Daniel Cashmore, partner in construction and engineering disputes at Osborne Clarke, warns of potential unforeseen consequences of the recent retention payment ban
The UK government has announced what it describes as its “most ambitious legislation to tackle late payments in over 25 years”. This included plans to ban retentions in construction contracts, cap payment terms at 60 days for large firms paying smaller suppliers, and require all commercial contracts to include statutory interest at 8% above the Bank of England base rate on late payments. There will also be new powers to investigate suspected poor payment practices, adjudicate payment disputes and fine large companies that persistently pay suppliers late.
Whilst the intention is to improve cash flow to smaller companies by reducing financial pressures caused by late payment, an outright retentions ban could have unintended consequences and increase complexity for parties to a construction contract. Abolishing retentions entirely, rather than regulating them more tightly, raises understandable concerns among clients, contractors, funders, and investors and is likely to affect how and when disputes arise.
Retentions have been criticised as a source of unfairness in the construction supply chain, but they remain one of the few simple tools used by employers and funders to incentivise contractors to rectify defects and to manage the downstream insolvency risk. Removing them without a fully developed alternative inevitably prompts questions about risk, performance and behaviours on site.
The details of how the ban will be implemented remain to be seen, and its interaction with existing legislation — in particular the Housing Grants, Construction and Regeneration Act 1996 — will require careful thought.
Impact on project delivery and disputes
The increased risk of disputes is likely to emerge both during the construction phase and after practical completion.
Without a retention pot to fall back on, employers and contract administrators are likely to tighten their approach to punch lists and snagging at practical completion, with pressure to keep lists short and limited to minor issues. We can also expect closer scrutiny of the criteria required to reach practical completion, with site project managers likely to push for stricter interpretations of the practical completion threshold and greater use of notice mechanisms to build a detailed paper trail to support future payment valuations and potential claims. This creates scope for further arguments about whether practical completion has been unreasonably withheld, and may increase exposure to liquidated damages for delay where certification is pushed back.
Post-completion, the commercial dynamic will change significantly. Under a retention model, the usual pattern is “withhold and negotiate”, which provides both with an incentive to resolve defects pragmatically. Under the proposed regime, the model in theory becomes “pay and recover”. The employer will have already paid in full and will need the contractor to return to remediate the defects. With less obvious financial leverage, employers may feel driven more quickly towards formal routes such as adjudication to compel performance or recover the cost of having others do the work.
To mitigate this loss of leverage, employers may seek more onerous performance obligations in their contracts, including detailed, measurable standards tied to completion and defect obligations. That might provide clearer hooks for claims, but it also risks making contracts more prescriptive, more complex, and more prone to disagreement – pointing to a likely increase not just in the number of disputes, but in their scale and cost.
Security, insolvency and surety
Without retentions, employers are likely to explore other options to minimise risk exposure (such as downstream insolvency), including switching to payment upon completion of stated milestones rather than monthly progress-based valuations, or using project bank accounts. The viability of these alternatives will depend heavily on the details of the eventual legislation.
The ban is also likely to drive increased use of performance bonds and other surety instruments, which will bring their own complications. Bond costs have risen in recent years, and contractors – particularly SMEs – may resist shouldering them. Bond calls are frequently disputed, and any such dispute introduces an additional party into what may already be a complex situation. There is also a risk that bonds will be drafted inconsistently across the industry, creating uncertainty as to their scope and enforceability. The combination of more onerous obligations around practical completion and greater reliance on bonds is likely to increase the overall risk of disputes.
What happens next?
The government will consult on the implementation of its proposals, but has not yet provided further details or a timetable. It has also said it will work with the Construction Leadership Council and major construction clients to develop practical approaches to minimising defects, and with the financial services sector to help develop the surety market. To minimise the scope for disputes, legislation will need to be shaped around a clear policy goal and a realistic understanding of how the ban is intended to work in practice.
The ban is intended to be brought into force by way of amendments to the Act. One particular complication is the existing definition of “construction operations”, which is complex and nuanced in the way it excludes certain categories of work. This will be especially challenging for “hybrid contracts” covering works both within and outside the scope of the Act, as there could be a dispute over whether an employer was permitted to request retention for particular elements of the works. At contract formation, parties may need to spend more time understanding whether their arrangements fall within the Act, lengthening negotiations and increasing transaction costs.
Will the ban apply to all contracts in the same way? The reforms are meant to protect SMEs from late payment from larger companies, but it is unclear how this will be defined. This raises an interesting commercial question for larger contractors who may be subject to the retention ban upstream but are unable to pass that risk.
Until further consultation, many questions will remain unanswered. In the meantime, the industry needs to consider how standard contracts, risk-sharing arrangements and surety tools may need to evolve, so that businesses can participate meaningfully in the consultation process and minimise disruption when the proposals ultimately come into force.
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