Reviewing the Role of Retention

5 years ago I wrote a post about whether you could trust an employer with your retention. In the light of Carillion’s pending/actual/recent insolvency* (delete according to when you read this), I wanted to clarify the legal position on retention.

For simplicity the employer refers to the paying party – for many of Carillion’s subcontractors, that means Carillion, the main contractor on their projects; and contractor refers to the recipient.

Whose money is it anyway?

Generally retention is a growing sum deducted from, or not paid as part of, each interim valuation, based on a percentage of the costs otherwise due to the contractor. It is not retained from other claims by the contractor.

The employer is obliged to pay 50% of the fund after completion (or taking over), and any remainder after the end of the defects or maintenance period. Most standard form contracts deal only with (1) how the retention is held during the project, and (2) when the contractor can expect to receive it.

Is it the employer’s money? You may believe that the retention money belongs to the employer to ‘pay for defects’. Most standard forms do not say when the employer can use the retention money.  JCT and NEC make no reference to claims against the retention. Under FIDIC 2017 there is no specific reference, although the employer could not use the retention money without following the procedure for claims under clause 20.

Is it the contractor’s money? You may believe that the retention money belongs to the contractor as it is payment for works completed. But FIDIC 2017 does not state this. NEC4 does not state this. JCT 2016 DB and SBC state that the employer’s interest is as trustee for the contractor (ie to whom the money belongs), although most JCT contracts are amended to remove this reference and give the employer legal ownership.

Is it the bank’s money? The truth is that most employers whose projects are financed by borrowing only draw down the net amount of any valuation ie excluding the retention. This avoids the employer paying a borrower’s rate of interest on money which is then held dormant in a savings account for many months. Until the project reaches completion (to the satisfaction of the bank), the employer does not receive the retention. Essentially it is held by the bank!

Until completion of a project, the retention money is in limbo – the employer could use it towards defects or property removed from site or other breaches by its contractor; and the contractor cannot request its payment as it is not properly due to the contractor until it is certified.

Carillion’s subcontractors

There are more layers of complexity to take into account:

The Hierarchy: The company that is failing is not the employer, but a contractor. Even if Carillion’s retention money is held on trust for it, once it is paid to Carillion it becomes part of the general assets of Carillion and will used to pay preferential creditors before unsecured subbies. Under most standard construction contracts, there is no retention fund that covers the whole supply chain.

Variable Retention Amounts: Some standard forms provide that the parties can decide the minimum amount the employer can hold as retention. This was intended to prevent tiny amounts being uncommercial to recover and allowing the payer a series of unexpected bonuses as subcontractors got fed up with chasing. However often these are set at £0. The actual retention percentage is set in the Contract Particulars (JCT), Contract Data (NEC and FIDIC). The best method of checking the amount currently held is by reviewing the last payment notice.

Pay When Paid/Pay If Paid: Although the Construction Acts 1996 and 2009 do not allow a contract to state that release of the subcontractor’s retention is dependent on acts or periods in the main contract, the stark reality is that a main contractor will not release the retention due under the subcontract until it has received its own retention. Often this is achieved through lengthy payment periods (read more) or complex payment procedures (read more).

Termination: As Carillion is effectively insolvent (unable to pay its debts) then if its contracts are terminated by the employer or automatically, all future obligations cease to apply and the return of any retention will depend on negotiations between the parties. If I was a subcontractor working on a Carillion project I would want assurances about how any current retention funds had been safeguarded as well as confidence that future works would be properly paid.

Making payment fair

The data is shocking (research carried out by the Department for Business, Energy and Industrial Strategy):

Over a three year period the industry – primarily SMEs – has lost £700 million worth of retention monies because of upstream insolvencies.  This works out at almost £20m per month, £4.5m per week and £900,000 per working day!

None of the standard forms and hardly any companies within construction adopt the Construction Supply Chain Payment Charter, which requires:

We will either not withhold cash retention or ensure that any arrangements for retention with our supply chain are no more onerous than those implemented by the client in the Tier 1 contract. Our ambition is to move to zero retentions by 2025.

Ensuring that retention arrangements are ‘no less onerous’ than these unclear and unhelpful standard procedures is not good enough.

What should we do?

As Rudi Klein said (reported in Construction News): “What the government needs to do, as much as supporting firms like Carillion, is look at ways to support the supply chain with things like these retention changes [set out in the proposed new Bill].” He estimated that Carillion alone holds approximately £¼ billion of retention (reported here).

We need to move fast towards (1) safeguarded retention as proposed in the new Construction (Retention Deposit Schemes) Bill 2018 and (2) zero retention.

Either would have solved or acted as a salve for Carillion’s supply chain.

Note: for more details on the provisions on retention of standard forms, see the RICS Guidance Note on Retention (GN 90/2012) available from http://www.rics.org/Global/retention_dwl.pdf 

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