Review of Retentions
Proposal For A Statutory Requirement To Put Cash Retentions In A Ring-Fenced Account
|LIKELY ARGUMENTS AGAINST
|The retention issue is a business to business issue; not a business to consumer issue (where legislation protects the consumer as the weaker party). The statutory requirement for placing shorthold tenancy deposits in a deposit scheme is a consumer protection measure.
||There are many examples of legislation that seek to protect the interests of weaker parties in a business to business relationship – Unfair Contract Terms Act 1977 (provisions protect consumers as well as businesses); Housing Grants, Construction and Regeneration Act 1996 as amended (“the Construction Act”) which offers payment protection to construction firms;
Groceries Code Adjudicator Act 2013 (protects suppliers to the large supermarkets and retail outlets the Adjudicator can fine supermarkets for actions constituting bad practice); Small Business Act 2015 etc (various measures to support small firms such as publication by large companies of their payment performance); Enterprise Bill (introduces the Small Business Commissioner).
|Putting retentions into a protected account will mean that the monies will be taken out of circulation so that no-one will be able to use them.
||The answer to this is two-fold:
- a requirement to protect the monies is likely to mean that either retention monies will not be withheld (leading to other options) or, if withheld, will be released over a shorter period of time (rather than the 2 plus years it takes at present);
- irrespective of the above firms will be able to use cash retentions that are protected as security for bank lending; currently this is not possible.
|As far as protection from insolvency risk is concerned, retention monies should not be treated any differently from other payments.
||There is a difference between retentions and other payments.
Retention monies are withheld from payments that have been made and are for the particular and limited purpose of providing security for performance; not for the purpose of boosting the assets of the paying party in order to enhance the pay-out to prospective creditors.
In English law this situation generally gives rise to an implied trust, i.e. the party holding the monies is a trustee of the monies (with recourse to them to use for their specified purpose) and, as such, must protect them by depositing them in a separate trust account. There hasn’t been litigation in the UK on this in relation to retentions but recently (in 2012), the Malaysian Court of Appeal has considered the matter. The Court confirmed that these circumstances gave rise to a trust (Qimonda Malaysia SDN BHD (in Liquidation) v Sediabena SDN BHD). The Malaysian legal system reflects the English common law system.
This issue of trust has been acknowledged in the JCT standard forms (which have express trust provisions) and in legislation in other common law jurisdictions (e.g. the US, Australia).
In this context there is a related issue. On public sector works the tier 1 supplier does not have the risk of public sector client insolvency; its retentions are safe. But this risk is incurred by firms in the supply chain on public sector works. Even where the client is a private sector client, a tier 1 supplier is able to pass on the risk of client insolvency by relying on a pay when paid clause (legitimised by section 113 of the Housing Grants, Construction and Regeneration Act 1996). Since the bulk of a tier 1 supplier’s retentions are provided by supply chain firms, the tier 1 supplier’s residuary loss (in respect of losing its retentions by virtue of an upstream insolvency) is minimal.
|The economic case for protecting retention monies has never been developed either in the UK or in other jurisdictions.
||The relevancy of this argument is questionable. The key issue is the status of the monies and how they should be treated – as explained in the response above the insolvency argument. Furthermore it is untrue that an economic analysis has not been done in other jurisdictions. In 2014 the New Zealand Ministry of Business, Innovation and Employment attempted such analysis in its Regulatory Impact Statement when considering statutory options for protecting retentions. Furthermore an economic analysis carried out in 2015 by a construction economist concluded:
“It is clear from this analysis that firms, even relatively small firms, need to build in a substantial working capital reserve in their financial strategy in order to safeguard themselves from late payments during a project and especially delayed retention payments at the end. It is also clear that although the problem of the additional cost of delayed retention payments is relatively small compared to the cost of late payments in general, it is often the straw that breaks the camel’s’ back.”
(The Economic and Financial Implications of Retention Payments, Stephen Gruneberg, Reader in Economics at the University of Westminster).
There may not be any cost attached to depositing retention monies in a scheme similar to a tenancy deposit scheme (the latter is funded by the interested gained on the deposits). The cost to public bodies and private sector organisations of not having beneficial access to retention monies is difficult to estimate – because of the different uses made of the monies. For example, some organisations (including some public bodies) use the monies for investment purposes whilst others use the monies to aid the cashflow of the different parts of their organisations that are more in need of it. For the most part the monies are used to booster working capital and finance on-going business activity. These purposes are not, of course, those for which retentions were deducted in the first place.
A crude assessment of the cost of not having access to the monies would be to assess the loss of interest on the £3billion worth of retention that is outstanding at any one time. At the current rate of interest this would amount to £15million.
If the monies were protected the benefit is likely to exceed this £15million by a large margin:
- Since there won’t be access to the retention monies (other than recourse to them for failure by a firm to remedy defects – for whatever reason) this would result in a substantial reduction in requests for cash retentions (a point that has already been made). This will put more funds into those businesses that actually carry out the work; with such funds being devoted to training, upskilling, employment and capital investment – the elements that help to drive growth and productivity.
- Businesses are likely to save millions of pounds a year as a result of not having to continually chase outstanding retentions or having to abandon the chase. Furthermore the wait for the release of the funds is likely to be considerably shorter, thus, improving cash flow – a point that has already been made. (See also the response to the argument regarding the tying up of the funds.)
- Some costs arising from the lack of protection for retention monies are difficult to ascertain, such as the costs connected with the insolvency of supply chain firms consequent upon the loss of their retentions.
- There is also a negative macro-economic impact associated with the misuse of retentions as working capital.
“The use of retentions as working capital is the key concern for the Government; funding working capital from retentions can mask and reward poor performance and poor financial management practices. For example, undercapitalisation and low-price tendering are long standing features of the construction market that contribute to its low productivity and innovation. The use of retentions as working capital enables those features to remain with no incentive to change and no incentive for clients or lead contractors to properly manage project risks.”
Statement by the New Zealand Ministry of Business, Innovation and Employment (legislation requiring that cash retentions are put in trust has been passed by the New Zealand Parliament).