The Department for Business and Trade has launched a consultation on legislative measures to tackle poor payment practices and, specifically in the construction sector, unfair practices around cash retentions. Michael Kitson examines the proposed changes.
Background
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 later). The aim is to secure against quality issues and insolvency risk.
Despite their intended purpose, cash retentions present various problems:
- Research suggests around 13% of retention sums are never repaid. While some of those sums are expended on rectification of defects or to cover costs arising from the payee’s insolvency, nearly all contractors and subcontractors will have examples of improper or unsubstantiated claims.
- 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 imposes additional administrative costs on payees who must chase the funds.
- They tie up working capital, limiting businesses’ financial flexibility.
Options under consideration
The government is proposing to amend the Housing Grants, Construction and Regeneration Act 1996 to address poor retention practices in “construction contracts”.
There are two options on the table.
- OPTION 1: BAN RETENTIONS
- OPTION 2: ALLOW PROTECTED RETENTIONS
This option would prohibit retention clauses in new construction contracts from a specified date, with a transitional period for businesses to adjust and manage their working capital. The consultation notes that payers may choose alternative protections (such as insurance or bonds), though these would not be mandatory.
Under this option, retentions would still be permitted, but any withheld sums would need to be protected. This means payers would have to either:
- Segregate retention funds into a designated bank account, with those funds being held for the payee’s benefit; or
- Secure the sums with a guarantee (e.g. an insurance policy or bond).
As with option 1, a transitional period would apply.
Key features of option 2
- Funds are automatically segregated and held for the payee’s benefit when deducted.
- Only a single retention sum may be deducted and withheld from the final payment in respect of works until the expiry of the applicable rectification period. This is a significant change from current practice where retention funds are deducted from each payment prior to completion.
- Interest accrued on retained funds is “owned by the payee”.
- The payer may use a single, segregated bank account for retentions but must maintain separate ledgers for each payee and contract.
- Retention sums are released automatically at the end of the defect rectification period “unless the required notice is made”.
- Disputes will be resolved through existing dispute-resolution processes, such as adjudication.
- Payers must report to payees on withheld sums and provide access to records.
- Contracts lacking these 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.
Thoughts and insights
The consultation closes on 23 October 2025 and views on the proposed measures and any potential unintended consequences are invited.
Key considerations are:
- 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 “allow protected retentions” option still requires substantial changes to contracting practices and will need support from the insurance and banking sectors.
- If clients and main contractors must hold retention funds in segregated accounts, could all payments be processed through a project bank account?
- The ban / protections will apply to “construction contracts” under the Housing Grants Act 1996 so construction contracts with residential occupiers and in certain industries will fall outside any new rules.
- Industry bodies, such as Build UK, have proposed that retentions not be deducted for lower value contracts. Could this approach or other measures gain traction in the debate?
Whichever option is chosen, strengthening SME working capital and reducing insolvency risk will benefit the long-term health of the construction sector. The reforms may also drive innovation in financial management and contract administration, encouraging more efficient project delivery.
Published 11 September 2025
