The future of retentions
by Mark Woodward-Smith, Group Managing Director -
The withholding of retention is commonplace within the UK construction industry and forms part of the contractual provisions contained within the majority of the standard forms of contract.
This practice of withholding retention until the contracting party has satisfactorily discharged its contractual obligations relating to completing all works and defects has come increasingly under the spotlight and more particularly following the collapse of Carillion.
It is estimated that Carillion was holding £800m of unsecured retention from its supply chain when it became insolvent.
The UK is out of step with other countries where legislation is already in place to ring-fence cash retentions and/or to provide security for construction payments in general. In Canada and the United States, for example, a system exists whereby a legal charge can be placed on a building or structure by a firm that has not received its payment.
According to UK Government figures, more than £10.5bn of SMEs’ potential working capital is locked up in retentions every year and almost £8bn of cash retentions has remained unpaid over the last three years.
No other industry puts so much cash at risk and places such a burden on small businesses.
As it stands there is no statutory protection of these retention monies against an insolvency of the withholding party and there is also the opportunity for the withholding party to abuse its position by the unjustified delay or non-release of the retention monies withheld. A withholding party currently has no obligation to place retention into a separate ringfenced account and these monies are often used for cashflow and as general day to day operating capital.
In the current market maintaining positive cashflow is critical for a construction business if it is to sustain payment of its operating expenses and its supply chain. Inevitably the timely receipt of retentions is a fundamental part of this cashflow that applies across all tiers of the construction industry supply chain.
Highly competitive tendering conditions and low margins are inherent in the construction industry characterised by the single figure margins achieved by many UK contractors. The timely receipt of all withheld retentions is a significant financial contribution towards cashflow and eventual operating profit and, underlines the importance of overhauling the current retention practices.
What are the current issues?
In October 2017 the Government published a research paper which revealed the extent of the delayed or completely unpaid retentions within the UK construction industry.
Almost three quarters of the contractors surveyed stated that they had experienced delay in the release of retentions compared with the prescribed contractual timescale for their release. The extent of these delays was found to be even greater for tier 2 and 3 contractors.
More than half of contractors surveyed identified that they had experienced instances where the final release of retention had taken more than 3 years.
Some of these delayed or non-payment of retention issues may have been justified where there was genuine incomplete making good of defects.
However, the non-payment of retention which purports to be conditional upon release under an upstream contract is unlawful under the HGCRA.
Similarly unlawful, but all too commonplace, is the practice where even though all works and defects may be complete retention repayment continues to be withheld due to outstanding obligations pertaining to works under a different contract between the parties.
All too regularly a party is denied repayment of retention due to the insolvency of the withholding party given that there is currently no requirement to deposit retention into a trust account.
What is going to change?
As far back as 1994, Sir Michael Latham had recommended the placing of cash retentions into a secure trust fund. While his other payment-related recommendations were implemented in the 1996 Construction Act, the omission of any provision for retentions has not been rectified.
The proposed “Aldous Bill” is currently seeking an amendment to the Housing Grants Construction and Regeneration Act 1996 (“HGCRA 1996”) to implement mandatory provisions to hold and ring fence retention in a government approved third party trust to protect the supply chain from upstream insolvency and payment insecurity.
According to the building services contractors group BESA, 207 MPs – almost one a third of all MPs –have expressed their backing of the Bill and if it becomes law, the proposed stringent obligations will require the cash retention deducted from payments by the supply chain to be held in a retention deposit scheme.
This backing comes alongside what is described as the “largest fair payments campaign ever formed in the UK”, by an unprecedented coalition of over 80 industry bodies and trade associations, representing over 580,000 businesses and sole traders.
However, it should also be noted that certain bodies have withheld their support, some of them claiming instead that cash retentions should be abolished outright.
Whereas a level of retention security is provided currently in circumstances where project bank accounts, or escrow accounts are used, the Aldous Bill introduces supporting legislation designed to prevent the reoccurrence of the £700M loss suffered from construction insolvencies experienced between 2014 and 2017.
What are the risks?
The final Bill introducing any such retention deposit scheme will need to consider whether it is applicable to both new and existing contracts and if so how the latter would be administered.
Whether the proposed changes will be subject to phased introduction is unclear, but it is bound to have an impact on those organisations which currently utilise retention as part of their operating cashflow.
How release of retention is to administered, how any disputes relating to release are to be resolved, whether set off is allowed, who will pay for the scheme and what happens with any interest which is accrued is still to be clarified. Other legislation such as insolvency may need to be adjusted to facilitate access to funds held in trust after insolvency.
The proposed Bill is intended to apply to all construction contracts and will affect both main and sub-contracts. The main contractor will be required to pay the retention under the sub-contracts to a deposit holder even though it has not itself been paid its retention by the client.
It could be argued therefore that this takes money out of the construction cash flow system at the very point when it is required – for payment of main contractor wages, materials, overheads and so on. All construction projects rely on a steady flow of cash between the parties; any new reforms which withhold cash from any stage within that process may be counter-productive.
It may be more appropriate for a single ‘project’ retention to be held, with the main contractor and its sub-contractors and supply chain each entitled to separate diminishing percentages. In order to operate this would require significant transparency in pricing which main contractors are unlikely to support.
Undoubtedly, the operation of the current UK retention process needs an overhaul, and any changes that address the unjustified delayed or non-payment of retentions would benefit the industry as a whole.
An improved process that makes available, as working capital, the cash currently held up in overdue retentions would allow companies to invest in apprentices, staff training and new technology with consequential improvements in overall productivity and quality.
Whereas the Aldous Bill appears to have gained a general level of support across Parliament and industry, significant further work is still required in respect of the details and practical operational issues before the industry can start planning and preparing for implementation of the changes it proposes.
1 Building Engineering Services Association (BESA)
2 Pye Tait Review – Retentions in the Construction Industry, BEIS Research Paper 17, October 2017
3 HGCRA – Housing Grants Construction and Regeneration Act 1996