Kirsti Olson: Could Scotland lead the way in improving the UK construction industry payment process?
Kirsti Olson, a construction partner in Dentons’ Edinburgh office, has been following the Scottish Government’s progress in confronting the issue of payments in the construction industry since its announcement in December that it intended to consult on the subject.
The Scottish Government has announced its intention to consult on the use of retentions in the construction industry. The consultation, which will take place in 2019, is part of the Scottish Government’s initiative to step up engagement with the construction sector and grow “a more sustainable, productive and innovative industry”.
There have been numerous past attempts by the UK Government to look at this issue. But to date, it has been slow to take action.
Retentions are common in UK construction projects. An agreed percentage of every payment that becomes due to a contractor for its work is withheld. The money accumulates throughout the project. Usually, half of the retention is released on completion and the balance around 12 months later, when defects have been made good.
The purpose of retention is to give the employer security: it encourages the contractor to come back after completion and fix defects in its work, and protects the employer against the contractor’s insolvency. If the contractor is unwilling or unable to rectify defects later, the employer can use the fund to pay for the work that needs to be done.
However, concerns have been expressed about the abuse and misuse of retentions.
Retentions mean that payment for work done is delayed, sometimes substantially. Sub-contractors working on larger projects may have to wait until the main contract (or a subsequent phase of work) has been completed in order for the retention to be released. Sub-contractors often seriously lack visibility on when their retentions will be paid.
This delay in payment can cause hardship, particularly so for smaller sub-contractors further down the contractual chain, who have to wait longer to be paid. Retentions restrict cash flow and reduce the ability of contractors to invest in their business. Chasing for payment diverts valuable resources, and late payment can contribute to a business becoming insolvent. The smaller the business, the harder it is likely to be hit.
The risk of upstream insolvency is of even greater concern. There is no current requirement for a retention fund to be protected in any way – it sits in the bank account of the holder until it is paid. If the holder of the fund becomes insolvent, the fund becomes part of the general pot of money available to creditors. It has been reported that around 44% of contractors have suffered non-payment due to upstream insolvency in the last three years. Large main contractor failures, such as the 2018 collapse of Carillion, can have a dramatic effect on those businesses left out of pocket, with a knock on effect on the ability of the UK’s construction industry to operate as a whole.
There have been past attempts to address this issue. One of the key recommendations in Sir Michael Latham’s 1994 report “Constructing the Team” was for Government legislation to be introduced to protect retentions. The other payment recommendations in his report became law in the 1998 Construction Act. But his recommendation on retentions was not followed through.
Towards the end of 2017, the Department for Business, Energy & Industrial Strategy launched a consultation on “Retention payments in the construction industry”. The consultation closed on 19 January 2018 but no recommendations have been published.
Finally, in January 2018, Conservative MP Peter Aldous introduced a Private Members Bill (The Construction (Retention Deposit Schemes) Bill 2017-19) into the House of Commons. The purpose of the Bill is to protect retentions by placing them in a retention deposit scheme. Failing which, the money will have to be paid out in full within 7 days. However, the second reading of the Bill has been delayed on numerous occasions, no doubt overshadowed by the Brexit process.
The UK is now seriously out of step with other jurisdictions, which have legislated to ring-fence cash retentions or allowed contractors to provide alternative means of security. So, the Scottish Government’s intention to consult separately on this issue is to be welcomed and it may be more fleet of foot in implementing a solution than the UK Government has been. Certainly, this new Scottish initiative will be followed with interest.