Further to the Government announcement of its intention to prohibit retention on construction projects, Weightmans' Construction Team consider the potential implications and alternatives to retention, in preparation for this significant change.
The purpose and use of retention in construction projects
Retention has long been a common form of security on construction projects, primarily to protect the buyer (e.g. the employer under the main contract or the contractor under a sub-contract) against supplier (e.g. contractor or sub-contractor) failure to complete works and/or rectify defects.
In brief, parties to building contracts and sub-contracts commonly agree that a retention percentage (often between 3% and 5%) be retained from interim payments to the supplier during the course of works. The retention held accumulates as the project progresses and the value of the works increase.
Retention funds may be (i) a conditional loan, or (ii) held on trust by the buyer. This is explicitly addressed by some standard documents. For example, JCT standard form contracts provide that the buyer holds retention funds as a trustee and so has fiduciary duties to act in the interests of the supplier who has a right to that sum on satisfying the triggers for release. However, in practice, this is often amended to remove such fiduciary responsibilities.
Retention is often released in two parts: half on practical completion of the works and the remainder following the end of the defects rectification period (which is usually between 12 and 24 months following practical completion). During the rectification period, the buyer generally has the power to notify the supplier of a defect and require it to remedy any such defect; should the supplier fail to resolve the defect, the buyer may keep an appropriate amount from the retention as security to rectify the defect.
Section 110(1A) of the Housing Grants, Construction and Regeneration Act 1996 (‘The Construction Act’) prohibits the release of the balance of retention to a sub-contractor being linked to the completion of works under the main contract.
Why is retention reform being considered?
Two key concerns with retention were identified in the Government's 2025 late payment consultation:
Administration of retention and poor practice
Delay returning retention cash to suppliers can cause cashflow issues. This can often be caused by buyers using retention funds as working capital, in an attempt to supplement its own cashflow (which is in direct conflict with the default fiduciary duties if not removed).
Insolvency risk
If the employer becomes insolvent, the supplier risks losing retention monies owed to them under the contract.
What are the Government’s suggested reforms?
In addition to considering the issue of late payment and poor payment practices more widely (including proposing maximum payment terms of 60 days and a deadline for disputing invoices), the Government’s consultation document considered two options in relation to retention in construction contracts; either prohibit the use of retention or introduce strict requirements to protect retention funds by requiring the following:
- retention monies are segregated in a separate bank account once deducted from the payment due to the supplier, held for the benefit of the supplier;
- the default position would be to withhold the retention sum from the final payment application;
- requirement for retention to be automatically released, unless a notification is made to the supplier (reversing the common position requiring a supplier to apply for their retention release); and
- any interest accrued on the retention sum will be payable to the supplier.
The consultation response confirms intent to pursue option 1 and ban the use of retention in construction contracts entirely. The proposed route is to implement the ban via amendments to the Construction Act.
A complete ban was considered the most economical and efficient method to address retention mismanagement: "simpler for the industry to implement and easier to enforce".
Further payment reforms
As well as reforms to retention payments, the Consultation Response sets out preferred options on other measures to tackle poor payment practice across sectors, notably:
- Legislative (maximum) 60-day payment terms. It is worth noting that a similar principal already exists under the Scheme for Construction Contracts where implied payment terms result in a final date for payment of less than 60 days.
- Legislation that will require interest to be paid on late payments at 8% (above BOE rate). Currently the Late Payment of Commercial Debts (Interest) Act 1998 provides this as a default rate if the contract does not already provide for interest for late payments and this change would make that default rate apply in all instances ; and
- Introduction of a time limit for disputing invoices. Similar to (i) above, under the Scheme for Construction Contracts there are strict time scales which effectively act as deadlines to dispute invoices. Strict dates for Payment Notices and Pay Less Notices result in specific windows for buyers to dispute supplier invoices.
What are the alternatives to retention?
The Consultation Response acknowledges concerns were raised regarding the challenges of ensuring quality of delivery in construction projects, that the rate of errors and defects in the industry remains high, and retention often did not cover the costs of resolving defects.
The Consultation Response confirms the need to develop a range of solutions to meet the needs of construction clients and the supply chain in the absence of retention. A number of potential alternatives are considered below.
Bonds
There are various forms of bond that might replace retention including payment bonds, retention bonds, performance bonds, and defects bonds.
Retention bonds and performance bonds seem the most appropriate candidates to step into the place of retention.
Retention bonds are obtained by a supplier, in lieu of retention being withheld, and given by a third-party surety (bank or insurance fund), committing to pay an agreed sum in the event the supplier fails to rectify a defect.
A performance bond operates in a very similar way; the supplier obtains the bond and the bondsman agrees to pay a certain percentage of the contract value if the supplier fails to perform its obligations under its contract.
The market for specific defects bonds or defects insurance is likely to see increased interest.
The strength of a bond will also be subject to whether it is on demand or conditional and bonds can be seen as a costly up-front expense to suppliers (in contrast to retention being a deduction from payment). At present a bond for 10% of the contract value might cost up to 5% of the contract value. The availability and affordability of bonds is a particular concern for SME's, whom the retention reform is primarily focussed on protecting. It is hoped that the insurance market will respond to the retention ban to make alternative products available.
Parent Company guarantees
One option which might avoid the additional cost involved with bonds is a parent company. Given to the buyer by a parent company of the supplier, it guarantees either performance or payment if the supplier fails to perform its obligations.
Project bank accounts (PBAs)
A separate bank account set up to hold project funds prior to payment to the supplier. This gives the supplier comfort that (at least a portion of) monies are in place to pay for their works. Historically, PBAs have often only been used on high value, complex projects because of the cost involved to set up and manage them. A ban on retention may see their use increase.
Retention Deposit Scheme / Trust Accounts
A separate bank account, where retention funds are held on trust for the benefit of the supplier. Though it remains to be seen whether this remains an option if retention is completely banned.
Adjusting the interim payment gearing using milestone payments
The parties are of course free to adjust the interim payment regime to suit their requirements. Whilst the retention reform would prohibit the buyer from retaining a percentage amount from payments that are due to the supplier, the parties could achieve a similar result by utilising milestone payments and having milestones at practical completion and conclusion of the defect rectification period with each triggering payment of (say) 2.5% of the overall price.
Conclusion
The Government’s intentions around poor payment practices and retention are clear and bold.
Respondents to the Department’s consultation supported a staged approach and a 12 – 24-month transition period, so watch this space for further updates on how the ban will take effect and its implications for construction contracts.
Key contacts
Matt Clover | 0151 242 6806 | Matt.Clover@weightmans.com
Natalie Keyes | 0191 244 4452 | Natalie.Keyes@weightmans.com
Daniel Barchet | 0121 616 6625 | Daniel.Barchet@weightmans.com
Weightmans team of construction lawyers can support you and your business with all retention related queries including alternative forms of security, and securing retention release.
