Alex Reid is legal director and Ed Lamport is a senior associate at Winckworth Sherwood
After many years of discussion over construction payment practices, it now looks likely that the government will overhaul the industry’s use of retentions. The implications of the proposals could be far-reaching, disrupting the financial norms that industry partners rely on to manage risk and protect quality.
The ‘Backing your Business’ consultation from the Department for Business and Trade, which closed in October, sets how change might come forward. Aimed at tackling poor payment behaviour and protecting smaller firms, it invites solutions to the problem of late payments and potential controls on, or alternatives to, the use of cash retentions.
“The biggest potential change concerns the use of retentions – long relied upon by developers”
The rationale for exploring changes is to preserve and optimise cashflow. Weak cashflow contributes to the sector’s instability.
Successive governments have already taken aim at payment terms, including mandatory reporting of payment practices and tougher penalties. The consultation looks to go further – considering an 8 per cent charge on payments outside terms, and a legal limit of 60-day payment terms. It also recognises cases where disputes are used as a stalling tactic for payment, proposing that invoices could only be challenged within the first 30 days.
However, the biggest potential change concerns the use of retentions – long relied upon by developers, which hold on to 3-5 (but occasionally up to 10) per cent of contract value as security against defects or incomplete work.
The government has laid out two options in its consultation. The first is that retentions remain but are ringfenced to specific criteria or backed by a guarantee. This would protect the contractor against client insolvency and improve certainty over repayment. Retained sums could also accrue interest for contractors and caps or other time limits have also been raised as alternatives. While these measures would protect contractors, they are likely to lead to a higher compliance burden on clients – with more administration, more cost and additional reporting.
The more significant option is a full ban on retentions. This would mean developers lose one of their most familiar tools in getting projects finished on time and to a high standard. It could force a shift towards other forms of protection including performance bonds, escrow arrangements or retention bonds.
There would be likely trade-offs for contractors too. Providers of surety bonds are likely to be reluctant to lend on comparable terms. Developers could be forced to adjust their contracting strategies, including tighter vetting, shorter defects liability periods, or milestone-based payments.
Be prepared
New contracts will need to be prepared to reflect any new statutory obligations, and standard contracts including JCT 2024 would need redrafting.
Despite the scale of potential reform, awareness among industry stakeholders remains patchy. Scenario planning now makes sense, because the pace of change is expected to be fast when it happens.
While the objective behind these proposals is to improve financial resilience in the supply chain, the reality is that the compliance burden on clients and contractors will grow in the short term.
Those who plan ahead to review contracts, engage with supply chain partners and prepare alternative forms of protection will be best placed to navigate what could become one of the biggest changes to contracts for decades.