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Cash retention adds to the COVID-19 construction crisis

11/05/2020

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United Kingdom

The financial implications of the coronavirus (COVID-19) pandemic have re-ignited concerns over payment retention in the construction industry and the need to inject and maintain liquidity in the supply chain.  

  Cash retention in construction is money withheld from interim payments, used to hold tier 1 contractors and subcontractors respectively to their contractual obligations to complete works to the required standard and to make good any defects within a set timeframe.  

The typical sum retained is 3-5% of the contract sum, with a step-down upon issuance of a statement of practical completion and the balance payable upon certification of making good defects.  

In practice, retention monies are often held for considerably longer, or not released at all. A report published in February 2020 by the UK's Department for Business, Energy and Industrial Strategy estimated that £4.5 billion was being withheld from contractors in the form of retention payments.

Employers retain retention monies and customarily amend standard form construction contracts to provide that such monies are not held by the employer on trust for the contractor (and there is no fiduciary duty imposed on the employer).  

In 1994, The Latham Report recommended that cash retentions should, at least, be protected in a trust account. However, 26 years later, such measures are rarely adopted, despite the standard form position.  
By contrast, since 1 April 2013, landlords are required to protect private sector tenancy deposits in an approved Tenancy Deposit Scheme. 

A survey carried out by the Building Engineering Services Association earlier this year revealed that 58% of firms that responded expected to invoice just 25% or less of their usual monthly amounts at the end of April 2020.  

COVID cash crunch

There is no doubt COVID-19 has created significant cash flow issues in the construction industry, and the practice of cash retention is exacerbating these problems.

The UK construction industry is potentially losing hundreds of millions of pounds-worth of work per day during lockdown and anecdotal evidence suggests subcontractors' cash reserves are now all but used up, meaning insolvencies are inevitable.

The collapse of British facilities management and construction services company Carillion in January 2018 saw that business fold still owing £800 million in payments to subcontractors.  

In support of a Westminster debate on cash retentions on the 27 February 2020, led by Alan Brown, Shadow SNP Spokesperson on Energy and Climate Change, Margaret Ferrier, SNP MP for Rutherglen and Hamilton West, commented:

"The UK government’s own research found that smaller construction firms lose almost £1 million in fees per working day due to insolvency issues further up the supply chain. That is untenable. The economy is not well served if smaller firms can be held to ransom by larger firms, placing every other contractor in the supply chain in a precarious position.

The ripple effect of lost retention monies, particularly for SMEs, may be considerable. 

Funds for investment, training, innovation and growth may be lost as profit margins erode. In worse case scenarios, SMEs may go insolvent or simply decide to exit the industry.

Further, if, as expected, Brexit ends the free movement of persons, then the loss of capacity and growth in the sector will be felt even more sharply.

The case against cash retention is long-standing and well documented. However, various initiatives since the Latham Report have failed to materialise. The Construction (Retention Deposit Schemes) Bill 2017-19 introduced by Peter Aldous MP in January 2018 is yet to be passed.  

More recently, in June 2019, Build UK, a representative organisation for the UK construction industry, published a set of minimum standards on the use of retention payments, with the aim of achieving zero cash retention in the industry by 2025. 

The issue is still being debated in parliament, but until legislation is passed, there is unlikely to be any material shift in behaviour.

It remains to be seen if the repercussions from COVID-19 will force the issue of retention monies to the forefront and result in much needed industry consensus (and parliamentary intervention) as to what should replace retentions.   
 
 

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