Retentions in the British construction industry

In the British construction industry, a retention is money withheld by one party in a contract to act as security against incomplete or defective works.

They have their origins in the Railway Mania of the 1840s but are now common across the industry, featuring in the majority of construction contracts. A typical retention rate is 5% of which half is released at completion and half at the end of the defects liability period (often 12 months later). There has been criticism of the practice for leading to uncertainty on payment dates, increasing tensions between parties and putting monies at risk in cases of insolvency. There have been several proposals to replace the practice with alternative systems.

DescriptionEdit

Retentions are widely used in the British construction industry; featuring in the majority of all contracts awarded.[1]:27 It is a sum of money that is withheld as a security against poor quality products (defects) or works left incomplete. Clients withhold retention against main contractors and main contractors withhold payment against sub-contractors.[1]:16 Retentions typically take the form of a percentage on the contract value.[1]:18 The rate can vary wildly but is typically around 5%. The general state of the economy can affect the rates set: in a buoyant economy with plentiful work sub-contractors are able to pick which work they accept and therefore have potential to negotiate more favourable rates.[1]:19

The chain of retention starts with the client who withholds money on the main contractor. The main contractor withholds money on sub-contractors who may also then withhold on sub-sub contractors.[1]:18 The retention money is typically released in two portions (known as moieties); the first being payable at completion of a project and the second at the end of the defects liability period. This period is the time during which the client is able to identify works that are defective to the contractor who must then remedy them; it is often twelve months.[1]:18 The use of retentions is not common to all sectors of the industry; for example lift installers have developed their own guarantee system instead.[1]:18

ImpactEdit

The use of retentions is intended to encourage efficiency and productivity. The contractor has a financial incentive to achieve completion as early as possible (to release the first moiety payment) and to minimise defects in the works (to achieve the second payment).[1]:27 Retentions held against sub-contractors are also a key source of cash for main contractors, who may use them to finance new projects.[1]:27[2]

However sub-contractors often complain about the system.[3] They sometimes lack a firm date on which retention monies will be paid and a 2017 British government report noted that more than half of contractors had experienced late or non-payment of retention monies.[3][1]:20 Delays are reportedly longer for sub-contractors and sub-sub contractors than for the main contractor.[1]:20 This restricts cash flow available for the company as a going concern and for capital investment.[3] The chasing up of payments is also resource intensive, as such smaller businesses are hit more severely than larger ones.[3] Some smaller companies simply write off the retention money, increasing their prices to compensate.[1]:20[1]:23 The practice has also been described as increasing tensions between the parties in contract.[1]:22

There is no current requirement for retention monies to be ring-fenced (kept separately to general company funds and preserved from spending) and they are usually held in a client's or contractor's main bank account.[3] This can cause problems in cases of insolvency, where the money can be lost and payments owed to the supply chain put at risk.[1]:22 The use of retentions (which are considered a form of stage payments) can also render construction companies unsuitable for factoring (the sale of accounts receivable).[4][5]

HistoryEdit

The practice of retentions has its origins in the British Railway Mania of the 1840s.[1]:32 This period saw a rapid increase in the number of contractors, often with little experience of the industry. There was a rise in the number of insolvencies and a drop in workmanship standards. Railway companies therefore began withholding a minimum of 20% of payments to contractors as a security against incomplete and defective works. This practice had spread across the industry by the mid-19th century.[1]:33

The 1994 Latham Report recommended that legislation be introduced to protect retention monies held by a party, which would prevent it being lost during a liquidation. Despite all of Latham's other payment recommendations being incorporated into the Construction Act 1998 this one was omitted.[3] The practice was reformed somewhat by the Construction Act 2011. This made it illegal for the release of retention under one contract to be linked to that of a second. This ended the practice whereby contractors would refuse to release retention to sub-contractors until they had been paid it themselves by the client, over which the sub-contractor had no influence.[1]:18

The 2018 collapse of contractor Carillion had a dramatic effect on the industry.[3] Many of its sub-contractors lost large sums of money as £250 million in unpaid retention was lost when the business went into liquidation.[6]

Proposed replacementEdit

There is limited use of alternatives to retention in the British construction industry.[1]:24 However, there have been recent movements to try to effect change. The Department for Business, Energy and Industrial Strategy (DBEIS) commissioned research into the matter to determine the extent of the use of the practice and its effects on the industry and economy. This was published in 2017 and also identified a number of alternatives to the practice.[1]:16–17 A DBEIS public consultation was subsequently launched; this closed on 19 January 2018 but no recommendations were subsequently made for government action.[3] A private members bill was introduced to the House of Commons by Peter Aldous on 9 January 2018 seeking to introduce protection to retention money but did not proceed through parliament.[7]

The Build UK industry group wants to secure abolition of retentions by 2025, following an ambition outlined by the Construction Leadership Council in 2014. Build UK put forward proposals that retentions by the main contractor on sub-contractors should be no more onerous than those imposed by the client on the main contractor. They also proposed that retentions should only apply to permanent works, as temporary works are unlikely to lead to defects. The organisation also wants small value contracts (less than £100,000) to become retention-free by 2021, as the risk to the main works is lower for these contracts.[2]

