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

6. Retention Deposit Scheme – Development of Business Case

52. The Short Life Working Group consider that where retentions continue to be used in construction projects the money should be held in an independent Retention Deposit Schemes (RDS). An RDS can be either custodial or insurance. The short life working group considered both types of scheme and had reservations about an insurance backed scheme in the current economic climate. It is clear that Insurers consider much of the construction sector to be high risk and so an insurance backed RDS is potentially a costly proposition and subject to the volatility of the insurance market. With the industry already seeing sharp rises in premiums in relation to Professional Indemnity Insurance the group consider that a custodial scheme can deliver more certainty for businesses.

53. This section of the paper considers a custodial scheme which would hold retention money as cash deposited into a ring-fenced account set up solely and exclusively for that purpose, and which is neither designed nor intended for the money to be used as working capital by the account holder(s). It sets out areas to be considered further in the development of a detailed business case and before legislation is enacted. The business case should also consider whether it is possible to pilot such a scheme in advance of parliamentary consideration, utilising the weight of public sector construction contracts. The main principles of such a scheme include:

• retention money deducted by the payer is transferred and held in an independently run, protected deposit scheme for the period of the construction contract or as agreed between parties
• payer is responsible for registering the retention and transferring it into a deposit scheme in order for it to be protected.
• automatic release of retention on sub-contract PC (Project Completion) and DLP (Defects Liability Period). This removes "pay when paid" (jargon for the construction sector commercial practice of payers making their obligation to a payee in one contract dependent on being paid firstly in another contract. Banned by the Housing Grants, Construction and Regeneration Act 1996 but still prevalent) and allows parties to focus wholly on assessing whether there are issues with the work such that intervention is necessary to prevent automatic release of the monies
• defined processes prior to automatic release date – Payer to review works for possible defects prior to release date, clearly articulating issues and what needs to be rectified, with opportunity for payee to respond. This allows payee opportunity to address any defects
• if an unresolved dispute emerges this is referred to an appropriate and proportionate dispute resolution process and the retention is held by scheme pending decision
• otherwise retention is released automatically, unless evidence justifying otherwise is submitted, with the relevant notice period and production duration written into the construction contract
• Specified Release procedures are established in the event of either an upstream or downstream insolvency

Retention Deposit Scheme

Topic

Business Need

Areas to Consider

£124 million in cash retention is thought to be held under construction contracts in Scotland at any one time (Pye Tait)

There is evidence that late and non-payment of retentions is a significant issue for businesses in Scotland. This falls disproportionately on SMEs

Some businesses will not tender for work where a retention is to be held again them

Topic

Organisational Overview

Areas to Consider

The Scottish Government believes in fair, transparent and prompt payment practices and recognises the importance of a thriving construction sector

Topic

Contribution to Key Objectives

Areas to Consider

Provides assurance against upstream insolvencies and retention abuse

Provides assurance against underperformance

Removes cash flow incentives from retentions

Provides greater confidence across the sector but particularly to SMEs

Topic

Stakeholders

Areas to Consider

Engagement across the construction industry will be required. Those commissioning construction contracts, Professional bodies (RICS/RIAS), construction businesses etc

Topic

Existing Arrangements

Areas to Consider

Cash retention (typically around 5 per cent of contract value) in construction industry contracts is a long standing practice, particularly in the public sector. The retention (the 5% of contract value) is withheld from the party completing construction works (full payment is not made) to ensure they properly complete activities required of them under contract, particularly once they leave site. At practical completion on-site, half the retention is returned to the contractor. The remainder is retained for a period (defects liability period) determined by the contract (commonly 12 months) in order to insure against defects which arise after practical completion

Ordinarily the retention is simply held in the bank account of the client/contactor imposing the retention and can be used for other purposes although it remains committed to pay for work completed.

Topic

Scope

Areas to Consider

The business case must, at a minimum:

• determine how the scheme will align with existing legislation (such as tax, trusts, insolvency, money laundering etc)
• determine payment release mechanisms, and alignment with construction contracts
• ensure ease of access (who can access funds, how and when?)
• include a mechanism for dispute resolution
• include the design and delivery of a mechanism for easy payment and automatic release
• consider staged payments linked to completion (i.e. a retention held against a company completing groundworks at the start of a project should not be held until the entire project has been completed)
• consider costs of delivery and scope to be free to use, utilising interest on investments to fund operational delivery
• benefits and disbenefits of provision through private, public, third and not for profit sector
• consider opportunities to use smart banking technology to support the ambitions of the scheme

Topic

Constraints

Areas to Consider

Cost and complexity of any retention deposit scheme – At a minimum any scheme should be able to operate through the interest raised on funds deposited i.e. it should pay for itself and require no additional funding in line with schemes associated with tenancy deposits

Payers may chose not to use cash retentions and this may affect the commercial viability of any scheme that is established

Delivery of schemes may be insufficient – market appetite