Changes To Construction Law Around Retentions

12/03/2018

The Department for Business, Energy & Industrial Strategy (BEIS), recently ran two parallel consultations from 24th October 2017 to 19th January 2018.  The first consultation focused on the practice of clients and contractors holding cash retentions from their supply chains.  The second looked at the impact of the amendments to the Housing Grants, Construction and Regeneration Act 1996, Pt II, brought in from October 2011 through the Local Democracy, Economic Development and Construction Act 2009 (Click here for more information)

Retentions are one of the most controversial issues within the construction industry.  Retention is a percentage of the amount owed to a contractor (typically around 5%) on the interim certificate.  It is taken from the amount payable and retained by the client.  This is to ensure the contractor completes their side of the contract properly and remedies any problems that are picked up during the defects liability period.

In most cases, half the retention amount is paid to the contractor upon completion of the project, the other half is handed over at the end of the defects liability period (usually 12-24 months). 

Although rare, there have been cases of retention funds being paid late or not at all.  In a letter to the Daily Telegraph in December 2017, a consortium of more than 20 trade associations representing builders, plumbers, and electricians told of a "growing problem" of local councils and big businesses withholding chunks of their fees long after the work is completed in order to make their own finances appear healthy[1]. 

The letter stated that around £10.5 billion of the overall construction sector turnover of £220 billion is held in retentions by clients.  It went on to say an estimated £7.8 billion in retention money has been unpaid in the construction sector over the past three years, while £700 million was lost due to insolvencies.

It is likely that the collapse of Carillion will shine a brighter spotlight on this problem.

There are concerns that despite initiatives such as the Construction Supply Chain Payment Charter, the Prompt Payment Code, and project bank accounts, legislation is going to be required to protect second-tier (Tier 2) and third-tier (Tier 3) contractors from larger companies and public bodies from withholding retentions.  With the economic forecasts looking rather gloomy as Brexit draws nearer, the government will be keen to ensure SMEs are not further hampered by withheld retention payments that can cripple their cash flow, leading to insolvency and subsequent layoffs.

What are the proposed reforms to retentions?

There are two main proposals for reforming the way retention are managed; however, both come with additional challenges.

The first option is to utilise project bank accounts and the voluntary Supply Chain Payment Charter.  These options may assist in reducing the risks.  Project bank account requires payments to be ringfenced.  The Supply Chain Payment Charter which was launched in 2014 sets out 11 fair payment commitments, one of which states:

“We will either not withhold cash retention or ensure that any arrangements for retention with our supply chain are no more onerous than those implemented by the client in the Tier 1 contract. Our ambition is to move to zero retentions by 2025”.

However, neither of these initiatives have received widespread uptake from the construction industry.  In addition, because there is no accompanying legislation with the Charter, it is difficult to see how it will be enforced.

Holding retention monies in trust is another option.  The Joint Contracts Tribunal (JCT) contracts specify this, but the relevant provisions are usually removed to enable employers to use those funds elsewhere in its business.  Whilst holding the money in a scheme, similar to the tenancy deposit scheme used in landlord/tenant situations, would not provide a solution for late or non-forthcoming payment, it would protect the funds in the event of an insolvency. 

The problem with transferring the money into a trust is it can limit the amount of working capital the employer has access to. 

Retention Bonds

Retention bonds may provide a solution; these are already widely used on major infrastructure or engineering projects, as well as for utilities projects and in cross-border arrangements, typically on an ‘on demand’ basis from a bank.   With a retention bond, amounts that would otherwise have been held as retention monies are instead paid, with a bond being provided as security.  Similar to retention, the bond’s value will usually reduce after the certification of practical completion.  The retention bond can only be called in in cases where the work is not completed, or defects are left unrepaired.

The main issue with retention bonds the balancing of cash flow.  Because retention bonds can be called in instantaneously, banks usually demand they are backed by cash before issuing them.  And if the employer is to meet the cost of paying retention upfront, it may ask for the overall price of the contract to be reduced.

As you can see, there is no quick solution to the issues surrounding retention monies.  We will keep you updated as to the findings of the consultation and the government’s proposed solutions.