Retentions – An Unnecessary Evil?

Retentions are divisive for several reasons and which side of the fence you sit will normally be predicated on where in the supply chain you sit.

For a paying party, a retention is a useful way to protect yourself against works not being complete and/or defects not being rectified in accordance with the contract. Equally, retentions provide a level of protection in the event a payee becoming insolvent.

Conversely, from a payee perspective, particularly for SMEs, there is little control over retention payments and, with little to no bargaining power, they can often find themselves with retention not being repaid (or significant delay to any payment being received). This has an adverse impact on cashflow and overall profit because the retention payment (usually between c.5% of the contract sum) can reflect a supplier's profit margin for the particular project.

Similarly, a payee is not afforded the same insolvency protections (and in fact faces the opposite position). Consider, when Carillion collapsed in 2018 it owed circa £800m in retention payments to supply chain members. How much of that was recovered? We suspect very little, if any.

As a result, with a payee "hat" on, retentions are open to abuse and are sometimes used as a way to recoup any additional costs incurred during the concurrency of the works. In the event of insolvency, the likelihood of payment reduces further leaving an aggrieved party with very little recourse to recover any retention payments.

Reform?

This retention imbalance is not new. It has persisted for decades but very little has changed. Where change has occurred, it is generally accepted as not going far enough to rebalance the scales.

For example, the 2011 amendments to the Construction Act outlawed payments (including retention payments) being conditional on performance obligations under separate contracts (i.e. paid when paid conditions)[1] and states:

"The requirement in subsection (1)(a) to provide an adequate mechanism for determining what payments become due under the contract, or when, is not satisfied where a construction contract makes payment conditional on—

(a) the performance of obligations under another contract, or

(b) a decision by any person as to whether obligations under another contract have been performed."

The intention here was to prevent subcontractors at the bottom of the supply chain from having to wait for retention payments to be released further up the chain before being paid. Each retention payment under each Subcontractor is therefore entirely separate from the other. This is now reflected in the JCT suite of contracts for example[2].

So far so good? Not quite.

Application of S.110(1A)

The Department for Business, Energy and Industrial Strategy Commission research into whether the industry wide approach to retention payments had been improved since the 2011 amendment. In its research paper dated 24 October 2017[3], the answer was a resounding no and found that:

"Around 71% of contractors surveyed…. experienced delayed in receiving retention monies…"

"…the qualitative evidence gathered suggests that unjustified late and non-payment of retentions appears to be a significant cause of issues associated with the practice of holding retentions within the construction sector…"

In a consultation paper published by the Minister for Business and Industry in February 2020[4], the Government found that:

• "82% [of those surveyed] thought that existing measured were ineffective in addressing the challenges of prompt release and security of retentions…"
• "87% thought unjustified non-payment (excluding insolvency) was significant or very significant."
• "88% thought unjustified late payment was significant or very significant."
• "74% believed non-payment of retentions due to the company holding the retention becoming insolvent before return, was significant or very significant".

Directly related to Section 110(1A), the consultation paper found that:

• "65% believed non-payment of retentions due to ‘payers’ citing that obligations under another construction contract have not been met, was significant or very significant."
• "…late payment of retentions due to obligations under another contract not being met, with 63% of respondents citing this as significant or very significant."

Is further legislative reform the answer?

The issues surrounding retentions are well known and it is broadly accepted that reform is needed.

In 2018, the draft "construction (retention deposit scheme)[5]" bill was introduced which proposed a further amendment to the Construction Act and impose a statutory deposit scheme for retentions. The intention was to effectively ringfence retentions and take control over retentions from contractors to a separate third-party entity. However, the second reading in the House of Lords is listed as "in progress" (some six years later).

In 2021, undeterred by the apparent lack of reform appetite, the draft "construction (retentions abolition)" bill was introduced[6]. This proposed a total abolition of retentions and a move to alternatives such as retention bonds. However, little or no progress was made and has not passed first reading stage in the House of Lords.

The reason for this inaction in the apparent face or necessary reform? The Government is "waiting for the emergence of an industry consensus…" before taking any steps to remedy the issue (as remarked by Lord Aberdare when introducing the latter Bill).

This therefore brings us full circle and back to the imbalance of the payor / payee relationship. On one hand, a payor will want to retain retentions for the reasons set out above and the payee will most likely favour wider reform on the basis absolute control is moved to a third party (either to a statutory scheme or surety for example). The cynics among us may be inclined to believe that an "industry consensus" is unlikely to arrive because of these opposing positions and thus serves to prolong the lack of any real legislative reform.

The emergence of an industry consensus

There is, despite the cynical view suggested above, traction for the abolition of retentions from both contractor and subcontractors alike. Take Build UK for example and its members' commitment to the abolition of retentions by no later than 2025[7].

In circumstances where retentions are necessary, the Build UK members (which include many tier 1 contractors / subcontractors) have agreed to implement a number of "minimum standards" designed to circumvent some of the common issues with cash retentions. Interestingly, these minimum standards include both policy and practical considerations:

Policy:

1. The retention provision in a subcontract should be no more onerous than the retention provisions in the main contract.
2. Retention payments should be made in respect of permanent works only. Temporary/preliminary works should not be subject to retention deductions. Where a contract is exclusively for temporary / preliminary works, no retention should be taken at all.
3. Where retention deductions are to be made, they should be made in one payment towards the end of the Works and not as a part of the interim payment certification process to preserve cashflow.
4. Retention percentages should be reduced to 1.5%.

Practical:

This introduces a new "threshold" test for whether a retention is appropriate and states a total abolition of retention should be used where:

1. The contract value is less than £50,000 and/or
2. Where the works are for temporary and/or preliminary works only (i.e. scaffolding).

Where no retention is to be withheld, this can be reflected in modest amendments to both the JCT and NEC 4 contracts (i.e. Retention Percentage in the JCT contract is stated as "Nil" and in the NEC4 contract, Option X16 does not apply).

Where a retention is to be withheld, the "minimum standards" propose a suite of contract amendments to ensure transparency, consistency and hopefully limit the issues that that plagued the construction industry regarding retention, to date.

Conclusion

While other jurisdictions take alternative approaches to regulating retention, it does not appear that the UK is going to take any radical steps towards reform (at least any time soon). Therefore, it may be up to the industry to reform itself from within. While progress has been slow, there is now a growing consensus that traditional retention provisions should be a thing of the past. There are positive steps for change and to reduce the unfairness that can arise from the current approach to retention.

Whether or not the "minimum standards" are adopted across the industry remains to be seen but they do appear to be the building blocks for a convention that suits all and balances the interests of both the contractor and subcontractor in equal measure.