Following the 2018 collapse of Carillion there have been increased calls for retention reform. Some propose retention deposit schemes, whereby money is deposited with a third party, though these lead to increased fees and bureaucracy and do not solve disputes between parties over when retention should be released.[8] The Scottish Government began a consultation on retentions in 2019. Its stated that the UK was behind other countries by continuing the practice, despite the matter having been looked into several times by the UK Government.[3] Alternatives include project bank accounts (which are used for all payments from the client and contractor), retention bonds (a form of insurance against defects taken out by the contractor), performance bonds, escrow stakeholder accounts (monies held by a third party), parent company guarantees (guarantee of completion by the main contractor's parent organisation) or trust funds to hold retention monies.[1]:24

Contractual basisEdit

The Joint Contracts Tribunal contracts system allowed for a reform of retentions by permitting the employer (client) to hold retention monies in trust. The 1998 revision of the contract allowed the contractor to request that the client hold the money in a separate bank account; it also permitted the use of retention bonds. The 2016 JCT contract allows for retention-free projects.[8]

The NEC Engineering and Construction Contract, introduced in 1993, has now allowance for retentions in its core clauses. Retentions can be, and often are, introduced by the client through variant clauses (so-called "x clauses"). The basic contract relies on the spirit of collaboration between parties to minimise defects. Under the 4th edition of the contract (introduced in 2017) there is an allowance for retention bonds. The contract also allows for retention to be withheld only on the labour-element of any price or only to be applied on the final few payments made. The NEC system also has an option to allow the use of project bank accounts in lieu of retention.[6]

Use in other countriesEdit

Retentions are used in several other countries. They are common in China, though in some cases the moiety payments are guaranteed by the Agricultural Bank of China.[1]:165 They are also used in the United States where the percentage retained is typically higher at around 10%. However the release of retention is different with 50% of the withheld money often released once the works are considered to be 50% complete. Some states have taken measures to abolish or limit the use of retentions in public contracts.[1]:163 In the United States the use of retention bonds is more common than in the UK.[1]:164 Retentions are common in Qatar where the proportion retained may be up to 30% of contract value due to the large number of foreign companies that operate under limited liability law in the state.[1]:165 In Canada retentions are known as "holdback" payments; since 1997 all retention monies in Canada must be held in ring-fenced accounts.[1]:164[1]:24

Retentions are used in Australia; in New South Wales all retention monies for projects in excess of $20 million must be held in ring-fenced accounts with an authorised bank.[1]:23[1]:164 In New Zealand all retention monies are required to be held in trust and must be in cash or other liquid assets; this requirement was introduced following the 2013 collapse of main contractor Mainzeal.[1]:24[1]:164 However, after the 2019 collapse of Stanley Group it was discovered that retention money was not properly administered, residing in the company's main account, despite the group claiming to sub-contractors that it had been held in separate accounts, and was therefore liable to loss during the liquidation process.[9] The retention system is not used in Germany where the works remain the property of the contractor until completion and are, therefore, liable to be withheld from the client in cases of dispute.[1]:165

See alsoEdit

  • Cost contingency
  • Mobilization payment, an advance payment to a contractor at the start of a project to assist in the beginning of operations.[10][11]

ReferencesEdit

  1. ^ a b c d e f g h i j k l m n o p q r s t u v w x y z aa ab ac ad ae af Pye Tait Consulting (October 2017). "Retentions in the Construction Industry" (PDF). British Government. Department for Business, Energy and Industrial Strategy. Archived (PDF) from the original on 2019-07-25. Retrieved 2019-10-15.
  2. ^ a b "Build UK agrees next steps on retentions reform". Construction Index. 10 July 2019. Archived from the original on 15 October 2019. Retrieved 26 October 2019.
  3. ^ a b c d e f g h i Olson, Kirsti (15 May 2019). "Could Scotland lead the way in improving the UK construction industry payment process?". Scottish Construction Now. Archived from the original on 17 May 2019. Retrieved 26 October 2019.
  4. ^ Accountancy. Society of Incorporated Accountants and Auditors. 1989. p. 137.
  5. ^ Milne, Robert W.; Macintosh, Ann (1999). Applications and Innovations in Expert Systems VI: Proceedings of ES98, the Eighteenth Annual International Conference of the British Computer Society Specialist Group on Expert Systems, Cambridge, December 1998. Springer Science & Business Media. p. 203. ISBN 9781852330873.
  6. ^ a b NEC (8 May 2019). "Retentions and their use with NEC contracts". Archived from the original on 2 November 2019. Retrieved 27 October 2019.
  7. ^ "Construction (Retention Deposit Schemes) Bill 2017-19 — UK Parliament". Parliament Website. Archived from the original on 21 October 2019. Retrieved 21 October 2019.
  8. ^ a b Blundell, Steph (19 February 2019). "What's wrong with retention?". Planning, BIM & Construction Today. Archived from the original on 15 October 2019. Retrieved 21 October 2019.
  9. ^ Hope, Sharnae (25 September 2019). "Stanley Group directors apologise to angry crowd of creditors". Stuff. Archived from the original on 15 October 2019. Retrieved 21 October 2019.
  10. ^ Rameezdeen, R.; Palliyaguru, R.S; Amaratunga, D. "Financing Contractors in Developing Countries: Impact of Mobilization Advance Payment" (PDF). www.irbnet.de. Retrieved December 5, 2019.
  11. ^ "Item 01699.1010 M – Site Mobilization" (PDF). www.dot.ny.gov. Retrieved December 5, 2019.