Cash retention under construction contracts: short life working group final report and recommendations

2. Background

12. The construction sector is a crucial part of Scotland's economy, accounting for £7.8 billion of Gross value Added (GVA) and annual turnover of £19.2 billion in 2018. The sector also provided employment to 143,000 people in 2019. There were over 47,000 businesses operating in the sector in 2020 of which 99% of those were small enterprises (0-49 employees).

13. Following concerns expressed by parts of the industry on late and non-payment of retentions and the disproportionate effect on SMEs, the Scottish Government agreed to undertake a review. To support the review, the Scottish Government commissioned independent research from Pye Tait (Retentions in the Scottish Construction Industry Pye Tait report.pdf (consult.gov.scot)) and held a public consultation on their use in the construction sector in Scotland (https://consult.gov.scot/industrial-sectors/retention-payments-in-construction/)

14. There is evidence (Pye Tait) that the practice of retention does not work to the advantage of the Scottish construction sector. Cash retention, where the process is misused or abused is a barrier to investment, productivity improvements and growth. The Pye Tait report notes:

"The overall perception of the practice of retentions is negative. Many recognise the system's role in protecting clients and higher Tier contractors from potential for poor quality work and the subsequent need to rectify latent defects. However, many interviewees feel that the system is poorly administered by all parties and open to abuse."

15. The impact of this is significant and in a sector with small profit margins. The time and energy lost in tracking and chasing retentions payments and the disproportionate impact this has on SMEs undermines a sector of great importance to the Scottish economy.

16. A retention is money withheld from payment of a construction project. The part of the contract sum which is held back is intended to provide a means of incentivising contractors and subcontractors to return to correct any defects during a specified period of time or to provide a means of funding the procurement of another contractor to do so, if necessary, as outlined in contract terms and conditions. In most cases a retention is imposed by the client employing the main or Tier 1 contractor and this is mirrored in subsidiary contracts throughout the supply chain. In Scotland, as across the rest of the UK, the retention amount is typically 5% of the contract value, although often 3% in projects worth over £5 million. The defects liability (maintenance) period is typically 12 months after practical completion, although it is often programmed to extend beyond this period depending on project type and complexity or for other reasons (Pye Tait). The group heard of examples of retentions being held for 5 or more years, and of the challenges SMEs often face in recovering these payments.

17. For the purposes of its work, the SLWG agreed the following definition of retentions:

Retentions represent an amount deducted and withheld from each progress payment made to a contractor or subcontractor to secure obligations under a construction contract and ensure defects are remediated without the holder becoming liable for costs arising from unmet contract performance.

18. The retention system is a long-standing practice in the construction industry throughout the UK and the Scottish Government consultation found that there are a range of views across Scotland's construction sector about the current use of retentions and on the best way of assuring construction contracts.

19. Several key issues were identified through the research and consultation process:

• evidence suggests that retentions can distort the market, with a significant proportion of companies saying they deliberately avoid business in which retentions are involved
• the current system of retention operates to the advantage of clients and Tier 1 contractors but to the disadvantage of medium and smaller companies, particularly where a contractor insolvency might occur
• qualitative evidence suggests that late and non-payment of retention monies is a significant issue for some contractors
• medium and smaller businesses believe that the practice of retentions in its current form inhibits their business growth, causes a drag on cash-flow, weakens relationships, and reduces investment

20. This document sets out the recommendations of the SLWG established to consider the options that emerged from the consultation process. These were:

• legislate to ban retentions
• introduce a retention deposit scheme
• recommend an alternative mechanism of assurance

21. Our approach to this work was to consider each of the three options in turn whilst recognising that organisations which commission construction work must have the ability to avoid becoming liable for costs arising from unmet contract performance by implementing a means of assuring it.

22. We are clear that whilst some of the alternative mechanisms discussed provide assurance on construction projects or provide security of payments, none appear to provide an appropriate stand-alone solution to all of the issues associated with the practice of cash retention.

23. Having considered options, including a ban on retentions, the SLWG strongly support the development and implementation of a custodial retention deposit scheme in Scotland. Further work is necessary to set out the details of such a scheme, including how best to secure automated payments and align with, for example, HMRC requirements. The group believe such a scheme would resolve many of the problems currently associated with retentions.

24. The SLWG recognise that it will take some time for a statutory scheme to be established, and have made a number of further recommendations to improve the current system including providing the industry with much needed best practice guidance to help negate some of the bad practice that has developed.