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Construction (retention deposit schemes): a step in the right direction

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Posted by Michael Hiscock on 23 January 2018

Michael Hiscock Partner - Head of Construction

Whilst the concept of retentions is considered industry standard for the construction sector, they are perceived to have a negative impact on the industry by restricting cash flow for contractors and limiting investment in new projects.

It is therefore encouraging to see that there is a huge drive in the industry to find better ways of dealing with this difficult issue.

What are retentions?

Construction retentions are, in essence, a mechanism under which the client withholds a percentage of payment due for construction work carried out by the contractor for a contractually agreed period. Retentions are intended to provide security and act as leverage for clients as contractors are obliged to rectify defects within an agreed timeframe if they want the retention sum to be released.

Under many standard industry contracts, a percentage of the retention money is returned upon practical completion, with the balance returned within 12 months (or at the end of the defect liability period). So, how have we reached a position where approximately £8 billion of cash retentions accumulated over the last three years is currently held, with contractors losing an average of £79,900 of retention per contract due to the insolvency of those further up the contractual chain?

The problem

The system for the release of retentions can be notoriously problematic for all parties in the supply chain.

While it is logical for employers to try and protect themselves against the risk of defects developing, the sums retained are unlikely to be sufficient to deal with major problems and, furthermore, retentions do not necessarily provide an appropriate (or effective) mechanism for ensuring quality or payment. Indeed, withholding a percentage of the sum due can hinder cash flow and affect a project’s viability. Retentions can also increase the cost of construction with contractors factoring the risk of non-payment into their price.

Retentions are a critical issue affecting the viability and productivity of small and medium-sized enterprises in the construction supply chain. As can be seen from Carillion’s recent collapse, even larger contractors can fail and, in such circumstances, there is no guarantee that sub-contractors  will ever see the return of their retention money. Given that this is money they have “earned”, and are due, this is a huge burden to place on small businesses and it is hard to think of any other industry that works in this way.

The solution?

On 9 January 2018, the Construction (Retention Deposit Schemes) Bill 2017-19 had its first 10 minute reading in the House of Commons.

The proposed solution under the bill introduces a requirement for a deposit scheme, similar to the statutory requirement in section 215 of the Housing Act 2004 under which deposits taken from shorthold tenancies are placed in a Government-approved scheme. A similar system will, in effect, ring-fence retention money in the event of any issues arising.

Ring-fencing the money ;like this would mean that funds remain secure and available to be released once work is complete and free from defects, helping to increase cash flow within the industry. In addition, it is hoped that banks would be more willing and able to lend to firms on the back of such a retention security.

The retention deposit scheme pitched to the House Commons at the first reading last week would be self-funding through the interest earned on the deposits with any profit made from the scheme to be transferred to a charity that provides training in the construction sector. Such a scheme must be a win-win for construction: not only would it secure the supply chain but it would also provide a source of much-needed funds for training. It may also allow for greater investment in jobs, apprenticeships and technical innovation.

There is strong support from the industry for such a deposit scheme, with specialist engineering contractors recommending that a statutory ring fence of retentions is the best option.

It can only be hoped that recent collapse of industry giant, Carillion will provoke serious thought about how the industry needs to change – and this proposed bill (the second reading of which is 27 April 2018) may just be the start of a quiet revolution.

About the author

Michael Hiscock

Partner - Head of Construction

Michael is a specialist in construction and engineering procurement, advising on a wide variety of works contracts.

Michael Hiscock

Michael is a specialist in construction and engineering procurement, advising on a wide variety of works contracts.

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