Cash retentions in construction contracts have recently come under scrutiny by the Government. The Department for Business, Energy and Industrial Strategy is in the process of carrying out a consultation on the use of cash retentions in the construction industry. In addition, we have a private member's bill seeking to amend current legislation in relation to the same issue. So what does the future hold for retentions?
Most standard form building contracts allow an employer to retain a percentage of the construction cost from each interim payment payable to the main contractor. The retention can is withheld regardless as to whether there are any problems or defects with the work carried out. The retained cash is then usually partially paid on practical completion of the works, with the final payment at the end of the defects period – potentially up to 24 months after practical completion. The main contractor in turn withholds a percentage from payments to their subcontractors, and so on down the chain, with increasingly extended repayment periods. Whilst such retentions are common practice in the construction industry it is easy to see how they are a peculiarity to other industries, where the ability to withhold part payment from a supplier without default would be considered unfair and uncommercial.
Since the days of the Latham Report over 20 years ago, and recently in the Farmer Review, there has been recognition that for a healthy construction industry, cashflow through the supply chain is essential. Cash retentions are contrary to this principle as they tie up cash during the course of a project and for a time post-completion.
Retentions not only impact on cashflow, but also have the potential to result in a loss of that retention in the event of the insolvency of a party further up the contractual chain. This was starkly highlighted in the recent collapse of Carillion. The Construction Index reported that Carillion were holding £800million of their subcontractors' money when they went into liquidation – money that the subcontractors are unlikely to recover, and which those subcontractors will not be able to pay down to their own sub-sub-contractors.
Even where there has not been any insolvency, late repayment or unjustified non-payment of retentions ties up working capital and results in parties having to incur additional financing costs, as well as having the potential to damage relationships between parties, again an outcome that is contrary to recognised best practice principles.
The use of retentions is also contrary to the principle of transparency within supply chains, as vaunted by the Latham Report, as contractors and subcontractors factor in additional costs to offset the impact of retentions and the risk of not receiving their money back, which in turn increases construction costs.
Although there is pressure from trade bodies to abolish retentions, the consultation is focused on seeking alternatives to cash retentions, rather than abolition. The favoured alternatives appear to be the use of a retention deposit scheme or a requirement that retentions be held in a trust account, and there will be a cost/benefit analysis of each alternative. The use of a trust account is the approach promoted in the private member's bill of Peter Aldous, who wants current legislation to be amended to require retentions to be held within a third party trust scheme.
Other alternatives under review are project bank accounts, retention bonds, performance bonds and escrow stakeholder accounts, but from the outset it has been suggested that these approaches would not address all of the issues that have been identified as being problematic with cash retentions.
The consultation is also looking into potential limitations on the withholding of retentions both in terms of the amount and the length of time for which the retention can be held.
Our view is that those in the industry who predominantly appoint main contractors are likely to resist (in practice if not in principle) any alternative that requires additional paperwork and bureaucracy and which incurs additional cost. Withholding retentions is the simplest method of performance security available to an employer or contractor, and in our experience, most employers already reject any contractual obligations that require them to place the retention monies in a separate bank account and hold the retention monies as trustee.
However, subcontractors, particularly SMEs, who are seen as being more at risk of losing or struggling to reclaim retentions will welcome any measures which safeguard their money. Whether or not they will accept a share of the cost is another question.
We look forward with interest to seeing the outcome of the consultation in due course, and to see whether this, or the private member's bill, makes it onto the statute books.