Proposed reform to cash retentions
Retentions are a controversial issue within the construction industry. It is common for a sum of money – often around 5% of the total value of a contract – to be retained by employers against their suppliers until the end of the project. They are viewed as an incentive for contractors to complete their works in time and defect-free, while providing a degree of security for employers against contractor insolvency. On the other hand, contractors face the risk of upstream insolvency if the retention monies are not ring-fenced and the burden of extracting payment. Research found that SMEs suffer the highest average delays in receiving their retention and more than 40% of construction businesses with experience of having retentions held from them experienced non-payment due to upstream insolvency.
The Construction (Retention Deposit Schemes) Bill 2017-2019
The Construction (Retention Deposit Schemes) Bill (the Bill), which is due for its second reading on 23 November 2018, proposes to amend the law such as to require any retention monies to be placed on deposit in an approved scheme, echoing the scheme in place for residential tenancy deposits. Similar schemes have recently been proposed in New Zealand and Australia. The collapse of Carillion and gloomy economic forecasts accompanying Brexit negotiations have contributed to a groundswell of support for the Bill, although detractors point to the inevitable increase of bureaucracy and suggest that efforts should be focussed on reducing abuse of the current system.
The Bill, in its present form, will:
- Amend section 111 of the Housing Grants, Construction and Regeneration Act 1996 (the 1996 Act) such that any clause in a construction contract entered into after the enactment of the Bill which enables a payer to withhold cash retentions shall be of no effect unless the monies are deposited in a retention deposit scheme and, prior to the first withholding of monies, the payer has notified the payee of the scheme administrator’s name and contact details and the scheme administrator of the payee’s name and contact details. A failure to comply with the requirements will require the payer to refund the retention to the payee no later than seven working days after the date on which the retention was withheld.
- Extend the meaning of a “construction contract” as currently provided for in the 1996 Act to include “any contract created to have a similar effect to a construction contract for the purposes of withholding monies which would otherwise be due under the contract”. This anti-avoidance mechanism is designed to prevent side-agreements operating to circumvent the scheme.
- Define “cash retention” as meaning any “monies which are withheld from monies which would otherwise be due under a construction contract, the effect of which is to provide the payer with security for the current and future performance by the payee of any or all of the latter’s obligations under the contract”.
As is common, the draft Bill offered little detail at the first reading stage and envisages that the arrangements for the schemes will be put in place by regulations. It is intended for operating costs to be covered by interest generated on the deposited funds but this, and the dispute resolution process, are yet to be fleshed out.
Proposals for reform in Australia
Due to inconsistencies in Security of Payment (SOP) legislation across the different jurisdictions within Australia, the Commonwealth Government commissioned a review to identify legislative best practice, and improve the protection afforded to subcontractors. Released in May 2018, the Murray Review (the Review) made 86 recommendations.
In response to the Review, the NSW Government’s draft Building and Construction Industry Security of Payment Amendment Bill 2018, proposes amendments to the Building and Construction Industry Security of Payment Act 1999, including changes to the retention money trust account arrangements.
Since 2015, head contractors in NSW projects having a value of at least A$20 million must hold retention money for subcontractors in a trust account, keep records in relation to the trust account and issue annual reports.
Although amendments to the Building and Construction Industry Security of Payment Regulation 2008 have not yet been drafted, the government proposes the following amendments to the existing requirements for retention money trust accounts:
- Monetary threshold at which the trust account requirements will apply to be reduced from A$20 million to A$10 million (project value).
- Subcontractors permitted to inspect the retention money trust account records held by the head contractor.
- Annual reporting requirement will be removed.
- Penalty notice offences for trust account requirements will be prescribed (for both corporations and directors/managers).
A further period of targeted consultation is expected in the coming months.
If the proposed UK reforms are introduced, it is likely to lead to an increase in confidence amongst construction companies that they are better protected from up-stream insolvencies and that retention monies will be appropriately ring-fenced. The government may also see the reforms as an opportunity to bolster confidence in the sector as Brexit approaches. Regardless of the progress of the Bill, clients working on international projects will still need to consider whether an alternative to a cash retention may be more suitable as the reforms will only apply to projects within the jurisdiction.