As we continue to navigate a challenging economic climate, it’s claimed that late payments cost the UK economy £11bn per year and are accountable for the closure of 38 businesses each day. As a result, the Government’s Department for Business and Trade (DBT) held a consultation in October 2025, seeking views on legislative measures to address late payments, long payment terms and disputed business-to-business payments across all industries, including the use of retention clauses in construction contracts.
Ministers have stated this will be the most significant legislative reform in 25 years and the construction industry is at the heart of this issue, with it being estimated that around £4.5bn is tied up in retentions annually and 44% of contractors have lost retention payments due to upstream insolvency.
Identifying late payment challenges
It’s no secret that the construction industry is facing many challenges, with labour shortages, skills gaps, rising materials costs, and regulatory hurdles such as delayed building control Gateway approvals being just a few that quickly spring to mind. However, late payments are persistently having a detrimental impact for many contractors due to the disruption they cause to cash flow – especially for small and medium-sized enterprises – with an increasing number of businesses filing for insolvency as a result.
In response to this, the DBT’s consultation aims to find a remedy to address four key inter-related problems: late payments, long payment terms, disputed payments and unfair practice around retention payments. Out of these four, retention payments are of the most interest for the construction industry. But why are retention payments seen as controversial and causing so many cash flow issues?
Increased issues with retention clauses in construction contracts
Retention funds allow employers and contractors to hold back a sum of money – usually a percentage of the value of the contract works – to provide some security that the contractor/ sub-contractor will return to correct any defects and comply with contractual obligations. Historically, retention payments have been commonplace in construction contracts, including JCT, NEC and FIDIC standard forms, as some form of protection against breach and insolvency and can be up to 3-5% of all the valuations throughout the life of the project. Typically, retention funds are released in two parts: the first upon completion of the works and the remainder once the defects liability/ rectification period has passed.
However, it is not uncommon for contractors to simply forget about it and not claim the sums held in the retention fund. Many contractors are busily getting on with the next job and forget to go back to the previous job to claim any monies owed. Employers aren’t always proactive with releasing the funds either, often holding them indefinitely and treating them as a form of discount or alleging the cost of remedying defects exceeds the retention sums held. This is one area a liquidator will look at, checking all past jobs to see if there’s any outstanding retentions to claim or be paid.
Issues over unpaid retentions commonly lead to disputes and – depending on the size of the project and value of the retention fund – tend to end up in adjudication, with employers arguing there are still defects which they’ve had to remediate and spend the retention fund on. It’s not uncommon to see delays with settling the final account or employers trying to leverage it as a discount – which, on one hand, they could say they are entitled to do so as part of a commercial deal, but it’s not what retention funds are intended for. Furthermore, if a contractor/ sub-contractor comes to the end of a job and the employer’s gone bust, they wouldn’t necessarily be able to recover sums held as retention. So, the whole retention mechanism rarely operates correctly and efficiently, leading to abuse of a system designed to provide security and protection. And, as these issues have become more deeply ingrained, it’s led to some contractors adding price risk to projects to protect themselves – contributing to the construction costs inflation issue.
Seeking a suitable solution
In terms of alternative solutions, the Government is potentially proposing two main legal options following the consultation analysis: an outright ban on retention clauses in construction contracts or the protection of retention funds through separate bank accounts or an instrument of guarantee such as an insurance/ surety bond.
But before evaluating the two proposed alternatives, the industry should take it back to basics and question why retentions are needed at all and how they came about. One scenario regularly discussed is, what if the contractor went bust? The employer would then need to reevaluate the works and employ someone else, but the fund is not there to employ somebody else – it’s only there to cover defective work and provide some element of a cash reserve cushion.
Potential retention clauses ban on the horizon
Certainly, prohibiting retention clauses is an interesting proposal and a big change for the industry. Could the industry manage such a significant cultural shift, and would it lead to more collaborative working? Currently, employers probably see retention funds as a bit of a comfort blanket. So, in taking them away, is the industry going to become more adversarial? It would be interesting to see how the industry would respond to such a move, given retentions are so entrenched. However, it’s likely to be a positive action and probably the preferred route. The Government, through the DBT, is trying to make the industry more friendly, transparent and reduce the amount of conflict through collaborative working – which takes it back to the 1994 Latham report: ‘Constructing the Team’ which initially influenced the Housing Grants, Construction and Regeneration Act 1996. So, this is quite full circle considering the DBT consultation would be looking to implement amendments to the retention mechanism, although, perhaps not in the way Latham recommended.
