Professor Rudi Klein LLB, FCIOB, FRSA, Barrister, Cert. Ed
CEO at Specialist Engineering Contractor's (SEC) Group, UK
Money is like muck, not good except it be spread.
Francis Bacon, English lawyer, courtier and philosopher in Essays (1625)
The UK construction industry has long had a worldwide reputation for its prowess in design, engineering, and project management skills. However, its ability to deliver high quality infrastructure and construction projects within cost and on time is severely hampered by embedded and outdated practices that add cost rather than value. The delivery process is often characterised by fragmented and disconnected inputs that detract from prioritising the needs of the project and the requirements of the client or customer.
There have been two recent events in the UK that have highlighted some of the dysfunctionalities in the construction delivery process. The first was the closure of 17 Edinburgh schools in 2016. This followed the collapse of nine tonnes of masonry at a primary school early in 2016. It was extremely fortunate that there were no injuries or fatalities amongst the children. The independent inquiry into the collapse confirmed that it was the result of poor quality construction. This was not solely the fault of one contractor but was the result of a poorly managed delivery process driven by a lowest price culture. Professor John Cole, the author of the Report of the Independent Inquiry into the Construction of Edinburgh Schools (published in February 2007) recommended – amongst other things – that best practice methodologies be introduced into the procurement process to optimise design and construction quality.
Then came the Grenfell Tower tragedy. On 14 June 2017 a fire engulfed a 24‐storey residential tower block in West London; 72 residents were killed. An independent review of the regulatory framework around building safety was set up.
It was led by Dame Judith Hackitt. In her final report she had this to say:
Payment terms within contracts (for example, retentions) can drive poor behaviours, by putting financial strain into the supply chain. For example, non‐payment of invoices and consequent cash flow issues can cause subcontractors to substitute materials purely on price rather than value for money or suitability for purpose.
Para. 9.11, Building a Safer Future – Independent Review of Building Regulations and Fire Safety.
These events, together with the collapse of global contractor Carillion at the beginning of 2018, shattered the image of UK construction. Various inquiries into the collapse of Carillion revealed its contempt for its supply chain and the extent to which it abused those firms carrying out its work.
Some would argue that construction is only as good as its clients. There is, no doubt, some truth in this. Many client organisations – in both private and public sectors – are ill‐advised by their consultants and legal advisers who tend to go down the path of least resistance by sticking with what they know. As a result the emphasis continues to be on driving down price and ensuring that all risk is laid off to the supply chain.
There is no other industry sector that outsources product/or service delivery to the extent seen in construction. According to research carried out for the UK Government Department for Business in October 2013 the average project in the UK deploys between 50 and 70 tier‐two contractors (subcontractors). The contract packages can be as small as £20 000 but most will average £50 000. There is further subcontracting to levels three, four, and even more. The delivery process has become characterised by disintegrated, hierarchical, and sequential inputs.
As a consequence the cost of UK construction exceeds that in most of the European Union member states. Every project participant will seek to recover its costs and margins together with contingencies to take account of possible risks. Each will have taken out project‐related insurance policies such as professional indemnity and contractors' all risk policies, which all cover the same type of risks. Furthermore all the myriad interfaces have to be coordinated and managed.
In this scenario the incidence of disputes is high. The lack of an overall and robust risk management strategy, which ensures that the design and construction will deliver the value demanded by the client, inevitably means that some risks will fall into ‘black holes’ or are simply ignored in the hope they will eventually disappear. Much time, effort and cost is then expended in seeking to allocate responsibility when the risks in question actually materialise.
All this is compounded by the fact that the largest UK contractors are severely under‐capitalised. Under one legal test of insolvency they could be described as insolvent if the value of their assets are exceeded by that of their liabilities. For many years their business models have been shaped by reliance on their ability to drive down the prices of firms in their supply chains and to manipulate their supply chains' cash flow. Generally they are not in a position to meet the claims from their supply chains before they have received the necessary funding from their clients.
There is a double economic ‘whammy’ for construction supply chains. First, they may have to subsidise the cost of construction because lead contractors will often not be in a position to pass on to their clients the full costs associated with the extent of the outsourcing on particular projects. Second, they will often have to subsidise the lead contractor by extending trade credit and, thus, ultimately, funding the project. According to research carried out for the UK Business Department referred to earlier, tier‐one contractors were found to be net receivers of trade credit whereas tier‐two firms were net providers of trade credit.
