Mark London, senior partner, and James King, knowledge development lawyer at Devonshires, discuss what impact the banning of retention payments will have for SME construction companies
Retention has never been compulsory, but it has long been a common practice in the construction industry. Construction contracts will typically allow the employer or contractor (through their supply chain) to withhold a small percentage of the contract sum, with release taking place upon completion of the work and at the end of the rectification period.
The rationale for retention is that it provides a degree of security to the employer or contractor. If the contractor’s or sub-contractor’s work fails to conform to the contract, retained sums may be used as leverage to require their return to the site or applied towards the rectification of the defects. It is an easily accessible form of security, and, from a contractor or sub-contractor’s perspective, it is now a known quantity; a contractor can forecast that 3-5% of invoice sums will be taken on each payment and released at prescribed stages.
However, concerns have emerged that retention contributes to the wider problem of late payment in the construction industry, as, in practice, tight margins make cash flow the lifeblood of the industry.
An industry under strain
Legislation was introduced in the 1990s to support cash flow by requiring construction contracts to include adequate provisions for interim and final payments, the ability to use the “rough and ready” adjudication process and prohibiting pay-when-paid clauses.
Despite these measures, the construction industry remains the sector most affected by insolvency, accounting for around 17% of all business insolvencies and 23% of individual bankruptcies in 2025.
The responses to the recent consultation on late payment practices highlighted that withholding retention is detrimental to cash flow, particularly for SMEs, where retention reduces available capital and the ability to invest in other projects. Concern was expressed that the current balance of benefit tilts too heavily towards the payer, especially where the threat of withholding retention can be weaponised. Contractors may be deterred from pursuing sums owed due to the cost of adjudication or litigation, and may risk insolvency if sums are not recovered.
Unsurprisingly, the majority of business respondents to the consultation fell into the most impacted SME category (519 respondents, around 88% of the total), compared with large businesses (66 respondents, around 11% of the total). The proportion of respondents in favour of reforming retention practices mirrored this split almost exactly, with 87% supporting change.
The consultation considered two options: an outright ban on retention or the introduction of retention protection measures, such as requiring held sums to be placed in a ring-fenced account or replaced with a guarantee instrument (e.g., insurance or a bond).
An outright ban was the least complex option to introduce as legislation and, potentially, the lower-cost option for the industry. As a result, the current proposal is to prohibit the use of retention payments altogether. Alongside other measures, including mandatory interest and 60-day payment-term caps, the intention is to increase cash flow and combat insolvency-related losses.
Practical uncertainties?
This announcement has been hailed as overdue by many, but it remains unclear whether banning retention will deliver the intended benefits for SME contractors and subcontractors.
Retention has historically provided a cost-effective, straightforward means of enforcing obligations under construction contracts. In a post-Grenfell regulatory environment, ensuring that construction works meet safety and quality standards is a high priority. Removing the ability to withhold retention would arguably increase the risk that defects remain unrectified, particularly where a contractor is unwilling or unable to return to the site. The challenge lies in striking the right balance between the need for cash flow and the need to maintain effective quality assurance.
In reality, employers and contractors who previously relied on retention are likely to find another means of securing their funds. A ban would require significant changes to standard industry drafting practices and could give rise to an alternative mechanism in its place.
One possible outcome is the greater reliance on stage payments, with the final payment deferred to the end of the rectification period. In substance, this would operate much the same as retention but under a different name. Coupled with more onerous contractual quality criteria, which could make final certification harder to achieve, this could lead to an unintended boom in related disputes. In contrast to retention, this could be for significantly more than the customary 3-5% of the contract sum.
Until compliant alternative practices become established, and unless workable alternatives are readily available, the costs and friction associated with chasing retention may simply be displaced into other forms of disputes.
Bond-based options or insurance-backed defect cover offer potential non-cash alternatives, even if they are not mandated. However, at present, these products are not widely available, and smaller, less established companies may struggle to access them.
Next steps for greater security
For these options to provide a realistic substitute, the insurance market would need to adapt in step with the construction industry. An additional insurance product will invariably increase project costs, which will either need to be accepted by clients or absorbed by contractors, further narrowing margins and increasing reliance on timely payment.
Where contractors are within wider company groups, increased use of Parent Company Guarantees (PCG) may also be expected. While these would not require cash security, they would provide an employer with a wider net of assurance in the event of defects. That being said, this will not be available to companies outside a wider group, and PCGs wouldn’t provide the employer with the immediate, tangible leverage that retention (or modified stage payments) offers.
Further consultation is planned on the implementation of the retention ban, meaning the precise timeline, form and measures to prevent circumvention remain uncertain. It is expected that there will be a one- to two-year transitional period to allow for stakeholder engagement and for industry to adapt.
Ultimately, banning retention represents a delicate balancing act. On the one hand, there is a clear need to better protect SMEs from the dangers of late and withheld payments. At the same time, a ban could give rise to alternative practices that may prove equally, if not more, detrimental. In any event, it is unlikely that the proposed changes will bring complete, immediate relief to SME contractors. Rather, the industry is likely to experience a transitional phase characterised by different, but familiar, forms of dispute before new norms emerge.
The post Will banning retention payments benefit SMEs as intended? appeared first on Planning, Building & Construction Today.
