Subcontractors throughout the supply chain are at risk of losing cash due to the retention system. So what statutory measures should be put in place to safeguard the money?

Rudi Klein

At the end of 2015 cross-bench peer, Lord Aberdare, tabled an amendment to the Enterprise Bill. The amendment sought to protect cash retentions by placing them in a ring-fenced account. The amendment was withdrawn following a promise by the (then) business minister, Baroness Neville-Rolfe, to review the retention system. That review is delayed and unlikely to be published until after the election: in the meantime, on 26 April, Alan Brown MP introduced a Construction Industry (Protection of Retentions) Bill as a private member’s bill. This would have required cash retentions to be placed in trust but, again, the election has intervened.

On 31 March (just gone) legislation was implemented in New Zealand imposing trust status on retention money. There is a growing recognition around the world that some form of protection is required. This comprises everything from payment bonds and bank guarantees to charges on the land (on which the work was carried out) and statutory trusts. Anything less than some form of statutory protection will not help to safeguard retention cash. The UK government’s Construction Supply Chain Payment Charter has an “ambition” to get rid of retentions by 2025 but no mechanism to achieve this. If cash retentions are to be kept in a secure “pot”, there would be little point in withholding the cash – since it cannot be used.

Anything less than some form of statutory protection will not help to safeguard retention monies

A recent independent scrutiny of the accounts of the UK’s top dozen contractors revealed that they were owed £1bn worth of retention cash. Approximately 90% of the £1bn is funded by their supply chains. No other industry sector would tolerate such volume of cash being wholly at risk. In 2015 almost £50m worth of retentions was lost by SMEs following insolvencies further up the supply chain. Not surprisingly lending institutions do not consider a firm’s retention ledger as sufficient security for lending purposes.

All contracting firms have their horror stories. One small plumbing company recently revealed that it had lost £150,000 worth of retention over the last five years because of insolvencies. In recent years the insolvency risk has increased because large companies are holding on to their supply chains’ retentions for a longer period. Subcontract retention release has been pushed out to two, three or more years after handover. This is to counteract the fact that main contractors can no longer simply delay release by linking subcontract release dates to some certificate stating that the main contract works are fully compliant.

But contractual consent for holding back retentions (from already due payments) does not extend to their being defrayed for the purpose of satisfying the payer’s creditors. Their purpose – ostensibly – is to provide security in the event that a firm does not return (whether for reasons of insolvency or any other reason) to remedy non-compliant work. Contractors agreeing to retentions being withheld should insist on greater clarity as to the purpose for which the money is handed over.

Firms concerned about the security of their retentions may be able to obtain a declaration from an adjudicator that the money is trust money

In effect retentions are a conditional loan; the condition being that the loan will be repaid in the event that the works are in accordance with the contract or the contractor has rectified any non-complaint work. In a 1970 case, Barclays Bank vs Quistclose Investments Ltd, Quistclose had lent money to a company to enable it to pay a dividend to shareholders. Instead the company had used the loan to pay off an overdraft owed to Barclays Bank. The House of Lords (as it then was) decided that Barclays held the money on trust for Quistclose, because it had not been used for its intended purpose.

Similarly misuse of retention cash (that is, using the cash for unconnected purposes such as paying off a loan or bolstering working capital) could attract trust status. In a more recent case (Twinsectra Limited vs Yardley and Others [2002]) Lord Millett in the House of Lords explained the Quistclose trust as follows: “[It] is a simple, commercial arrangement akin […] to a retention of title clause […] which enables the borrower to have recourse to the lender’s money for a particular purpose.”

Until or unless the money is used for the designated purpose, it is branded as trust money and should be ring-fenced. Firms concerned about the security of their retentions may be able to obtain a declaration from an adjudicator that the money is trust money. As such it should be ring-fenced in a trust account.

For now we await publication of the government’s review.

Professor Rudi Klein is a barrister and chief executive of the Specialist Engineering Contractors’ Group