Is this what real retentions reform requires? Follow up to government announcement on late payments to SMEs

New government research shows that SMEs are owed an estimated £26 billion in late payments, or an average of a potentially crippling £17,000 for each affected business. The figure is likely higher in construction with late payments cited as a ‘big’ problem by more leaders than in any other sector.

The problem has been known for some time, with earlier government research revealing that the amount of retention money unpaid each year due to upstream insolvencies is £229 million (and that was in 2015 prices).

The risk, as the government sees it, is “higher business overheads, weakened relationships throughout the construction supply chain, increased costs of construction projects as firms price in the risk of losing retention monies, and constrained business growth.”

So, as part of its late payments reforms for small and mid-size businesses, it has just announced a proposal “to take forward a legislative measure to prohibit the deduction and withholding of retention payments under the terms of a construction contract. However, given the ambition of the policy, we will consult further with interested parties on the impact of this measure before taking a final decision on implementation.”

The aim is two-fold, to prevent non-payment due to upstream insolvency and reduce late, partial or non-payment of retentions due to “poor payment behaviour”.

How could the reforms be implemented? 

It is… unclear, shall we say? An outright ban on holding retention would be a counterproductive move certain to provoke a strong reaction from the industry. Retention money is viewed by many as an important incentive for contractors to meet time and quality obligations. It has been in common use for over a century and removing it from building contracts altogether leaves the employer exposed. In its response to the Late Payments Consultation published in March, however, the government now seems committed to a ban.

The issue is not the act of holding a retention itself – it is the problems that arise when employers fail to meet payment obligations. This is what needs to stop, which is why enforcement and accountability will be key.

But as for practical solutions, the government is likely to leave it to the industry admitting: “We recognise that both clients and the supply chain will need time to adapt and establish alternatives that effectively incentivise high-quality work and limit defects in construction.”

In practice, the market will innovate, likely by undervaluing on payment certificates or inflating tender prices. Surely a better approach would be for the industry to reach consensus on a fair, practical way to manage payments balancing security for employers with timely, reliable cash flow for contractors.

A practical, equitable solution

One option is a dedicated fund where retention money is safeguarded, ensuring contractors get paid promptly when retention is due for release.

Previous government consultations supported this idea, highlighting support for a transparent, FCA-regulated online scheme where escrow accounts serve as a retention deposit scheme. The recent late payments consultation also suggested allowing “the use of retention clauses in construction contracts” requiring “any retention sums withheld to be protected”. The important thing is to ensure that, on release, retention money flows smoothly down the chain with no upstream blockages. This is not a theoretical concept; exactly such a scheme has been available from Security for Expenses Ltd. since the government published the findings of a similar consultation in 2017.

Employers are naturally resistant to the idea. Contractors, though keen, cannot force the issue if they want to win work. Making such a scheme mandatory, as with the residential Tenancy Deposit Schemes, would compel employers to safeguard retention monies. This would balance protection for contractors and suppliers while maintaining protection for employers. But while there is precedent, it seems the government has rejected this approach for the time being.

What happens next

What is essential in this interim stage is a broader shift toward conversation and shared responsibility to ensure construction payments work for everyone and so build a financially stronger sector. Easier said than done, of course.

In its implementation consultation, the government proposes to “work with the Construction Leadership Council and construction clients to develop practical approaches to minimising defects, as well as working with the financial services sector to identify ways of developing the surety market for the construction sector.”

We will update the website as soon as we hear more.

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