Retention in construction contracts under review

The government consultation to review the 2011 changes to the Construction Act 1996 and the practice of cash retentions in construction contracts closed on 19 January 2018. In light of well publicised Main Contractor insolvency, the review of retentions has been thrust into the spotlight.

What is retention?

Retention is a widely used mechanism in the construction industry, whereby a percentage of the sums certified for payment under a construction contract (typically 3-5%) is held by the employer during the construction phase. The sums are returned only at completion and expiry of the defects liability period. It is commonly accepted in the industry that retention benefits the employer. It is used as an assurance of project completion and is intended as a safeguard against subsequent defects that the contractor may fail to remedy. Up to £5.9billion per year is tied up as retention monies.

In theory, retention encourages efficiency and productivity for the construction project. It should incentivise a defect-free project.

In practice, the risk of retention on contractors and sub-contractors is immediately apparent: insolvency. While parties along the supply chain are waiting to be paid, the client (or another company up the chain) may become financially unstable, leading to losses. Estimates suggest up to £40 million per year of retentions are lost due to upstream insolvency. Contractors and sub-contractors can also experience a drain on cash flow. This may be compounded by issues such as limited access to finance and additional administrative time resulting from retentions.

Usual Approach / Practice

The response by the industry has seen standard contract forms such as the JCT 2016 make the employer’s interest in the retention to be as a trustee for the contractor. This may be suitable in some cases.

However, as highlighted in the Pye Tait report prepared on behalf of BEIS for the consultation, most retention is held in a main bank account. Therefore, retention monies for contractor’s work may not be ‘ring-fenced’ or held in a trust account, meaning that they have no protection from the real risk of upstream insolvencies.

The usual approach of employers is to amend the standard wording to delete reference to holding the monies on trust (i.e. as fiduciary), and replace with drafting that:

• grants the employer a full and unencumbered beneficial interest in the retention monies;
• establishes that the employer owes no fiduciary obligation to the contractor in relation to the retention; and
• confirms that the employer will have no obligation to segregate the retention into a separate banking account.

Why is this the case?

The now common departure from the standard form approach may be explained by the strict and potentially onerous duties on the employer that a fiduciary relationship can create.

Cases dealing with retention are rare but Bodill & Sons (Contractors) Ltd v Mattu [2007] demonstrated the effect of a requirement to hold retention monies on trust and in a separate bank account.

In that case, the employer and the bank were slow in complying with the contractor’s request to set aside the retention monies in a separate bank account to ensure a proper trust mechanism was established. The court therefore granted a mandatory injunction to ‘force’ the employer to comply with the request immediately. The court required that the name of the account be made sufficiently clear that it was a trust account.

What next?

When dealing with retention it is important to ensure that all parties understand what the contract says about the treatment of retention monies. Parties should consider the use of differing mechanisms to protect their interests.

For example, a contractor may suggest a retention bond, which can be expensive to provide but may be acceptable to the employer and/or any funders. Further, contractors could require that the contract provides that retention is to be held in a separate designated trust account.

In any event, whilst we await the outcome of the recent consultation later this year, a private members bill, Construction (Retention Deposit Scheme), is making its way through parliament. In addition, there are loud calls from contractor and sub-contractor bodies that the current practice of retentions (where money is not held on trust or in another secured form) should come to an end in the near future. We do not expect that these calls will go unanswered.

Please contact our construction team for advice.