New Zealand Law
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Under the recent amendment To the Construction Contracts Act part 2A creates a trust regime but this is not in force yet. So the answer is in your contract documents. Which form of contract are you using?
Are the variations accepted or are they being negotiated?
Normally all payments under a payment claim are subject to retention. So if the payment for the variation was included in the payment claim, and the contract provides for retentions, the whole of the payment claim including the variations will be subject to the retention provision. That is, provided your contract actually says there are retentions. You have not sighted the exact contract, but the standard form contracts generally do provide for retentions on larger jobs
The issue will be whether your contract provides for retentions, or whether they are just applying this, because they want to. If there is no provision for retentions, you could respond with a schedule objecting to the deduction of the retentions, provided that you are within the time to lodge the schedule (20 working days)
A variation to the contract incorporates the same terms and conditions as the contract, except of course for the specific items added as an extra from the contract. This means that if they are entitled to deduct retentions for the progress payments, the same applies to variations
You will find that this gets even more complicated once the new retention regime comes into force, but the upside will be that they are obliged to hold the money on trust, whereas under the present system, if they go broke before the retention money is paid out, it can be lost in the insolvency. So the new system under part 2A of the act will give you better protection, although not necessarily better cash flow
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