Following a consultation process last year, the UK Government has proposed to bring into effect legislation tackling late payment in the UK, which the Department for Business & Trade (DBT) estimates costs the UK economy £11bn each year and leads to closures of thousands of businesses. Part of that legislation would make it illegal to withhold construction retentions.
The options on which it consulted were “softer” alternatives such as the use of project bank accounts (a note on the working of these can be found here) or, more radically, total abolition, which is what is now proposed. The DBT’s reasoning as set out in their paper “Time to Pay Up” was as follows:
“Written responses were split between the two options, with agreement with the effectiveness of the measures at 62% for a ban, or 65% for a protection measure… There was often the view, however, from a combination of written responses and stakeholder engagement, that a ban would be simpler for industry to understand, to legislate for, and to enforce.”
Department for Business & Trade
Such a ban would clearly bring about a big cultural shift in UK construction contracts and security practices, and one wonders whether all of the implications have been thought through.
Background
In fact, a Bill to ban retentions was first introduced in the House of Lords in April 2021 and can be found here.
It sought to introduce a new Section 113 to the Housing Grants, Construction and Regeneration Act 1996 (Construction Act). In that draft bill, retention was defined as “monies which are withheld from monies which would otherwise be due under a construction contract, the effect of which is to provide the payer with security for the current and future performance by the payee of any or all of the latter’s obligations under the contract.”
Proposed Changes
The DBT paper cited above describes Labour’s plans as “the most ambitious legislation to tackle late payments in over 25 years”, and it is not clear what form the legislation will take, but it is intended that, as well as the ban on retention, it will introduce the following changes:
- Payment periods will be capped at 60 days, with very limited exemptions (in excess of e.g. JCT interim norms but less than average final account periods);
- A maximum invoice challenge period will be introduced – this will be a statutory time limit for raising a dispute relating to an invoice, and if not raised within that time period, compensation will be payable to the supplier. It is not clear at present how this would work with existing limitation periods, etc., and the DBT paper acknowledges that work needs to be done in order to link this measure with the existing payment process requirements under the Construction Act;
- Boards/audit committees of persistently late-paying large companies will be required to publish commentary on reasons for late payment and mitigating actions being taken;
- There will be a mandatory interest rate for late payment for all commercial contracts of 8% over the base rate; and
- The Small Business Commissioner will have powers to investigate businesses, adjudicate payment disputes and impose fines for persistent late payers.
Practical Drivers and Concerns
On retention, as they say, other forms of performance security are available. These include performance bonds, parent company guarantees and bonds in lieu of retention. If the legislation proceeds, there may now be far greater emphasis on these other forms of security. This in turn may put greater pressure on the surety market and bring renewed attention to the commonly used ABI standard “ascertainment” wording (versus on-demand bonds), which reflects the fact that bonds are mainly there for insolvency protection, not other defaults. It may also significantly disadvantage any contractor or subcontractor doing substantial work who is unable to produce the required bond in what currently remains a challenging bond market in the UK.
There is rational concern behind the proposed legislation in that retentions leave contractors and subcontractors exposed to the risks of both unjustified late or partial payment and also client and contractor insolvency (the examples of Carillion and ISG being frequently cited). JCT fiduciary retention provisions e.g. JCT DB 2024 clause 4.16, are meant to guard against this, but it is true to say that these provisions are more honoured in the breach, and they are habitually deleted, not necessarily for any particularly sinister reason, but simply because most clients invariably forget to keep retentions in a separate account and most contractors do not remember to ask, or because they are not appropriate for the funding position. Retentions are, of course, also open to abuse and may not be repayable for long periods well in excess of, for example, the completion of a subcontractor’s own works package.
There is, though, a practical driver for retentions, which is that the incidence of defects in the industry is still high and clients and contractors need some means of incentivising contractors and subcontractors to return post practical completion and rectify defects other than the mere threat of dispute avenues if they do not.
Timing, Impact and Conclusions
The timing is unclear, but the DBT paper acknowledges that further consultation is needed on the retention ban element of the proposals before a final decision is taken on implementation. The DBT paper states that “the responses to the consultation confirmed the urgent need to tackle late payments. We will introduce new legislation as soon as parliamentary time allows.” Whilst the Construction Leadership Council (CLC) welcomed the proposed ban, the CLC Co-Chair, Mark Reynolds of MACE, stated, “we recognise that both clients and the supply chain will need time to adapt and establish alternatives that effectively incentivise high-quality work and limit defects in construction.” The previous Bill involved a cliff edge and baldly stated that after the Act came into force any retention withheld must be repaid in full no later than seven working days after the date on which they were due but withheld, which for contracts already under way would mean an immediate cessation of withholding and complete repayment on day one. This would be a large sum of money which developers and other construction clients would be required to find (unless it is sitting there in a separate account), potentially on multiple contracts and within a very short period of time. Hopefully that is not what will happen, but whatever transitional provisions there may be are not currently known. The DBT commits to working with the CLC, construction clients and the financial services sector to develop practical approaches to minimise defects and to develop the surety market for construction.
Above all, this will entail a huge cultural shift by clients. JCT DB 2024, the most widely used JCT contract for substantial projects, currently provides for 3% retention, but clients and their cost advisors almost as a reflex seek to raise this to 5%. Doing this may, of course, lead to evasive action by the contractor, who will simply add the cost of financing delayed payment into the contract sum.
It will be interesting to see what anti-avoidance provisions may be included in the legislation. If construction clients/contractors are prevented from withholding retention, they may seek to restructure payment instalments under the contract so that there is a bigger “balloon payment” at completion, which is not withholding as such since the money is not “due.” It is also hard to see what security will be applied to the period between completion and making good of defects, so more emphasis again on bonds, ones which extend beyond completion. There is also an argument that as work is required during and after the defects period, it is only right that an element of the contract sum should only be paid once that work is confirmed to be satisfactorily completed, meaning we could see retentions outlawed and replaced with staged payments that still include a payment for making good.
As mentioned, the Government also proposes to legislate to take away the option under the Late Payment of Commercial Debts Act 1998 for parties to agree that the rate of interest payable on late payments is less than the statutory 8% above the base rate, provided that it is still a “substantial remedy” for late payment. JCT specifies 5%, whereas NEC provides for a mere 2% above base. Once again, this may have unintended consequences and lead to pressure to increase payment intervals.
This will be a welcome change for subcontractors and some contractors but undoubtedly increases risk for clients and contractors in terms of security with respect to insolvency and defects, and more work will be needed within the construction industry if this ban is implemented in order to help establish alternatives to retention that mitigate those risks.
