Building Contract Retentions
Following the recent article published in Construction News alluding to the Government’s proposed ban on retentions (The Commercial Payments Bill), we have provided our thoughts below. The bill is considered to provide the most significant legislation change to tackle late payments in over 25 years.
Please note that the following is written on the basis of the JCT Contract Suite being used. Other contracts and such mechanisms may be impacted differently.
What is Retention?
The retention is a percentage (typically 3-5% of the Contract Sum) of monies withheld from Contractors’ Payment Certificates (Principal Contractor when dealing specifically with JCT Contracts).
The withheld monies serve as an incentive for the Contractor to return and remedy any defects that arise during the Rectification Period, which is typically 12 months. Commonly referred to as the 'defects liability' period, this is the timeframe during which the retention monies remain relevant.
If the contracted party refuses to return to undertake any repairs, the retention sum can be used to source alternative contractors to undertake the same works.
The general outlook is that Contractors have long since considered these mechanisms a punitive measure. While there may be instances where this does occur, in our experience, contractors have always remained professional and understand the reasons behind retention. This does not necessarily make the process easier to manage.
Cash Flow Implications
In the current economic climate, it is unsurprising that retention mechanisms have come under increased scrutiny. Persistent cost-of-living pressures continue to place significant strain on the construction supply chain, with smaller subcontractors often bearing the greatest impact due to their more limited ability to withstand delays in payment.
In their view, they have completed the works, so they should be paid entirely. It is not the purpose of this insight to consider the agreements between Principal Contractors, and sub-contractors. From our view, who act as Contract Administrators and Employer’s Agents, the percentage of retention is transparent, and always known at tender stage. Whether the same percentages are ‘passed down the supply chain’ is not within the scope of this insight, but remains a grey area from our position.
In practice, Principal Contractors typically withhold a percentage of payments due to their subcontractors as a means of managing and limiting their own financial exposure.
Conclusion
If the Government follows through with the proposed ban on withholding retention monies, we do not see the withholding of monies from Payment Certificates ending there. With the best intentions of imposing the bill, to protect smaller businesses, we feel it will create a branch of newer contractual mechanisms/impositions on the supply chain.
Clients invest significant sums to undertake and complete their projects, and in turn provide an income to all the supply chain involved. With that in mind, they understandably want assurances that if any defects arise, the contractor will return to remedy them. In construction, ‘gentlemen’s agreements’, while they do exist and are based on relationships and trust, are not legally enforceable.
If retention monies are banned, we feel this will lead to alternative means (currently available but not always executed) being imposed on Principal Contractors. The use of Performance Bonds and Guarantees are likely to be given more thought. Such mechanisms remain widely used on larger projects, but they will potentially become the new ‘norm’ for smaller projects. Contract amendments are likely to become the norm on smaller projects (again, widely used/expected on larger projects).
These amendments will result in additional administration, ultimately adding to the project costs.
It also has a wider impact on existing contract mechanisms. If retentions are banned, what happens to the Rectification Period? Are all references to the Rectification Period to also be removed from any future contract amendments? Likewise, the issue of the ‘Certificate of making good’ would likely become redundant.
Time will tell, and the JCT (among other contract providers) will need to carefully consider the proposed changes. Ultimately, a client who is investing significant sums of money in projects will still want to retain some form of control to ensure that if any defects arise, there is some mechanism that the contractor remains liable to repair.
Please get in touch with any queries or to discuss your situation. Our team are happy to help!
Insight provided by Lewis Livesey.