Lessons from Carillion: Reform of the use of retentions in the construction industry at last?

In the wake of Carillion’s collapse, a new Private Members’ Bill aims to protect retention money set aside in construction contracts. Jonathan Hyndman of law firm Rosling King discusses the need for reform

The Construction (Retention Deposit Schemes) Bill 2017-19 (the “Aldous Bill”) was introduced as a Private Members’ Bill in January by Peter Aldous MP. The aim of the Aldous Bill is to make provision for protecting retention monies in connection with construction contracts by amending the Housing Grants, Construction & Regeneration Act 1996 (the “Construction Act 1996”).

The construction sector has some of the highest new company insolvencies per year. The need for reform is significant; a report published by the Trade & Industry Committee in 2002 estimated that retentions account for some £3.25bn per annum.

Retentions

Many building contracts and sub-contracts provide for an employer (under a main contract) or a contractor (under a sub-contract) to retain a percentage of the value of the work carried out until completion or any defects are made good. Retentions are therefore in effect a form of ‘insurance policy’ used as security to ensure that works are completed and/or the remedy of defects. The Construction Act 1996 does not expressly make provisions for retentions; however, the rules contained therein apply to the payment or withholding of a retention provided the contract is a ‘construction contract’.

The need for reform

In October 2017, the Department for Business, Energy & Industrial Strategy (BEIS) published a consultation to review the use of retentions, which referred to the results of Pye Tait Consultancy’s research. The BEIS consultation highlighted the following issues:

1. A significant proportion (44%) of contractors surveyed with experience of having retentions held from them experienced non-payment of retention monies as a result of upstream insolvencies due to the majority (87%) of parties holding the retention in their main bank account, which provides no ringfencing protection;
2. Evidence indicates that a proportion of construction customers may be making payment of a retention conditional on the performance of obligations under another contract (such arrangements being prohibited following reforms to the Construction Act 1996, which prevent a contract linking the release of retention monies to performance under another contract); and
3. Delays in releasing retentions appear commonplace and increase significantly further down the supply chain, with those further down the chain also being less likely to receive retention monies than those above it.

According to the statistics from the Insolvency Service, in 2015 the construction industry had the highest number of new company insolvencies in England and Wales in comparison with other sectors. The statistics, coupled with the issues identified by the BEIS consultation, only serve to support the argument for reforming the use of retentions in the construction industry.

The BEIS consultation favoured a statutory retention deposit scheme, akin to the tenancy deposit scheme that is compulsory for all residential assured shorthold tenancies. Such a scheme would ring-fence the retention and put the monies beyond the reach of an insolvency practitioner. Such schemes already exist in other countries. For example, in New Zealand, retention money must be held on trust and in New South Wales, there is the requirement of placing retention money in a trust fund in respect of projects over AUS$20m.

The current position

In the event that a contractor becomes insolvent, it is not necessarily the case that an employer can treat the retention monies as its own. Indeed, if the retention monies are held on trust then the monies should remain in the trust account until the criteria for the release of the balance is satisfied.

Many JCT contracts provide that the retention monies are to be held on trust and in a separate bank account. An example of this is JCT Standard Building Contract with Quantities, 2011 Edition.

However, there are many other forms of building contracts that do not provide for retention monies to be held on trust and JCT contracts are often amended to remove that provision. This is where subcontractors further down the chain are exposed.

The proposed reforms

The text of the Aldous Bill was recently published. In its present form, the Aldous Bill:

1. Amends section 111 of the Construction Act 1996 so that any clause in a construction contract, entered into after the passing of the Construction (Retention Deposit Schemes) Act 2018, which enables a payer to withhold cash retentions shall be of no effect unless the monies are deposited in a retention deposit scheme and prior to the first withholding of the monies, the payer has notified the payee of the scheme administrator’s name and contact details and the scheme administrator of the payee’s name and contact details. A failure to comply with those requirements will require the payer to refund the cash retention to the payee no later than seven working days after the date on which the cash retention was withheld.
2. Extends the meaning of a “construction contract” as currently provided for in the Construction Act 1996 to include “any contract created to have a similar effect to a construction contract for the purposes of withholding monies which would otherwise be due under the contract”.
3. Defines the meaning of “cash retention” as “monies which are withheld from monies which would otherwise be due under a construction contract, the effect of which is to provide the payer with security for the current and future performance by the payee of any or all of the latter’s obligations under the contract”.

If successful, the Aldous Bill will therefore create a mandatory retention deposit scheme. However, it is noted that the Aldous Bill lacks specificity as the same requires the secretary of state and Welsh ministers, by statutory instrument, to make arrangements for securing that one or more retention deposit scheme is available for the purpose of safeguarding any cash retention withheld in connection with construction contracts. Indeed, the scope of the definitions of “construction contract” and “cash retention” are wide and it remains to be seen how effective the reforms may be until the regulations put flesh on the bones of the act.

Moving forward

While it is rare for a Private Members’ Bill to reach the statute book, the bill has gained support, perhaps owing to the insolvency of Carillion earlier this year, which created a domino effect throughout the construction industry. According to the Building Engineering Services Association, 120 MPs have confirmed their support for new laws that would place retention monies into protection schemes.

The widespread misuse of retentions might exacerbate the number of construction company insolvencies further if their application is not properly reformed. It is hoped that the Aldous Bill will increase confidence in the sector by ensuring retention monies are ring-fenced and thus potentially reducing the knock-on effect of insolvencies in the future.

Jonathan Hyndman

Partner

Rosling King

Tel: +44 (0)20 7246 8049

jonathan.hyndman@rkllp.com

www.rkllp.com

Twitter: @RoslingKing