The Department of Business and Trade’s announcement of a proposed ban on cash retentions marks a significant shift in the way construction contracts may soon handle payments and defective work. Although the move appears alongside wider reforms to tackle late payment in business-to-business transactions, its implications for the construction sector extend far beyond cashflow timing. Retention has long been woven into the commercial and contractual fabric of construction, and its removal would fundamentally reshape pricing, risk allocation and project security.
Wider push against late payment
At the heart of the reforms is a broader push against late payments, expecting to build on the Late Payment of Commercial Debts (Interest) Act 1995 by increasing the remedies available for overdue invoices. Under the updated regime, the threshold for penalty payments is expected to trigger earlier and with greater effect – for example, a £100 penalty replacing the previous £40 level, and interest at 8% over base. While these reforms apply across sectors, the decision to abolish retentions in construction contracts sits squarely within the construction industry’s long‑running struggles with payment practices and supply‑chain insolvency. This proposal is part of the Government’s approach to encouraging the industry to be more open and cooperative, and potentially more robust in carrying out fair valuations.
Consultation
Historically, government consultations have explored two competing approaches: abolishing retentions altogether or holding them in a ring‑fenced escrow account subject to fiduciary duties around release of payments. Industry responses have been divided, but both options reflect an acknowledgement that the current system is not working effectively. Despite this consultation history, no detail has yet emerged on how the proposed ban will be drafted. A likely model, however, is that legislation would mirror the Housing Grants, Construction and Regeneration Act 1996 (as amended) in imposing outright prohibitions – similar to the existing restrictions on pay‑when‑paid and pay‑when‑certified mechanisms.
“Construction operations”
In considering where the ban might apply, it is important to recall that the statutory definition of a “contract for construction operations” is broad. It encompasses agreements that may not traditionally be viewed as construction work – for example, facilities management or maintenance arrangements. The Government’s messaging emphasises protecting small and medium-sized enterprises (SMEs) from late payment, but nothing in the announcement suggests that the retention ban will be limited to contracts involving small entities. The industry should therefore anticipate a blanket prohibition across all contracts falling within the scope of the Construction Act.
Retention mechanism
Retention is a simple mechanism in theory: a small percentage (typically 3 to 5%) of each interim payment is withheld, with 50% typically released at practical completion and the remaining 50% released at the end of the rectification period – usually 12 months later. In practice, however, it has evolved into a pooled sum managed by the employer or upstream contractor. When insolvency intervenes, the retained cash may dissipate within the general estate, leaving those further down the chain unable to recover sums owed. This cashflow risk disproportionately affects SMEs, whose working capital is most vulnerable to withheld funds.
Commercial approach and sureties
Some contractors avoid the cashflow impact by providing retention bonds rather than allowing cash to be withheld. While this preserves liquidity, it increases project costs and often consumes valuable credit lines – again placing SMEs at a disadvantage. Employers, for their part, view the retention pot as an essential resource for funding defect remediation when contractors fail to return or where supply‑chain insolvency leaves defects unaddressed.
Commercial approach
Contractors often assume retentions will never be fully recovered and price their works accordingly, either inflating costs to offset the withheld sum or front‑loading valuations to protect cashflow. This behavioural response raises a broader question of commercial effectiveness. If employers ultimately pay more for works because retention exists – yet cannot always rely on the withheld sum to address defects – the mechanism may offer neither economic efficiency nor genuine security. Retention is likely to be a contributor to construction inflation – already a major challenge for an industry grappling with labour shortages, material costs and squeezed margins.
Alternatives?
If retentions are abolished, employers will need to rethink how they secure defect rectification. Alternative security – whether guarantees, performance bonds or more sophisticated surety arrangements – may become more commonplace. The surety market already supports bond‑based solutions, often required by funders, but the Government’s announcement leaves unanswered whether security instruments generally will be regulated or restricted under the new regime. On one view, a prohibition on cash retention should not prevent non‑cash forms of security, as these do not impede the cashflow of SMEs in the same way. However, if employers respond to the ban by mandating more extensive or higher‑value defect bonds, contractors – especially smaller firms – could still face increased financial strain through bond costs and tied‑up credit capacity.
What does a retention-free future look like?
Ultimately, the proposed ban prompts wider questions about how risk for defect remediation should be shared. Retention has long functioned as a default solution rather than an optimal one, a compromise between cost, security and cashflow. If legislation removes it from the toolbox, the industry will need to innovate, developing security models that protect employers while maintaining liquidity for contractors. Careful drafting, robust contract administration, and commercially balanced alternatives will be essential. There will doubtless be attempts to work around the ban, and careful legislative drafting and practical remedies will be needed to ensure its effectiveness. Of note, standard forms of construction contract, such as JCT, include retention provisions and will therefore require updates or amendment.
The construction sector is no stranger to reform, but few changes have the potential to reshape its financial foundations as significantly as the abolition of retention. Whether the industry will emerge with more collaborative supply‑chain relationships – or simply new forms of financial pressure – will depend on the detail of the legislation and the creativity of the contractual solutions that follow.