial contracts. They are seen as a relatively cost effective method of providing some level of security to owners. The amount of money held as security is relatively small so retentions are sometimes used in combination with other security mechanisms.

Under the Construction Contracts Act 2002, an owner is required to hold retentions on trust for the builder. Practically this means that retention money is readily identifiable from the owner's other money and this is normally achieved by having the funds in a separate bank account or trust account. If retention funds are misappropriated then those responsible may be held personally liable for breach of trustee duties.

Contractor performance bond and bank guarantees.

In general terms, a performance bond is a promise by a third party to pay money in the event the builder fails to perform under the contract. Performance bonds stand alone from the contract itself as security and are normally issued by specialist construction insurers. Performance bonds can be drafted so they are either 'on demand' or 'conditional'.

An on-demand bond means that the bond issuer must pay the money if there is a call on the bond. There are only very limited circumstances in which a...

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