Increased retention protections: a plausible way forward?
The second proposed option more closely reflects Latham’s recommendations, which would be to introduce increased retention protection measures. This could see retention funds being put into a separate bank account where they’re held on trust. So, even if the employer went bust, the money would be safe. However, it would impose additional administration costs on projects. Currently, project bank accounts are set up in joint names, at the start of a project, to provide a trust mechanism to provide the contractor with security for payment and a vehicle for retentions to be held in trust. The contractor, in a similar way to a retention trust, would have an interest in trust in the project bank account (PBA) or the retention trust account so they’re entitled to get their money out of the bank account. However, in theory for PBAs, the necessary funds for each payment cycle are drip-fed in before the contractor submits its application, based on a pre-agreed payment profile. In practice, this rarely works as intended due to changes in the payment profile of the project and employer’s not wanting their funds sat in a bank account that is not solely under their control and potentially not earning as much interest as it could be elsewhere. Also, PBAs are difficult to operate beyond the first-tier supply chain and may need to be topped up at each stage if a particular package is losing money for the contractor. This makes it difficult to manage and creates all kind of additional administrative problems in each payment cycle, as well as becoming increasingly complex and burdensome the further down the supply chain it goes. As for providing security for supply chain retentions, the PBA only really works for the first-tier contractor who may be faced with familiar challenges when it tries to claim back retention funds at the end of a project.
Another alternative the Government could consider, following the analysis of the consultation, is the use of retention bonds. Instead of a pot of money, there would be a retention bond that stays with the contractor’s bank. This means they actually never give the money to the employer unless or until the employer makes a legitimate call on the bond to remediate any defects the contractor fails to remedy. However, the bonds market is expensive and involving insurance companies could see an increase in premiums for the construction industry. Although the theory is that if there were more protection on bonds, they would be cheaper due to market demand, but they are relatively high risk because of the number of disputes that arise in relation to retention issues. There could be a significant opportunity for the banking sector to get involved and put products in place that can make the process easier but whether there is the appetite is another question. While there are some products on the market that offer that kind of service now – such as trust arrangement bank accounts – the banks naturally take their cut, which may lead to disputes over who should pay any administrative costs.
Implementing mandatory protection measures that retain funds in a separate project/ retention bank account, or even an insurance or surety bond, would be a positive move as it would ring-fence that money if either party filed for insolvency, ensuring it’s still accessible. However, there would need to be a clear-cut process and detailed provisions for how far down the supply chain such a mechanism extends. Otherwise, a number of issues could arise. For example, if an employer goes bust and the contractor wanted to make a claim for retention, who’s going to administer it? Is it going to be a straightforward system, or will it just lead to further disputes? The contractor would still face the same dispute – just without an administrator role and without an employer – albeit with the assurance that the money is there and available for the first-tier contractor, but what about the rest of the supply chain. Would it actually change industry behaviour?
Potential effects can only be a good thing for the construction industry
It wouldn’t be practically possible to apply any changes retrospectively but there is likely to be some form of transitional period to allow the industry to adapt. If the Government was to amend the Housing Grants, Construction and Regeneration Act 1996, it would likely be a prohibition on retention-type clauses. This might lead to two potential outcomes: firstly, it could create a split within the industry. The upper-tier contractors would probably take it in their stride and be happy to adopt the changes as standard procedure as, in my experience, they tend to be more collaborative and engaged – certainly on government projects. Secondly, the industry might see more increased scrutiny on interim valuations just to make sure they’re done properly. Eventually, payers may try to undervalue the works more, which could make construction more adversarial again – I doubt it? In the short term, this could lead to more disputes, but it might also introduce more positive behaviours in the long run – such as more on-site quality assurance via clerk of works to reduce defects – and place a positive focus on the use of adjudication (as it was intended to be) so that bad payment practices are nipped in the bud during the life of a project. Any increase in quality assurance and compliance can only be a good thing in terms of the Building Safety Act 2022.
Given that construction is the industry with the highest number of insolvencies, it’s clear that some form of significant action needs to be taken. So, many will be holding out for the Government’s highly anticipated consultation analysis announcement in January 2026. Whether they propose an outright ban on construction retention clauses or a reformed practice for mandatory protection, it would certainly be good to see any changes lead to more positive behaviours and collaborative working to support growth and investment in the industry.