Cash retention in the construction industry16/07/2018
In January this year there was the first reading of a private members bill which was closely followed by the collapse of Carillion. Both events put cash retention in the construction industry in the spotlight. The Aldous Bill, now known as Construction (Retention Deposit Schemes) Bill 2017-19, was due to have its second reading in June, this has now been delayed until October, but will it go far enough?
Cash retention impacts on cash flow and working capital throughout the entire supply chain. When Carillion went into liquidation it had an estimated 30,000 creditors and £800m of retention payments held on the date of liquidation. The majority of the creditors were subcontractors or other companies in the supply chain and they may lose the money owed to them that is held in retention. The new Bill is addressing how to ensure retentions are released appropriately.
The Bill, which is due for second reading debate on 26 October 2018, is to amend the Construction Act and allow for the creation of a retention deposit scheme. The retention would be held in an independent scheme until it contractually falls due for payment. If a company goes bust, other companies in its supply chain should be able to recover the money owed to them that is held in retention. Such a scheme has support in the construction sector. Although others have stated that further changes are required and that the Government should abolish retention.
Most building contracts and sub-contracts entitle the employer to keep a percentage of the value of the work carried out until completion or making good of defects. This is generally referred to as the “retention”. The purpose of the retention is to provide security to the employer in the event that the contractor becomes insolvent during the construction phase of a project, does not complete the works or fails to remedy defects. In the standard industrial contracts, for example JCT, retention provisions provide that the contractor can request that the funds are protected in a separate bank account and thereby ensuring contractors have recourse to their retentions in the event of the employer’s insolvency. However, it is a standard industry practice that these provisions are always deleted. This means that the employer can use the retention money to help its own cash flow.
From the contractor’s perspective it can cause cash flow issues. It will usually have to wait to realise its profit on a scheme, the contractor is exposed to the employer’s insolvency and may only be able to claim to be an unsecured creditor, and its liability for defects to any interested party who had received a collateral warranty continues. The contractor will usually pass on a retention requirement to its subcontractors and suppliers who are then in the same situation.
Retention is not ideal for the employer either. From an employer’s perspective, on a large build it could be holding a significant amount just before practical completion and at practical completion, however, in the early stages of development an employer may not be sufficiently covered as the retention is taken as a percentage of interim payments. There are potential extra costs, for example, paying another contractor a premium to take on the works, paying subcontractors a ransom to stay on site, and the prospect of the employer having to pay delay damages to third parties. The retention is less likely to cover these costs.
These deficiencies are well known and it is why there is a market for retention bonds and performance bonds which are sometime used in combination with parent company guarantees. Cash retentions may be disproportionate, causing significant harm to the contractor and the liquidity of the construction industry whilst providing insufficient benefit to the employer. Perhaps, a full review should be undertaken of all the options that are open to the employer.