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Retention Payments in the Construction Industry

  • United Kingdom
  • Construction and engineering - Articles
  • Construction and engineering - Foundations

22-05-2019

Summary: The Construction (Retention Deposit Scheme) Bill was expected to have its second reading in Parliament on Friday 22 March 2019. If enacted it could make significant changes to cash flow in the construction industry. What is it and will it become law?  

Introduction

Carillion’s insolvency, which left an estimated 30,000 SMEs in the UK construction industry without any chance of recovering the retention monies due to them, created a clear call for action to safeguard these monies.

On 9 January 2018, just days before Carillion’s collapse, a Private Member’s Bill - the Construction (Retention Deposit Schemes) Bill - was introduced in the House of Commons under the Ten Minute Rule and, unusually, passed its first reading.

The Bill was prescient and supporters said it was developed with a ‘large contractor insolvency’ nightmare in mind. The second reading of the Bill has been repeatedly delayed due to the distractions of Brexit, and the last date of March 2019 has come and gone with no new date being announced.

This UK Insight Article looks at what the Bill does, its supporters and detractors, international comparisons, and alternative solutions.

What The New Bill Does

The Bill seeks to amend the Housing Grants, Construction and Regeneration Act 1996 and broadly contains three limbs.

Firstly, the creation of ‘retention deposit schemes’ to safeguard retention monies withheld in connection with construction contracts and make it easier to resolve disputes relating to those retentions.

Second, a prohibition on retentions that are not placed into a retention deposit scheme.

Lastly, a duty to refund that any retention which is not placed into a retention deposit scheme. This has to be refunded within 7 working days after it was withheld.

Like most new payment mechanisms, this is likely to take time to become a new habit and will result in a rush of adjudication for those clients who forget to either place the money into a scheme quickly or refund that money equally quickly.

The system is similar to the UK statutory tenancy deposit scheme, under which deposits taken from shorthold tenancies must be placed in a Government-approved scheme.

The Bill leaves much of the actual mechanics of the retention deposit schemes to be worked out in subsequent regulations but it still raises several questions:

  • Will the Bill’s requirement for the schemes to make resolving disputes easier sit alongside or replace the well-trodden route of adjudication?
  • Is the Bill intended to cover development and funding agreements, as its wide definition of construction contracts would suggest?
  • Will the scheme apply to tier 2 and 3 contractors?
  • Will the scheme apply to all contracts or just those above a certain value?
  • Who pays the costs of administering the schemes?
  • Who is entitled to the interest on the monies in the scheme?   

The Bill’s Supporters

Sir Michael Latham’s 1994 Report, Constructing the Team,[i] recognised the issues with the cash retention model and recommended either mandatory trust funds for payment or retention bonds. Whilst the option for on-demand retention bonds has been introduced into various construction contract standards forms, take up is low.

Since then the matter has been discussed in parliament and government-sponsored reports many times, and was the subject of two parallel consultations from the Department for Business, Energy & Industrial Strategy’s (BEIS) [link]. The Aldous Bill, as it is known, is not even the first Bill under the ten-minute rule. In April 2017, a Scottish MP (Alan Brown) introduced the Construction Industry (Protection of Cash Retentions) Bill – a  general election curtailed that Bill’s progress.

Are there enough supporters to ensure this Bill’s success?

The industry publication Building Services and Environmental Engineer reported that this Bill commands the support of over 80 trade bodies and over 200 MPs and is ‘the largest fair payment campaign ever formed in the UK’.

In addition, the issue is very much in the public eye due to the high profile collapse of Carillion and other teetering main contractors. Industry publications, as well as the mainstream press, carry weekly stories about payment in construction. Many are scathing about the UK government’s attempts to improve payment solely through voluntary initiatives such as the Construction Supply Chain Payment Charter and the Prompt Payment Code.

It is not hard to see why the Bill has supporters. In our experience, the retention percentage is typically 5% of the contract sum (until completion, reducing to 2.5% during the defects period). When profit margins are hovering at 1.5% to 2%, the retention far exceeds any profit on a project and ensures contractors are operating at a loss until it is paid.

Staying in business becomes dependent on:

  • the client or paying contractor remaining solvent for at least 12 months after completion (the defects period);
  • countering any unsubstantiated or unscrupulous use of the retention for rectifying defects;
  • the administrative challenge of keeping a record of what monies are outstanding to each member of the supply network across every project, each with a different timescale for the return of the retention;
  • the cost and burden of chasing up someone with the authority to release the remaining retention falling on the subcontractors and suppliers;
  • an English approach to ‘not to causing a fuss’ in the belief that to do so will maintain a better working relationship with upstream employers; and
  • the prohibitive costs of enforcing contractual rights to the retention through adjudication, when those involved have long moved onto other projects.

