One of the construction industry's most controversial payment practices may finally be nearing an end. The UK Government has now published legislation that would ultimately bring an end to the use of cash retentions in construction contracts.

Last year, I wrote about the UK Government’s consultation on retentions in construction contracts as part of wider reforms intended to improve business payment practices. At that stage, the Government’s preferred option appeared to be an outright ban on retentions, rather than allowing them to continue subject to safeguards (such as ring-fenced accounts or guarantees).

The publication of the Commercial Payments Bill confirms that approach. If enacted in its current form, it will prohibit retention clauses in construction contracts by amending the Housing Grants, Construction and Regeneration Act 1996 (the “Construction Act”).

Chapter 2 of the Commercial Payments Bill sets out the amendments to the Construction Act. Recognising the industry's longstanding reliance on retentions, the reforms would be introduced in stages to allow time for parties to adapt their contractual arrangements and payment practices.

Phase 1 – A two-year transition period, beginning when the new section 113A of the Construction Act comes into force.

    Phase 2 – An outright ban on new retention clauses

    Phase 1 – Two-year transition period

    During the two-year period:

    • Parties to construction contracts can still agree new retention clauses; and
    • Parties to construction contracts can vary pre-existing retention clauses.

    Any new or varied retention clause agreed during that period could then continue to operate for a further year. In practical terms, retention sums under those clauses could still be deducted or retained for up to three years after the start of the transition period, in accordance with the contract terms.

    At the end of that three-year period, those clauses would cease to have effect. Any sum deducted or retained during that period, described in the Bill as a “transitional retained sum”, would then become due for payment.

    It is also worth noting that existing retention clauses agreed before the transition period can also continue to operate in accordance with their terms, provided the clause is not varied during the transition period.

    However, parties relying on those pre-existing retention clauses should be mindful of the potential penalties where a “retention debt” arises (see the ‘Penalties’ section below).

    Phase 2 – Outright ban

    At the end of the two-year transition period:

    • New retention clauses would be prohibited and treated as void; and
    • Variations to pre-existing retention clauses would be prohibited, except where the variation makes the clause more favourable to the payee.

    Penalties

    The Bill also provides for penalties where there is a “retention debt”. A retention debt arises where:

    • A sum has been deducted or retained as retention; and
    • The deduction or retention relates to a sum to which “the requirement in section 111(1) of the Construction Act applies”, but that requirement has not been complied with. In other words, the relevant sum forms part of a notified sum that should have been paid by the final date for payment but has not been.

    Where a retention debt arises, the payee is entitled to a fixed penalty from the payer. The penalty is set at the higher of 50% of the retention debt and £40 and is payable in addition to repayment of the retention debt itself.

    The payee may also be entitled to statutory interest, currently 8% above the Bank of England base rate, together with any applicable late payment compensation. The Bill further provides that the protection in section 113E cannot be contracted out of.

    Key takeaways

    1. If the Bill becomes law, which is not expected before 2027, employers, contractors and subcontractors will need to review their standard terms and contracting practices during the transitional period. In particular, parties should start considering how they will manage the risks associated with quality, completion and defects without relying on cash retentions. This may include:

      - More rigorous inspections during construction and at practical completion;
      - A greater focus on performance bonds and other forms of security;
      - More onerous contractual provisions around how quickly defects are remedied and how default costs are recovered;
      - Greater diligence regarding parties’ financial standing and quality compliance systems.

    2. The controls apply to clauses where one party to a construction contract “deducts or retains sums of money equating to a percentage of” sums due to the other party until a condition for release or partial release is met. That clearly covers standard retention provisions, but it may also capture other arrangements where sums are withheld pending satisfaction of a condition – for example withholding 10% of the Contract Sum until a performance bond is delivered, or withholding a percentage of a works package until a subcontractor collateral warranty is delivered.

      Parties may explore the limits of this drafting although the Bill gives the Secretary of State powers to amend the provisions to address any perceived attempts to circumvent it.

    3. It is important to remember that, because the ban would be implemented through the Construction Act, it would apply only to “construction contracts” within the scope of that Act. While the term is widely defined and captures nearly all construction and engineering contracts, subcontracts and professional appointments, there are some notable exclusions. For example:

      - Some operations are excluded (e.g. supply only of construction components); and
      - Contracts with residential occupiers are excluded, so the use of retentions in contracts for the construction of a new house or extension may still be permitted depending on the circumstances of the employing party.

    4. The Government intends to implement the new measures across the UK, but late payment is a devolved issue in Scotland. The UK Government will therefore need to work with the Scottish Government on implementation. However, it seems unlikely that the Scottish Government would take a materially different approach, having consulted on the reform of retention practices in recent years and identified many of the same concerns around cash flow, insolvency risk and fair payment for SMEs.

    If enacted, the Bill would bring an end to a long-established feature of construction contracting and require a fundamental rethink of how quality and performance risks are managed across the industry.

    While the transition period provides time to adapt, employers, contractors and subcontractors would be well advised to start preparing for that change now.