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Fri January 28 2022

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The injustice of retentions

30 Nov 21 Draft legislation was submitted in the House of Lords last month, once again seeking to outlaw the use of retentions in construction contracts. Lord Aberdare, sponsor of the bill, explains why he is fighting for the cause.

Alastair Aberdare
Alastair Aberdare

Retentions are amounts withheld from payments which would otherwise be due under construction contracts as security against contractual non-performance by the party to which they are owed.  They have a damaging effect on the construction industry.  They restrict the ability of the firms from which they are withheld, mainly small and medium-sized enterprises (SMEs), to innovate, to invest, to train staff, to take on apprentices, to grow and sometimes even to survive.  The system is fundamentally unfair to such small businesses, which is what first led me to take an interest in it, having had experience of the crucial importance of cashflow and prompt payment when running small businesses myself.

It is estimated that some £4.5b annually is taken out of the economy through outstanding retentions, while around £1m per working day is wholly lost to smaller construction businesses through insolvencies of upstream contractors who have withheld funds due to them.  In 2018 about £10.5bn of the construction sector’s overall annual turnover of £220bn was estimated to be held in retentions, with unpaid retentions amounting to £7.8bn over the previous three years.  The collapse of Carillion alone resulted in the loss of hundreds of millions of pounds of such retained funds, forcing a number of small firms into bankruptcy.

There are several concerns relating to retentions.  The most significant are that retentions owed to subcontractors are sometimes never paid at all, and that the funds held are not ring-fenced or protected in any way, so that if the higher-level contractor holding them becomes insolvent they are lost, and again the firms to which they are owed receive nothing.  Inevitably this leads to prices quoted for work being inflated to allow for the risk of retentions being lost; nor can firms borrow money against retentions owed to them, because of the uncertainty of their being paid.  All of this reinforces a lack of trust and cooperation between contractors at different tiers, one of the most damaging consequences being the implied perception that the contractor engaged to do the works is not up to the task.

Other issues relate to the level of retentions (usually around 5% of the contract value, but sometimes significantly higher) and the length of time for which they are held.  A generally-accepted liability period would be 12 months following contract completion, but evidence shows that firms may have to wait on average for six months longer than that.  Underlying all these issues is the lack of regulation relating to retentions and, crucially, of effective recourse for firms seeking to pursue claims for retentions owed to them.  This is exacerbated by the natural reluctance of smaller firms to engage in potentially lengthy and resource-intensive disputes with larger clients from whom they might expect continuing business.  The government’s Prompt Payment Code lacks enforcement teeth, and it is unclear how far the role of the Small Business Commissioner, who oversees its implementation, might extend to issues relating to retentions – even though there are an estimated 350,000-plus SMEs in the construction sector.

I first became involved with retentions during the passage of the Enterprise Act 2015 through the House of Lords.  I was delighted that, following an amendment that I tabled during Committee stage, the government (represented by Baroness Neville-Rolfe, then the relevant Lords minister) agreed to undertake a review of the practice of retentions, to be completed within nine months of the Bill being passed.  In practice this review, conducted by Pye Tait, took much longer; it was published in October 2017 and followed by a consultation, the report of which finally appeared in February 2020.  Since then there has been little perceptible progress.

The issue is not covered in the government’s Construction Playbook, published last December, which “sets out key policies and guidance for how public works projects and programmes are assessed, procured and delivered.”  Indeed a number of government and arms-length bodies continue to use retentions themselves, so a first step for the government might be to put its own house in order.

It is widely acknowledged, including by government and a clear majority of the construction sector itself, that the problem of retentions needs to be resolved, and soon.  The funds lost in retentions within the supply chain could be much better used to support faster movement by the industry towards a low-carbon, high-skilled, technology-savvy future.  Retentions have been linked to poor and unsafe practices in the sector, for example in the Hackitt Report on Building Regulations and Fire Safety following the Grenfell Tower tragedy, which specifically noted that “payment terms within contracts (for example, retentions) can drive poor behaviours” such as causing subcontractors to “substitute materials purely on price rather than value for money or suitability for purpose.”

The Construction Leadership Council has endorsed the Build UK Retentions Roadmap, with its objective of reaching zero retentions by 2023, or at least no later than 2025 in line with the 2014 Construction Supply Chain Payment Charter.  Industry-led working groups within the Construction Leadership Council are exploring all the alternative options, including a system of managing defects and improving quality without the need for withholding retentions.

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The government has confirmed that it is seeking a resolution of the problem, and that this will require legislation.  It cites three difficulties in making progress: the complexity of the issue, the lack of industry-wide consensus, and the challenge of finding legislative time.  The issue is indeed complex, but a number of viable solutions have been proposed, ranging from various forms of retention deposit scheme to an outright ban on retentions, as envisaged by the Roadmap.  There is much support for protecting retentions funds in a ring-fenced scheme, possibly including an insurance element, as part of a process of transition towards eventual total abolition, hopefully by 2025.

Full consensus is never likely to be achievable, given the divergent interests of the parties involved in retentions: those withholding funds (often to help boost their own working capital) and those deprived of them, with no certainty of ever receiving them.  There is therefore a pressing need for the government itself to act to break the deadlock – and to act fast, if the 2025 target (let alone 2023) is to have any chance of being met.

As far as finding legislative time is concerned, if a stand-alone Bill on retentions is not feasible, there will surely be other Bills relevant to construction which could include the necessary provisions to address retentions – perhaps a Bill relating to prompt payment, or even the Building Safety Bill currently going through Parliament, which seeks to implement many of the Hackitt Report’s recommendations.  There are existing legislative approaches to draw on from countries which have already acted on retentions, including Canada, New Zealand and several states in America and Australia; Scotland and Wales are also considering possible legislation.

A number of peers have regularly raised the need for the government to act on retentions in questions and debates in the House of Lords, and are committed to maintaining pressure on ministers to do so.  We have had briefings from Actuate UK, an alliance of engineering services industry bodies, who are also keen for the issue to be resolved as this will improve the viability and capacity of the SMEs within their sector, especially as they recover from the pandemic.

I have recently introduced a very short Private Member’s Bill, which has the sole aim of helping to move the process along. [See previous report here.]  The Bill would simply ban all retentions from the date of its coming into force, set at 1st January 2025.  It would thus provide a fixed end-point for work to establish a plan for reaching this generally-desired conclusion.  The Bill is a long way down in the current queue of Private Member’s Bills in the Lords, so it may not even get as far as a Second Reading debate in the current session of Parliament – in which case I may seek to reintroduce it in the next one!  To become law, it would also need to pass through the Commons, with the support of sympathetic MPs as sponsors.

However, success will depend on the government stepping up to the mark itself.  Firstly it needs to spell out a clear policy approach, supported by a specific action plan and timescale, based on the Build UK Roadmap and recognising the importance of resolving this issue by 2025.  Then it needs to produce its own legislation covering retentions and take it through Parliament.

Ultimately only the government, through legislation, can finally resolve the issues around retentions, setting in train a formal statutory process at the end of which we would finally be rid of this pernicious practice.  Small construction firms might then at last be freed to play their full part in a more healthy, vibrant and cooperative construction marketplace, no longer hamstrung by the injustice of retentions.

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