A retentions ban is too simplistic

Ever since the Victorian railway boom, cash retentions have followed construction contracts. They have remained a source of controversy for nearly as long. Typically 3% or 5% of each payment instalment in the UK, they offer security against defects. Sir Michael Latham observed in his 1994 report that the concept was sound “though in practice the system no longer operates in that manner”. 

Grumbles are just as ageless: retentions are sometimes released late or not at all, they can be wrongfully withheld and their release is jeopardised by the payer’s insolvency. Among other reforms, the Commercial Payments Bill, which has passed committee stage, would introduce a ban on retention clauses in the UK, phased in over a transitional period.

The bill engages devolved matters. However, the intent has always been to have a UK-wide approach. For Scotland, this therefore contrasts with an earlier position of the Scottish Short Life Working Group, which evaluated retention reform five years ago and firmly rejected such a ban. Instead, it suggested, subject to a business case, a custodial deposit scheme that would hold retention money in an independently run, protected fund.

The government’s chief difficulty is that opinions in favour of cash retentions are at least as compelling as those advocating abolition. Over the past decade there have been three private members’ bills seeking substantial reform, the last of which sought outright abolition. None progressed far, albeit due to factors outside of their sponsors’ control.

The government appears to have settled on the most radical option … Less drastic and more tried-and-tested alternatives ought to be seriously considered first

The government’s own evidence has failed to confirm retentions as a direct cause of insolvency. In a 2017 research report commissioned by the Department for Business, Energy and Industrial Strategy, Pye Tait found that 44% of contractors surveyed with experience of retentions being withheld had suffered non-payment through upstream insolvency during the preceding three years. The corresponding insolvencies, nonetheless, affected only around 1% of all relevant contracts. The research company found no strong evidence that holding retentions directly caused insolvency, although it recognised they could be a contributing factor. Construction business failures have myriad causes, including inconsistent cash flow, thin margins, inflation, financing costs and disputes, some of which the bill seeks to tackle.

Alongside the Pye Tait report, the government consulted on alternatives to cash retentions. Its findings, published in 2020, offered mixed feedback for smaller businesses. None of the other options proved universally suitable across different sub-sectors or sizes of project.

The market’s reluctance to move on from cash retentions explains the government’s new approach of outlawing them and leaving project participants to figure out what to do next. But that philosophy may sit uncomfortably with the Green Book, the government’s longstanding guidance for appraising policy decisions. It requires proposed interventions to be carefully assessed against a “business as usual” benchmark. In the case of retentions, the government appears to have settled on the most radical option ahead of a further consultation which it has itself described as necessary.

To put the UK’s situation in context, cash retentions are in popular use all over the world. Only New Mexico has banned them (with minor exceptions), though not the possible workaround of back-loading payments to circumvent their prohibition. It is easy to imagine that other unsavoury practices could emerge to defeat a ban that may prove similarly hard to police, such as systematic undervaluing of interim payment applications.

Less drastic and more tried-and-tested alternatives exist around the world and ought to be seriously considered first. A straightforward amendment, proposed at the bill’s committee stage but rejected by the government, would be to cap the level of retention. Another, which could be deployed in concert, would be to provide that retention money is safeguarded in an insolvency through a statutory trust, following New Zealand’s example. There, the government enacted legislation to prescribe that such trusts arise automatically by law, while prohibiting commingling and introducing fines for non-compliance. These measures combined could materially reduce insolvency risk and the consequences of abuse without throwing the baby out with the bathwater.

As for an unreasonable withholding of retention money, the government could take a fresh look at adjudication. At sub-subcontractor level and beyond, retention sums can appear too modest to justify a dispute. This is a known access-to-justice problem where the cost and hassle of proceedings outweigh the prospective reward. The fix could be to introduce a short-form, streamlined adjudication process for retention disputes with capped fees proportionate to the disputed sum, in which the adjudicator’s costs and a fixed contribution to the winning party’s costs are borne by the loser. Several leading nominating bodies operate schemes for low-value claims that could potentially be adapted.

The argument against abolition is not that retentions function flawlessly. Rather it is that a government which has pledged to put the right values at the heart of everything it does should adopt the easiest solution or, instead, spend time working across the industry to ensure that it finds the best one. 

Francis Ho is a partner at Charles Russell Speechlys