UK: Is It Time To Release Retention As We Know It?

Retentions have been a common feature in the construction industry for over 100 years, yet over the past two years there has been a growing shift in the construction industry's views on retentions and whether reform of retention as we know it is required. Adele Parsons discusses these recent developments further.

From the Government's initial consultation on retention payments in the construction industry in October 2017,¹ to the collapse of Carillion in early 2018 which left millions in unpaid retentions, and the ever increasing number of construction company insolvencies that followed,² it became apparent that the current retention system is weighted heavily in favour of those holding retentions, while offering little or no protection or regulation for those providing retentions.

In this article we discuss the apparent change in attitude towards common place cash retentions, the changes proposed and their practicality.

Retention as we know it

Retention is a percentage of payment held back typically by a client or main contractor under a construction contract to act as security, or an assurance that the project works will be completed and that defects which may subsequently develop are remedied. Typically, the first half of the retention is paid when the project is completed, whereas the second half is paid following the expiration of the defects liability period.

It is estimated that the total amount of retention held in the construction sector in England alone over the course of a given year is between £3.2 and £5.9 billion.³

At first glance the existing retention practice seems uncontroversial: for the client or main contractor it ensures that the contract works are defect free, whereas in theory the contractor/ subcontractor's money is protected and ultimately released following a contractually agreed specific event or circumstance.

The reality, however, is a very different story where those holding the retentions, i.e. clients and main contractors, are essentially given a carte blanche as to how they hold and use retention money. For example, it is not uncommon for clients and contractors to use retention money to support cash flow or protect project margins as, put simply, retention creates case flow advantages.

Conversely, it tends to be the case that those who are working with small cash reserves and tight margins, i.e. small business and SMEs, are put at risk under the current retention system, which with no statutory regulations or guidance provides no guarantee as to how their money is protected and ultimately held. Neither is there anything within the standard forms of contract that specifies where, or how, retention is to be held or treated by the parties. Those forms only concern the amount of retention and the timing of its release.

The above issues, amongst others, prompted the Government's Retention Consultation and the Department for Business, Energy and Industrial Strategy to appoint Pye Tait Consulting to conduct research into retentions in the construction industry ("the BEIS Report").⁴

The BEIS Report found that around 71% of the contractors surveyed had experienced delays in receiving retention monies.⁵ Reasons for this can include: breaches of contract, an oversight by the party holding it, and contractors/subcontractors writing the retention off as a good will gesture or to encourage future work with a particular client or main contractor. However, one of the predominant reasons for the non-release of retention is insolvency higher up the contractual chain.

Insolvency

The BEIS Report found that 44% of contractors surveyed had experience of retentions not being paid at all within the past three years due to upstream insolvency.⁶ In fact those contractors had experienced upstream insolvencies on average 4.2 times each.⁷

The average amount lost per contractor across all their contracts due to upstream insolvencies was £79,900, whereas the average amount lost per contract was £27,300.⁸

Current insolvency rules do not ring-fence retention monies when a company becomes insolvent. Consequently, retention is merely added to the creditor's pot and distributed to creditors in accordance with applicable insolvency rules.

Carillion's collapse, while extreme, is not an isolated occurrence. Insolvency within the construction industry is continuing to rise. The Government's Insolvency Service reported that in 2018/2019, the construction industry lost more firms to insolvency than any other industry, with 3,100 firms becoming insolvent.⁹

The current state of the construction industry has created an ideal environment for delays in releasing retention, or its complete non-payment. The BEIS Report found that the impacts on the construction industry are:

Higher business overheads incurred from pursuing unpaid or outstanding retentions.

Weakened commercial relationships within the construction supply chain due to tensions arising from delays or non-payment.

Weakened relationships between main contractors and their clients.

Increased costs for projects as tender prices are increased to cater for the risks associated with retention monies. BEIS reported that 40% of those surveyed increased their tender prices to offset retention.

Constrained business growth as a result of less readily available working capital.¹⁰

Proposals for change

The above-mentioned issues have resulted in an industry-led roadmap to address the underlying problems caused by retention and to propose alternative mechanisms, such as project bank accounts; performance bonds; retention bonds; escrow stakeholder accounts; retentions held in trust funds; and parent company guarantees.