The Bill’s Detractors

Despite cross-industry support for mandating secured retention monies, 25 years have passed since Sir Michael Latham’s report without any legislation enacting his recommendation. Surely it is not just a lack of parliamentary time (more recently caused by Brexit) preventing action?  

Despite moves by more progressive employers clients such as Network Rail to remove retentions throughout its projects, there remains little support those in control of the chain of contracts: funders, employer and tier one contractors.

In our experience, these parties prefer the simplicity of retention. The alternatives - project bank accounts, retention bonds and trust funds – require additional legal, banking and administrative costs, none of which these parties want to pay for, especially when they perceive no personal benefit.  

It is often stated, although no-one seems prepared to admit to it, that withholding retention improves the working capital of tier 1 contractors, and reduces the need for employer borrowing, both of which improve their balance sheets (if only temporarily).  

Perhaps surprisingly, the lead organisation for the UK construction industry, Build UK, which – in theory – represents all levels of the supply chain, has not fully supported the Bill. Build UK (along with the Civil Engineering Contractors Association, Construction Products Association and Chartered Institute of Credit Management) set out their position in a letter to the Secretary of State for BEIS in which it restated its support for the outright abolition of retentions by 2025 as set out in the Governments Construction Supply Chain Payment Charter. And yet, Build UK sat on the fence and said that it had ‘not reached a consensus on a retention deposit scheme’ which is the foundation of the Bill!

Patchy supply network support and difficulties with the finer mechanics of the schemes combined with lack of Parliamentary time jeopardises the ultimate progress of this Bill in the UK.

Yet again we are lagging behind other countries…   

International Comparisons

Following the Collins Inquiry, prompted by the aftermath of the financial collapse of a number of well-established building and construction companies, New South Wales in Australia introduced legislation mandating that tier 1 contractors must safeguard some retention monies. The Act applies to projects worth at least A$20m and the monies must be placed in trust accounts with an authorised deposit-taking institution. Consultations are reviewing halving this threshold to A$10m.

In New Zealand, after the collapse of developer Mainzeal, legislation requires retentions to be held on trust, unless a retention bond is in place. This applies to contracts throughout the supply network, with no minimum contract value threshold.

In Canada and the United States, a system of charges (liens) can be placed on an asset if a firm has not received its payments. France has a statutory framework that requires bank guarantees to be used as security for payment in the construction industry.

What Can You Do Now? Alternative Solutions

This Bill is mired in Brexit delays and lack of government will, and the lofty ambition of abolishing retention looks further away than the planned 6 years. What can you do before then?

Firstly, consider the provisions in your standard form contracts.

If you are using a JCT 2016 SBD or D&B contract, then if it requires an employer to hold retention monies on trust for the main contractor. In addition, “if the Contractor so requests” those monies have to be placed in a separate designated bank account designated. If used, and not amended or deleted, this provision offers the contractor the protection that the Bill seeks to replicate. Even though the JCT Subcontracts do not expressly include the requirement to hold the retention on trust, it is implied under English law unless the contract says otherwise. But the subcontractor cannot request those monies are placed in a separate account (and that may be because the contractor never gets paid them).

The NEC4 core conditions have no retention but Secondary Options for either retention or equivalent protection by using a project bank account.

Secondly, consider the power of sector pressure and trade organisations. We routinely encounter responses from businesses in the vertical transportation sector where the contractors have decided they not accept a retentions and offer a specialist Lift and Escalator Industry Association Bond instead.  The piling sector has a similarly strong anti-retention stance.

Of course, the biggest change would come if employers (backed by funders) created a long-term strategy reflecting the needs of the entire supply network. If employers require their long-term and framework contractors to protect retentions or remove them altogether, this would create significant benefits. Side-effects could be reduced costs (for example by subcontractors not having to price the risk of contractor insolvency), better working relationships based on higher trust, and more accurate tender prices taking into account real profit margins. and It is not impossible: Network Rail has banned retentions within its supply network and Highways England has adopted project bank accounts.

Conclusion

Main contractor insolvency, poor payment practices, heavy debts and low margins are a perennial  feature of UK construction, provoking much worry in the supply network. The recent fate of leading contractor, Dawnus has been dubbed the ‘Welsh Carillion’.

Despite our obsession with talking about improving payments, this Bill has slipped off the government’s radar as it deals with other issues. Despite the progressive strategies of certain clients,  housebuilder Persimmon recently announced it will allow homeowners to deduct retention, with the knock-on effects for its suppliers and subcontractors. Retention looks likely to remain an unwelcome guest for many in the industry, at least in the short term.

To read more about the Bill and its status in Parliament click here.  See also our article [link] on the use of Project Bank Accounts to solve some of these issues.



[i] Available from Constructing Excellence. Click this link.

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