Infra.Law
Retentions in the Construction Industry
By Kate Knox
Retentions are a traditional, yet controversial, practice aimed at ensuring projects are completed to the agreed standards. This article explores their purpose, the ongoing debate surrounding their reform and the latest attempts to direct the spotlight back onto the issue.
Purpose of Retentions
Retentions in the UK range from 3-5% of the contract sum and are typically halved at practical completion, with the remainder repaid at the end of the defects rectification period. They serve as a financial incentive for contractors to return to the project post-completion to rectify defects that may arise during the defects rectification period and provide a small pot of cash should the contractor fail to rectify those defects. By withholding a percentage of the payment until the work is confirmed to be satisfactory, clients hope to encourage contractors to uphold quality standards and complete the work satisfactorily.
The Controversy
Despite their intended purpose, retentions have become a source of contention in the UK for several reasons:
- Cash Flow Impact: Contractors, particularly small and medium-sized enterprises (SMEs), often struggle with cash flow due to the withheld funds. This can limit their ability to invest in other projects, pay suppliers, and grow their business.
- Late or Non-Payment: There is a risk that clients may delay or fail to release the retention monies which can further exacerbate the financial strain on contractors.
- Administrative Burden: Managing retentions can be administratively burdensome, requiring record-keeping and follow-ups to ensure that funds are released on time.
- Trust Issues: The need for retentions can imply a lack of trust between clients and contractors, potentially leading to adversarial relationships rather than collaborative partnerships.
The Chartered Institute of Building have just published their report on the SME Construction Landscape in Wales, discussing systemic issues within the industry suggested by the considerable number of SMEs going into administration. Among the flagged issues was the practice of deducting retention sums and the non-release of these funds at the end of projects. With SMEs being less inclined or able to commence litigation to recover disputed deductions made from retentions, this adds to the financial pressure on SMEs.
The Debate on Reform
The construction industry and policymakers in the UK have been debating the need for reforming the retention system for years. Proposals for change have included:
- Retention Deposit Schemes to protect the monies from being used for purposes other than the intended rectification work or being lost due to insolvency.
- Zero Retention Policies to abolish retentions altogether.
- Prompt Payment Codes, implementing stricter prompt payment codes and regulations to ensure that retentions, if used, are paid back promptly and fairly.
- Cap on Retentions to limit the financial burden on contractors.
- Draft Legislation proposed:
- The Construction (Retention Deposit Schemes) Bill introduced in 2018, unsuccessfully attempted to make it unlawful for cash retentions to be withheld from payments under construction contracts unless they were deposited in a government approved retention deposit scheme.
- The Construction (Retentions Abolition) Bill was introduced in 2021. The title said it all and only had one reading in the House of Lords, making no further progress.
Latest attempts to direct the spotlight back onto the issue
There is now some UK Government engagement with the introduction of the draft Reporting on Payment Practices and Performance (Amendment) (No2) Regulations 2024, intended to come into force on 1 March 2025. Targeting retention practices is one of the measures being implemented by the UK Government intended to support cashflow for small businesses. As part of the requirement for the UK’s larger companies and limited liability partnerships (LLPs) to report twice in a financial year on their payment practices, these Regulations will introduce additional requirements on a qualifying company or a qualifying LLP to publish information about their payment practices and policies with respect to retention clauses in their construction contracts with their suppliers.
This includes statements as to whether:
- their qualifying construction contracts include the use of retention clauses,
- their standard payment terms include retention clauses or if they include them only in specific circumstances,
- there is a threshold contract sum (to be disclosed), below which, retention won’t be provided for,
- they apply a standard percentage rate in retention clauses, duly disclosing that percentage,
- they have a practice to ensure that the retention clause applied with their supplier is no more onerous than the one which their client has imposed on them.
Providing more transparency over the retention practices of main contractors, the draft Regulations also require disclosure in percentage terms of the difference between the value of deductions made by the company/LLP from monies due to its suppliers and the value of retention deductions which it is subject to under its qualifying contracts with clients. The Regulations are intended to apply to companies and LLPs which exceed two or all of the thresholds for qualifying as a medium-sized company under the Companies Act 2006 (as modified for LLPs) on their last two balance sheet dates with financial years beginning on or after 1 April 2025.
Conclusion
Retentions in the construction industry remain a hotly debated issue. While they are intended to ensure quality and completion, the practice can lead to financial and administrative challenges, particularly for SMEs. Clients who can offer a pipeline of future work to contractors, building collaborative ways of working and engendering trust, may be more willing to explore alternatives to the reduction of retention but they are currently in the minority. The arguments in support of the reform of the retention practice do need to be weighed against the increasing number of insolvencies being suffered within the construction industry, and there you have the chicken and egg argument, leaving the industry at an impasse.
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