This briefing Q&A aims to inform you on the issue and the possible solution. [Last updated November 2017]
What are cash retentions?
Cash retentions are monies (usually 5% but sometimes 10%) which are deducted from monies due to a construction business. Ostensibly they are deducted to provide security in the event that a firm fails to return to rectify defects. In practice they are withheld to bolster the working capital of the party withholding them. Under standard contracts in the industry they should be returned within 12 months of handover of the works in question.
So, what’s the problem?
According to government figures almost £8bn of cash retentions has remained unpaid over the last 3 years. Most of this cash has been provided by SMEs in construction supply chains. There is no other industry sector in the UK that puts so much cash at risk. In 2015 approximately £45m worth of cash retentions was lost because of upstream insolvencies. There’s no protection for the monies even though they still belong to the party that has consented to their withholding.
“There is……..far too much abuse of the system of cash retention, and it has been going on for too long. The burden of administrative time spent securing payments and drain on working capital weigh far too heavily on smaller firms in the supply chain…….” Margot James, Small Business Minister, House of Commons 27 June 2017.
But, don’t firms in the industry reflect the cost of retentions in their pricing?
It would be about pricing the unknowables. How long will the other party take to release the monies? One year? Two years? Maybe longer? Will the other party go bust in the meantime? What excuses will be thought up to delay release of the monies? What will be the cost of repeatedly chasing the monies or, eventually, giving up recovering them (as often happens)?
What’s the solution then?
Many past failed attempts to resolve the issue have confirmed that the only solution is legislation that secures the monies so that they will be available to be returned (subject to the other party having any rights of recourse to the monies). A possible solution is the statutory requirement in section 215, Housing Act 2004 (for Scotland and Northern Ireland there is similar legislation) that deposits taken from shorthold tenants must be placed in a government-approved scheme. A similar system would work for retentions or, indeed, any other scheme that offers a similar service.
Generally speaking Parliament would be reluctant to legislate on business to business contracts.
There are plenty of examples where this has been done. In construction there is Part 2 of the Housing Grants, Construction and Regeneration Act 1996 (popularly known as the “Construction Act”) which provides for a stop-gap dispute resolution process known as adjudication and offers a measure of payment protection. Unfortunately it doesn’t, as yet, provide protection for retention monies.
Isn’t it the case that your proposal for putting the monies in a protected account will simply mean that the monies are taken out of circulation and nobody will be able to use them?
Ring-fencing the monies will mean they will be secure and available to be released on time (rather than the current wait of two and more years). This will help increase the velocity of cash in the system. Furthermore the retention monies lost through insolvencies (upstream of the supply chain) deprive SMEs of much needed cash to invest in skills and cutting-edge technologies that contribute to their growth and overall productivity. If the monies are secured banks will be able to lend to firms on the back of such security.
As far as protection from insolvency risk is concerned, why should retention monies be treated any differently from other payments?
Cash retentions are deducted from payments that are due. The withheld monies relate to work, materials and services already provided meaning the supplier must bear a cost burden for what’s often an indeterminate period. The paying party only has temporary custody over the funds; there’s no intention to give him beneficial rights over the money so that he can use it as he pleases. Construction industry standard contracts have in the past acknowledged this by requiring that the monies are placed in trust (although these clauses were usually deleted by those at the top of the supply chain).
How do other countries deal with the problem?
Numerous other countries have legislation that ring-fence cash retentions and/or provide security for construction payments in general. Some jurisdictions have even banned the practice. In Canada and the United States there exists a system of liens or charges which can be placed on the building or structure by a firm which hasn’t received its due payments. Australia and New Zealand have legislated to ring-fence the monies. France has a statutory framework that requires bank guarantees to be issued as security for payment in the construction industry.
Since you are proposing to ring-fence the monies in some sort of scheme there is likely to be a cost to this?
There is a model that can be considered. The Tenancy Deposit Scheme – one of the government-approved schemes referred to earlier – funds the scheme through the interest earned on the deposits. Any profit made is transferred to a charity that provides training in the sector. Such scheme would be a win win for construction if it was to be a source of much needed funds for training.
What support exists within the industry for legislation?
99% of firms in the construction industry are SMEs. They all would support statutory protection. Over the years their hopes have been raised by numerous reports. The Banwell Report (a government report, 1963) recommended the abolition of cash retentions. The Latham Report (1994) recommended that, where cash retentions are deducted, they must be placed in a trust account. On two occasions – in 2002 & 2008 – the House of Commons Business Select Committee considered cash retentions as an outdated and unfair practice that should be phased out in the public sector.
It is understood that the Government is reviewing the retentions scheme?
This is correct. We welcomed the consultation as it shows that Government is seriously thinking of taking measures towards this problem; legislation to protect the cash does not prejudice the outcome of the consultation but it reinforces a viable solution. It would not ban retentions; cash retentions can continue to be deducted. The only difference is that where cash retentions are deducted as security for contractual performance there has to be mutuality of security; the cash must be ring-fenced in the meantime. In fact, one of the options under consideration in the consultation is a statutory retention deposit scheme.
What form could any legislation take?
It is envisaged that there could be a short Bill that would amend the Construction Act and require the Secretary of State to introduce regulations for suitable arrangements to protect the monies. On 26 April 2017 Alan Brown MP introduced a Private Member’s Bill to achieve this but it was lost as a result of the General Election.
If you would like to discuss the issues raised in this briefing and how you can help please contact Maria Balermpa, Operations and Public Affairs Manager, SEC Group. Email: firstname.lastname@example.org