BEIS reports that most of the above would be suitable alternative mechanisms to retention in certain circumstances. However, those most suited to an industry-wide alternative are retention deposit schemes and retention bonds.¹¹

Retention Deposit Scheme

In January 2018 Sir Michael Aldous introduced the Construction (Retention Deposit Schemes) Bill, or "Aldous Bill" as a Private Members' Bill. This Bill attempts to redress the imbalance and lack of protection smaller businesses face when it comes to retention by proposing the following:

• All cash retentions should be held within a government approved retention deposit scheme, whose operation would be determined by secondary legislation, and which would ring-fence retention from the other assets that a client or contractor may be holding so that in the case of any insolvency, the retention remains untouched.
• The money deposited in a retention scheme would be returned immediately upon handover of the works, and at the latest following the expiry of any defects liability period.
• Schemes would be expected to provide quick and inexpensive adjudication or mediation procedures to resolve any disputes regarding the release of the retention.
• The Bill also proposes that the Housing Grants, Construction and Regeneration Act 1996 ("Construction Act") is amended so that any clause in a construction contract enabling the deduction of cash retentions will be invalid unless retention monies are protected in a retention deposit scheme.

The Aldous Bill received its first reading in the House of Commons on 9 January 2018. 80 construction industry organisations and over 275 MPs supported the Bill, a strong indication that a change to the current retention system would be welcome. However the second reading of the Bill was delayed and was not carried over to the new session of Parliament which started in October 2019. Fresh legislation will therefore need to be introduced.

Any such change is not novel: the Aldous Bill reflected what other countries are already adopting in order to protect smaller companies from insolvency further up the line. For example in Canada, legislation requires retention to be held in a separate account.¹² In New South Wales, Australia, retention held on projects worth over $20m must be placed in a recognised deposit institution. In New Zealand legislation has been passed which states that retention money withheld under commercial contracts must be held on trust in the form of cash, or other liquidated assets readily converted into cash, unless a financial instrument is purchased.¹³

Retention bonds

The BEIS Report also proposed retention bonds as an appropriate industry-wide alternative. However, while a retention bond would offer the same level of protection as a retention deposit scheme, BEIS reports that the costs of setting up and implementing a retention bond could price out smaller contractors, i.e. those who require the most protection in terms of retention.¹⁴

The future of retentions

Whether the industry starts using alternatives to cash retentions, or even abolishes cash retentions, remains to be seen. However, the use of retentions is not universal across the construction sector as a whole, nor does it need to be. There are already sub-sectors within the construction industry that do not use retentions. For example, cash retentions are not typically used at all in the lift industry. Instead, lift sector organisations have developed their own Contract Guarantee Scheme, a conditional bond which gives clients protection in a similar way to retentions, both during the work prior to Practical Completion and during the Defects Liability Period. The key difference is that a sum only has to be paid if there is a contractual non-performance. This demonstrates that there are other workable alternatives to retention as we know it.

Further, events such as Carillion's collapse highlight that the current system is neither sustainable nor fair for smaller businesses, particularly in the current political and economic climate.

Overall it appears that the industry will favour retention deposit schemes as proposed by the Aldous Bill. That the Aldous Bill has significant support demonstrates that the industry is ready for change when it comes to retentions. However, further research and money will need to be spent on ascertaining how the proposed retention deposit schemes will operate in practice, in terms of both holding monies and resolving disputes regarding retention. There is also the issue of training those using the schemes to ensure retentions are managed properly.

Ultimately any change to retentions, particularly its ring-fencing, is going to require clear legislation and time.

Footnotes

1. Department for Business, Energy & Industrial Strategy (BEIS), Retention payments in the construction industry: a consultation on the practice of cash retention under construction contracts (24 October 2017).

2. The Guardian reported that insolvencies amongst construction firms spiked by 20% following the collapse of Carillion, and a total of 780 companies in the industry fell into insolvency in the first quarter of 2018 – a one-fifth rise on the same period the previous year (Guardian, 1 October 2018); https://www.theguardian.com/business/2018/oct/01/insolvencies-in-uk-buil...)

3. BEIS, Retention payments in the construction industry: a consultation on the practice of cash retention under construction contracts (24 October 2017), p. 20.

4. Department for Business, Energy and Industrial Strategy, Retentions in the Construction Industry, BEIS Research Paper no. 17 (October 2017).

5. Ibid., p. 102.

6. Ibid.

7. Ibid., p. 97

8. Ibid.

9. Government Insolvency Service, Company Insolvency Statistics, Q2 April to June 2019 (30 July 2019), p. 9.

10. Department for Business, Energy and Industrial Strategy, Retentions in the Construction Industry, BEIS Research Paper no. 17 (October 2017), pp. 22–23.

11. Ibid., pp. 24-25.

12. New Builder's Lien Act 1997.

13. Construction Contracts Amendment Act 2015.

14. Department for Business, Energy and Industrial Strategy, Retentions in the Construction Industry, BEIS Research Paper no. 17 (October 2017), p. 25.

This article is taken from Fenwick Elliott's 2019/2020 Annual Review. To read further articles go to Fenwick Elliott Annual Review 2019/2020

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.