Ban On Retention In Construction Contracts

In our previous blog, we covered the measures under consultation by the government to address retentions in construction contracts and to tackle late payments across all sectors. The government has now published its response: Late payments: tackling poor payment practices. Amongst other measures, the response includes:

• a proposed ban on retention payments in construction contracts;
• a 60‑day cap on payment terms for large firms paying smaller suppliers; and
• a statutory minimum interest rate on late payments at 8% above the Bank of England base rate.

The reforms aim to reduce the risk of insolvency for small businesses as a result of delayed or withheld payments and to improve cash flow across supply chains.

Ban on retention payments in construction contracts.

The government consulted on measures to amend Part 2 of the Housing Grants, Construction and Regeneration Act 1996 by either:

• banning the use of retentions in construction contracts completely; or
• requiring retention monies to be held in segregated accounts or protected with insurance‑backed instruments of guarantee.

The government has confirmed it intends to opt for the full ban on the deducting and withholding of retention payments under construction contracts – stating that the responses to the consultation demonstrated broad agreement with the problems caused by retentions.

Not everyone in the industry has welcomed the proposal. Some industry bodies have raised concerns that banning retentions could deter investor appetite by increasing perceived investment risk. There are also concerns that smaller developers will be disadvantaged as they rely on retentions to incentivise the timely rectification of defects.

Further consultation will follow on how best to implement the ban, with the government indicating a 12 to 24-month transitional period for contractual adjustments, financial planning, stakeholder engagement and the development of alternative assurance mechanisms.

New payment terms and statutory interest rate for non-payment

The government also plans to introduce a 60‑day maximum payment term for large businesses paying smaller suppliers. The government proposes to implement this with an appropriate transition period no earlier than 2027.

The reforms would also introduce a statutory interest rate for late payments in all commercial contracts, set at a minimum of 8% above the Bank of England base rate. Businesses will no longer be able to negotiate alternative remedies or lower interest rates for late payments.

For many commercial construction contracts, 60‑day payment terms may not represent a dramatic shift. However, the introduction of a minimum interest rate of 8% above the Bank of England base rate is likely to have a more significant impact. For example, the standard form JCT contracts specify that the interest rate for late payment will be 5% above the base rate.

Alternatives to retention payments?

The absence of retention payments means that clients will no longer have access to a dedicated cash reserve to fund the rectification of defective work. Consequently, developers will be concerned that the supply chain will lack the incentive to return and correct defects. This may result in a greater focus on quality assurance, including compliance monitoring from the client's professional team or a clerk of works to check that work is compliant.

We also expect more attention being placed on contract administration to ensure that defective work is not included in interim payments, or payments corrected if defects are discovered later.

It is likely that the legislation will contain anti-avoidance mechanisms to preclude alternative structures that have the net effect of clients and contractors withholding cash until the end of the defects correction period. We will need to wait until the legislation is published to determine what may or may not be permitted. The impact of the new rules on contracts that operate staged payment mechanisms will need to be carefully checked when the legislation is published.

Currently, clients often avoid performance bonds due to the cost involved, and many contractors will have limited bonding capacity. However, in the absence of retention, clients might start to look to strengthen the performance security package. Performance bonds typically expire at practical completion and therefore will not cover the defects correct period. Retention bonds may be an alternative, but they will carry a cost which clients will need to fund and may not be readily available (particularly an on-demand basis).

The response to the consultation acknowledges that a larger and more sophisticated surety market will be required to support the construction sector if retentions are no longer a means of mitigating risk of defective works.

Wider legislative context

The government's reforms sit alongside a wider set of reforms which aim to improve payment culture and enhance accountability within large organisations, which include new enforcement powers for the Small Business Commissioner, who will be able to investigate poor payment practices, adjudicate disputes and impose significant financial penalties for persistent offenders of non-payment.

What happens next?

The draft legislation to implement these changes has not yet been published, and so the full picture, including transitional provisions, remains to be seen. Implementation of the retention ban will involve further technical consultation, and more detailed government guidance would be expected. The government plans to work with the Construction Leadership Council and construction clients in relation to the concerns around build quality and surety alternatives. It also plans to work with the financial services sector to identify ways of developing the surety market for the construction sector.

We will continue to monitor developments and provide updates as further detail becomes available.

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