Specialist construction lawyer says working capital for businesses operating in sector could strengthen them
Proposed reforms to construction retentions could improve the working capital of SMEs involved in building projects, a lawyer believes.
Michael Kitson, a Director on construction law at independent Scottish legal firm Lindsays, spoke as a UK Government consultation on construction retentions continues.
The Department for Business and Trade is considering changes which aim to tackle poor payment practices, including consideration of two options for cash retentions in construction contracts.
If either option is progressed, it could trigger a significant shift in how contractors and sub-contractors manage cashflow and make payments.
One option for reform could see retentions being banned. The other could introduce protected arrangements where, amongst other measures, funds are either placed in a designated and segregated bank account or guaranteed via an insurance policy or bonds.
The consultation continues until October 23.
Mr Kitson said: “Whichever option is chosen, strengthening SME working capital and reducing insolvency risk should benefit the long-term health of the construction sector, where many work on razor-thin margins.
“The reforms may also drive innovation in financial management and more collaborative behaviour, encouraging more efficient project delivery.”
Any changes would apply to construction contracts, as defined under the Housing Grants Act 1996 so construction contracts with residential occupiers and in certain industries will fall outside any new rules.
Cash retentions are an entrenched feature of contractual practice in construction, with a retention (generally 3% to 5%) withheld from payments over the duration of a project.
Typically, the first half of the retention is released at practical completion – or its equivalent – and the remaining half at the end of the defect rectification period, often 12 or 24 months. The aim is to secure against quality issues and insolvency risk.
Mr Kitson added: “The outright ban on retentions may face strong industry resistance, making the protected retention reform more likely to proceed, although an outright ban was the Government’s preferred position when it published its options assessment in July.
“The option to allow protected retentions would still require substantial changes to contracting practices and will need support from the insurance and banking sectors.”
Research suggests that about 13% of retention sums are never repaid.
Lindsays says that retention funds are rarely held in segregated accounts, leaving them exposed if the payer becomes insolvent. Previous government research found 44% of surveyed contractors had experienced lost retentions due to upstream insolvency.
Late repayment of retentions impose additional administrative costs on payees who must chase the funds.
They also tie up working capital, limiting businesses’ financial flexibility, Mr Kitson explained.
If the protected arrangements option proceeds, only a single retention payment could be deducted at project completion stage and held until the expiry of the applicable rectification period.
“This would be a significant change from current practice where retention funds are deducted from each payment prior to completion,” Mr Kitson said.
“Contracts lacking the required protections will have terms implied by the Scheme for Construction Contracts, a familiar principle in the sector where terms are implied if payment or adjudication provisions are deficient.”
Lindsays lawyers, operating from offices in Glasgow, Edinburgh, Dundee, Perth and Crieff advise on the full spectrum of construction and commercial property issues.
