Retentions have long been a staple of construction contracts, providing employers with security to ensure performance compliance and defect rectification. Typically, a percentage (often 5%) of interim payments is deducted and retained by the employer until completion and then a further amount is retained through the defect liability period.
The ongoing debate: Are retentions still fit for purpose?
In recent years, concerns have grown over the fairness and transparency of retention practices. Contractors frequently report delays or outright non-payment of retentions and smaller contractors in particular, may struggle to recover retentions, especially when employers become unresponsive post-project completion.
Another key issue here is the risk of insolvency. If an employer becomes insolvent before releasing retentions, contractors often find themselves as unsecured creditors with little to no chance of recovering their money. Given the tight margins in construction, the loss of retention funds can be financially crippling.
Legislative reform updates
The collapse of Carillion in 2018 amplified calls for reform, with industry bodies pushing for change and attempts to introduce legislation in this respect. The proposed Construction (Retention Deposit Schemes) Bill 2017-2019 and the Construction (Retentions Abolition) Bill 2021 sought to introduce a mandatory deposit scheme for retention monies, similar to tenancy deposit protections in the rental sector.
However, these failed to gain enough momentum. More recently, the collapse of ISG has once again highlighted the continuing problem of retentions, with bodies including Build UK pushing for measures to remove retentions from the supply chain by the end of 2025.
The UK government are amending the existing payment legislation (The Reporting on Payment Practices and Performance Regulations 2017) to require certain companies to report on retentions. The Reporting on Payment Practices and Performance (Amendment) (No. 2) Regulations 2024 (“the Regulations”) will, when in force, apply to companies that meet the criteria for a ‘qualifying company’ under the 2017 Regulations – this criterion includes but is not limited to a turnover in excess of £36 million, more than 250 employees etc. The Regulations, currently in their draft version, create the concept of a ‘construction contract’ and a ‘qualifying construction contract’, with the definition of a ‘construction contract’ largely reflecting that in the Construction Act. The intention is that these Regulations will come into force on 1 March 2025 (but this may change) and therefore it will be vital for you to understand your obligations under the Regulations.
In relation to retention clauses in any qualifying construction contracts, these draft Regulations require qualifying companies and LLPs to publish certain information on their practices, policies and performance with suppliers.
This includes a statement indicating whether the company’s payment practices and policies involve retention clauses. If retention clauses are used, the company must provide additional details on those clauses, its approach to retention, and relevant retention payment performance data for qualifying construction contracts within the reporting period.
Alternatives to retention
Despite the above commentary, many have already voluntarily phased out retentions in favour of alternative security mechanisms. These alternatives provide financial protection while mitigating some of the risks associated with traditional retentions. Examples include:
Escrow accounts
Holding the retention monies in an escrow account or other third-party account ensures that funds remain safeguarded in the event of an employer’s insolvency or failure to release payments. This approach enhances security for contractors while maintaining the employer’s ability to withhold sums until completion or defect rectification.
Performance bond
Another option is to purchase a performance bond, which is a type of financial product. A performance bond contains a written promise from the bond provider to pay the contractor in the event of a breach of the building contract by employer and therefore provides greater certainty of payment.
Retention bond
Similar to a performance bond, a retention bond covers the retention that would otherwise be deducted and these are typically the in the amounts which would otherwise be deducted under a contract. However, there are typically additional costs involved in putting performance and retention bonds in place and therefore their use may be dependent on the financial position and risk appetite of the parties involved.
Need advice on retentions or alternatives?
At Herrington Carmichael LLP, our construction team advises project clients, main and sub-contractors, on draft contracts and claims concerning defects and the release of monies due under a contract. Please contact us to speak to a member of our Construction Team.