David Christie considers whether outlawing retentions is the best answer to payment practice issues

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Following the government’s consultations over the winter and the growing support for Peter Aldous MP’s ten-minute rule bill on retentions, the appetite for reform in this (and other) areas of payment practice is clear.

The details of the mechanism that might be adopted in any retentions reform are not really discussed in the government’s consultation paper. A possible move to a retention deposit scheme is, however, mooted in the consultation and seems to be the focus of Aldous’ bill. With apologies to Sir Humphrey Appleby, it seems that if it is considered that “something must be done” about retentions, then it looks likely that retention deposits will be the “something” that must be done.

This is hopefully not unduly cynical: there is surely scope to build on the existing use of retentions. So – as part of an initial thinking through of some issues that might arise in that process, it is worth considering which problems the deposit retention scheme might solve, and what further issues it might create. 

The consultation paper and the supporting report by Pye Tait indicates that there are four features of a retention. Two of these are additional benefits to the employer and two are burdens or risks for the contractor. 

The benefits to the employer are:

  • They provide a degree of incentive to the contractor to complete the works timeously and defect-free
  • They provide a degree of security for the employer if the contractor becomes insolvent.

The risks to the contractor are: 

  • The contractor is at risk if the employer becomes insolvent
  • The contractor is at risk if the employer refuses to pay. 

One of the key features of retentions is that they seem often to be created relatively informally: agreed in the contract, sure, but then operated by the parties within that framework – rather than engaging third parties. This informality can lead to problems, of course, but it is important in making retentions an accessible mechanism. 

There are other mechanisms – such as performance bonds and project bank accounts – which are already used and that address the first two features (security and incentive) while minimising the risks in the second. The evidence so far looked at in the consultation process indicates that more complex or formal mechanisms – where used – are layered on top of retentions, rather than used as an alternative. 

Suggested reform therefore has to tread carefully to mitigate the risks while minimising the additional formality. The suggestion of the use of trusts as the legal framework for the deposit scheme has potential. Trusts will provide the degree of security from employer insolvency that might be sought and could be worded in such a way as to increase the likelihood of retention release. At the same time, trusts can be set up easily and with relatively little formality. 

There are at least two significant uncertainties around this mechanism which would need to be resolved. 

First, the introduction of trusts would entail some extra formality compared with the present situation. At its simplest, a deposit retention trust would be constituted by declaration of trust by the employer. But there will be a question over the way in which the retention funds become trust property where they are retained by the employer: the more steps that need to be taken to ensure appropriate segregation, the more complex the situation will become.  

Second, the consultation envisages that the 1996 Construction Act and Scheme will potentially apply here – and certainly that would help ensure the enforceability of the obligation to repay the retention. 

However, in order to bring that possibility into play, legislation will need to be drafted in such a way that it is clear that the trust arrangement is to be caught within the definition of “construction contract” under the act, or that the act applies through some other mechanism. It is far from clear otherwise that the relationship between the employer (as trustee) and the contractor (as trust beneficiary) would fall within the statutory definition of construction contract. Moreover, since the use of retentions is likely to be most beneficial where the least formal contracts are entered into, the exclusion of residential property from the definition of construction contracts is also likely to hinder that goal. 

Finally: beyond these technical issues, it may be that legislative reform is too blunt an instrument. Retentions and their alternatives currently exist in contracts. The proposed alternatives could most likely be incorporated in that way too (although the points identified might well remain). 

If the outcome to the government consultation is to establish a clear, ongoing need and demand for retentions, perhaps the best response would be for the drafters of the standard form contracts to meet that demand – draft forms that parties could then tailor to their own specific requirements – rather than creating a legislative solution that does not adequately balance the competing requirements.