BUILT ENVIRONMENT JOURNAL

Is this finally the end of retentions?

Comment: Since the collapse of Carillion in 2016 there have been several legislative bids to end the practice of withholding retentions. If a new private members' bill succeeds, retentions will be abolished altogether

Author:

  • David Greenwood and Naveed Hanif

18 August 2022

Cranes on building site

Although the purpose behind retentions is clear – and indeed perfectly legitimate – there is mounting pressure to outlaw the practice. Primarily, this is because the retention release process is open to abuse.

Profit margins are notoriously tight in the construction industry, so it is perhaps understandable that payers – for example, employers – want to hold on to their cash for as long as possible. That sometimes leads to a practice whereby the paying party insists on elongated payment terms, and refuses to release retentions based on set-offs for ongoing defects when the liability period expires.

For payees, however, retentions can cause major cash-flow difficulties. There is also a risk that, should the paying party become insolvent, the retention monies will be taken by secured creditors. In such a case the payee, which has carried out the works, loses out on sums it is rightfully entitled to be paid. Carillion's collapse in 2016 illustrated this danger.

Legislation seeks to prohibit retentions

The Construction (Retentions Abolition) Bill has therefore been introduced in Parliament as a private members' bill, with the aim of prohibiting payers in the industry from withholding retentions. If it becomes law, it will take effect in January 2025.

It would amend the Housing Grants, Construction and Regeneration Act 1996 to add a new section 113A, the subsections of which would state the following.

  • Any clause in a construction contract entered into after the passage of the act that enables a payer to withhold retentions will be of no effect. 

  • After the act comes into force the payer must pay the payee any withheld retentions in full, no later than seven working days after the date on which they were due but withheld.

Section 113A will apply to 'construction contracts', as defined under section 104 of the 1996 Act. It would also cover 'any additional contract created to have a similar effect for the purposes of withholding monies [that] would otherwise be due under the primary contract'.

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How are retentions defined?

The bill defines retentions as 'monies [that] are withheld from monies [that] would otherwise be due under a construction contract, the effect of which is to provide the payer with security for the current and future performance by the payee of any or all of the latter's obligations under the contract'.

On a typical construction project, this means that the payee – for example the main contractor – will be entitled to receive interim payments from the employer as the works progress. From each of these payments, the employer is entitled to withhold a small percentage known as a retention.

Depending on the value, size and duration of the project, the retained sums can become significant. Often, half of the accrued sum is released at practical completion, with the remainder following when the certificate of making good defects is issued at the end of the contractor's defects liability period.

Retentions serve two primary functions during a construction project. First, they give an incentive to the contractor to perform its obligations and complete the works in accordance with the contract.

Second, they give the employer security: the funds are available to correct any defects, or to pay third parties to complete the works if the contractor fails to perform, becomes insolvent, or otherwise defaults.

Parliament and industry try to tackle issue

Since Carillion collapsed, however, the risks of this process have become clearer. Indeed, there have been two previous attempts to legislate on the issue, namely the Construction Industry (Protection of Cash Retentions) Bill 2017, and the Construction (Retention Deposit Schemes) Bill 2017–19. However, neither of these bills passed into law.

Unlike these, the new Construction (Retention Abolition) Bill is the first seeking to stop the practice of retaining cash in its entirety. On the one hand, the new bill may stand a better prospect of success in that it is simpler than the previous bills (i.e. it outlaws retentions altogether rather than seeking to limit their use or effects). On the other hand, the absolute abolition will divide opinion and those in favour of some form of lesser retention regime may oppose and block it.

Its planned effective date of 2025 also aligns its aims with those of a number of key industry bodies.

In 2018, Build UK published its Roadmap to Zero Retentions, ending with abolition in 2025. Along with the Civil Engineering Contractors Association and the Construction Products Association, Build UK has been at the forefront in calling for the abolition of retentions by 2025.

Scoping out alternative approaches

With the bill still in its early stages, there is time for the construction industry to prepare for the end of retentions before the bill passes into law, if it ultimately does so.

Although the bill is clear on what it is abolishing, it does not say what should replace retentions.

One obvious alternative would be project bank accounts, which are fairly straightforward. Sums are held in a central account, similar to a trust, from which all members of the supply chain are paid simultaneously.

This ensures money flows down the chain and circumvents the risk of upstream insolvency. But critics suggest that project bank accounts complicate matters, and can be costly to set up and administer.

Retention bonds are another alternative. This is effectively an on-demand bond providing that, in the event a contractor fails to carry out its obligations, an employer may request payment of the bond amount.

The money can be held as a security, or used to engage a third party to rectify issues. Retention bonds are already considered as alternatives to retentions in both the JCT and NEC4 contract suites.

Other alternatives to retentions might include the following. 

  • Performance bonds: A third party may issue a performance bond to the employer on behalf of the contractor, accepting liability for the performance of the contractor's obligations. In the event of a contractor default, the bond will become payable to the employer, to help it hire an alternative contractor to complete the works.

  • Parent company guarantees (PCGs): Like performance bonds, PCGs protect employers from the default of a contractor that is controlled by a parent or holding company. PCGs are often used to protect against insolvency, but could also be used to ensure a contractor performs its obligations under a contract.

  • Retentions held in a trust fund: These would operate in a similar way to retentions, but would be held in a trust fund rather than by the employer. The effect would be that the funds in trust would not form part of the employer's assets in the event that it became insolvent, so the contractor should still receive the sums due.

None of these are perfect solutions, and it remains to be seen how the industry will adjust if and when retentions are abolished. However, it is likely to involve a combination of these options.

Despite the growing calls for greater collaboration between the parties to a construction project it seems likely that, one way or another, the bulk of the financial burden and risk will still be passed downstream.

'With the bill still in its early stages, there is time for the construction industry to prepare for the end of retentions before the bill passes into law, if it ultimately does so'

 

David Greenwood is a senior associate at Pinsent Masons
Contact David: Email

Naveed Hanif is a solicitor at Pinsent Masons
Contact Naveed: Email

Related competencies include: Contract administration, Contract practice

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