Death Of The Retention?

The Government has announced plans for the most ambitious legislation in over 25 years to tackle late payment, including the abolition of retentions under construction contracts. If these changes come into force, they will have a significant impact on construction projects and cause concerns within the broader real estate industry.

In its consultation response to the "Late Payments consultation: tackling poor payment practices" it ran last year, the Government has proposed the following changes.

• An overall prohibition of retention monies – the consultation explored two options: (1) a complete prohibition on use of retention clauses in construction contracts; and (2) use of retention, but subject to requirements for retention sums to be protected. The Government has come out on the side of an outright ban on retentions, although it has said it will consult further on the impact of this measure before taking a final decision.
• Wider later payment measures, including:
  • maximum payment terms of 60 days (reducing to 45 days after five years) and removal of the current exemption that allows business to agree longer terms so long as they are not grossly unfair. There would be limited exemptions for contracts where:
    • both parties are large companies;
    • purchaser is a smaller party;
    • goods or services are being imported or exported;
  • mandatory interest on late payments of 8% above Bank of England base rate;
  • financial penalties for persistent late payers ; and
  • a time limit for raising disputes on invoices – the time period consulted on was 30 days. The response states that "a separate measure, aligned with the existing payment notice mechanism will be taken forward for construction contracts".

Whilst the entire industry will see the benefit in enhanced cash flow through the supply chain, there will be concerns, as follows.

• Retention is the only simple low-cost leverage available to employers in order to secure the making good of defects. The BPF has commented that "A retentions ban actively undermines the push for quality that the industry strives for and will just store up problems for the future".
• Removal of retention creates a situation where the contractor has been paid in full even though it has not completed all of its obligations. If the proposals move forward, they are likely to include anti-avoidance measures to prevent other milestone-based payment arrangements to cover this issue.
• Whilst retention bonds are clearly an alternative:
  • bonds add costs to projects - although the argument will be that insolvency and poor cash flow caused by the wrongful holding of retention are a greater cost to the industry;
  • the industry would be concerned about whether the surety market could support an expansion of bonding of this kind;
  • contractors and subcontractors will need to provide counterindemnities (and potentially security) to sureties in order for bonds to be underwritten. Whether the cost and administration of these arrangements will significantly reduce the perceived cash flow benefits is yet to be seen; and
  • the bond market has become much harder in recent years. If the market will not support on demand retention bonds, the cost of recovery under default-based retention bonds may be prohibitive. This could leave beneficiaries with no meaningful remedy as they would have no retention and no cost-effective recovery under a retention bond.
• The imposition of mandatory interest on late payment at 8% above base rate may cause a distortion where a payer considers it has a legitimate reason to withhold payment, but is at risk of having a penal rate of interest applied if it is found to have wrongly withheld.

The Government has indicated it is alive to some of these issues and has said it will work with the Construction Leadership Council and construction clients to "develop practical approaches to minimising defects" and with the financial services sector "to identify ways of developing the surety market for the construction sector". Whilst we already see some clients (with strong and longstanding supply chains) operate without retentions in their construction contracts, many will be concerned about the implications of an outright ban on retentions and certain of the other changes the Government is proposing.

Macfarlanes is a pre-eminent law firm advising a global client base across Private Capital, Private Wealth, M&A and Disputes.

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