What could the proposed retention payment reforms mean for construction stakeholders?

Significantly, the Government has proposed two options - either a prohibition on deducting and withholding retention payments under construction contracts or requiring retention sums to be protected. While the proposed reforms could benefit the cash flow for Contractors, the reforms could pose potential problems for Employers wanting to incentivise the completion of construction projects. 

This article explains the current position and the practical implications of potential reforms for Employers, Contractors and the wider construction industry.

What is the issue?

Retention payments are a common feature of construction contracts in England and Wales. In many construction contracts a proportion of the contract price (often 3-5%) is withheld and released in stages, with a final payment made at the end of the defects rectification period.

The Government’s focus on late payments highlights ongoing concerns about cash flow within construction supply chains, particularly for small and medium-sized businesses.  In that context, concerns about retention practices have been identified as contributing to delayed or uncertain payment.

The Government has indicated that it is considering how retention payments operate in the construction industry, by proposing:

• a prohibition on the use of retentions in construction contracts; or
• a requirement to protect retention funds to mitigate insolvency risk and late or non-payment under construction contracts.

At present, however, these remain proposals only, with retentions remaining lawful and widely used in industry standard forms of construction contract.

What does this mean for construction stakeholders?

A deviation from existing practice regarding retentions would significantly affect how construction risk is managed and priced by both Employers and Contractors.

Contractors: Removing or restricting retentions could improve payment practices by allowing businesses to be paid more promptly. In long payment chains, this could significantly reduce the risk of cash flow difficulties and the risk of non-payment due to upstream insolvency.

Employers: Retentions are commonly used as a way to incentivise completion of construction works and the timely rectification of defects. Any restriction on their use would require Employers to consider alternative ways to manage that risk, such as relying on other forms of protection like performance bonds and guarantees. These options can provide Employers comfort, but may involve additional cost, negotiation and administration.

For those involved in the real estate development and investment sectors, the issue goes beyond payment timing. It ultimately affects risk allocation, pricing and bankability. 

To summarise:

• Cash flow and supply chain health
  • The Government’s broader reforms are aimed at improving payment practices and ensuring that smaller businesses are paid more promptly. In the construction industry, where payment chains are often long, this could have a meaningful impact on Contractor stability and project delivery.
• Risk management on projects
  • Retentions are commonly used to incentivise completion of construction works and the rectification of defects and restriction on their use may encourage Employers to consider alternative ways to manage that risk. 
• Contract and procurement strategy
  • Retention provisions are included in most industry standard forms of construction contract If reform is introduced, this may affect how contracts are negotiated, how risk is allocated and how projects are structured from the outset.

Key takeaways

• Retentions remain a standard and lawful feature of construction contracts in England and Wales, but there is a clear indication from the Government that reform is being considered.
• The Government’s late payment consultation has brought renewed focus to retention payment practices.
• Reform could affect risk allocation, bankability and development costs. 
• Construction professionals and Employers should monitor developments and consider how their projects may be affected.

What should you do next?

If you are involved in construction projects, review how retention provisions are used in your construction contracts and consider whether alternative protections may be appropriate in the future.

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For more information or advice, please contact Francesca Morrison in our Commercial Property team.