The undercapitalisation of tier‐one contractors and their reliance on business models generating negative need for working capital may in practice be as decisive as industry attitudes to risk and business models of risk transfer in determining whether intended changes to procurement and form of payment (milestone payments, performance‐based contracting) will be taken up by the industry, and with what effect on competition.
(UK Construction: An Economic Analysis of the Sector, Department for Business, Innovation & Skills, July 2013).
Large tier‐one contractors will also deploy other means to extract funding from their supply chains. These will include so‐called main contractor discounts, rebates, pre‐bates and profits gained through the application of supply chain finance arrangements (whereby firms in the supply chain have to pay a fee for earlier payment).
Construction supply chains are not supply chains at all. Rapid mobilisation (and then dispersal at the end of the project) of numerous subcontractors at different levels of subcontracting – usually following selection on lowest price – can hardly be described as supply chains.
The UK construction industry…is thought to be more fragmented than its major competitors such as Germany or France.
(UK Construction: An Economic Analysis of the Sector, Department for Business, Innovation and Skills, July 2013.)
What are supply chains? Chains have links and therefore a fully functioning supply chain should, at least, have the following links:
The communications link is about having regular and positive dialogue between all parties to facilitate efficient delivery of the project; not, for example, issuing early warning notices that state there is a risk of delay and the recipient is responsible.
Supply chains do not exist for the purpose of funding projects. Recently the Specialist Engineering Contactors' Group analysed the accounts of the top dozen UK construction companies. They were owed £1 billion of cash retentions by their clients but 85% of this was funded as an unsecured loan by their supply chains.
The people link is about genuine collaboration between different supply chain entities to realise the objectives of the project. The product link enables all supply chain entities to fully understand the clients' success factors with a shared commitment to ensure that those factors are always prioritised in the delivery process.
In other words a supply chain is a dynamic resource that should be deployed to minimise project risk from the outset of the procurement process, not a receptacle for dumping all commercial and project‐related risk after the works have commenced. How many examples are there of projects having a risk register that has been signed off by key elements of the supply chain before commencement of construction? Probably very few.
In fact this picture has not significantly changed since the 1970s when architect Professor Denys Hinton described the construction in the following vivid terms:
…the so called building team. As teams go it really is rather peculiar, not at all like a cricket eleven, more like a scratch bunch consisting of one batsman, one goalkeeper, a pole‐vaulter and a polo player. Normally brought together for a single enterprise, each member has different objectives, training and techniques and different rules. The relationship is unstable, even unreliable, with very little functional cohesion and no loyalty to a common end beyond that of coming through unscathed.
The UK construction industry has never been short of reports and initiatives that have fully described the problems and offered solutions. Examples from recent memory include Latham (Constructing the Team, 1994), Egan (Re‐thinking Construction, 1998) and Farmer (Modernise or Die, 2016).
The late Sir Michael Latham's legacy was Part 2 of the Housing Grants, Construction and Regeneration Act 1996, commonly referred to as the Construction Act. The Act made a significant difference in improving payment security especially for small and medium‐size enterprises (SMEs) in the supply chain. Previously, payment disputes could only be resolved in arbitration or by the courts. This meant that most SMEs would have had to sacrifice their entitlements rather than having to incur substantial legal costs in issuing arbitral or court proceedings.
The Act introduced a statutory right to refer disputes to adjudication. This was to be an inexpensive and quick procedure aimed at providing a stop‐gap decision that would help the cash to flow. As the late Lord Ackner said in the debates on the Act in the House of Lords: ‘[Adjudication] was a highly satisfactory process. It came under the rubric of “pay now argue later” and was a sensible way of dealing expeditiously and relatively inexpensively with disputes….’
Now contrast this with the comments made by Lord Fraser in the recent case of Ground Developments Ltd v FCC Construccion SA & Ors (2016) EWHC 1946. First the facts in the case:
Ground Developments Ltd (GD) had been engaged as a subcontractor by a joint venture comprising FCC Construccion, Samsung, Kier Infrastructure and Merseylink Civil Contractors (the joint venture (JV)) to execute certain groundworks in connection with the new six lane toll bridge over the River Mersey.
GD had submitted three payment applications totalling almost £200 000 plus VAT. The JV chose to ignore them; they didn't issue any notices. GD sought adjudication. Unsurprisingly the adjudicator ordered the JV to pay up. He also ordered the JV to pay all GD's fees (no doubt reflecting the fact that there was no meritorious reason for the JV denying payment).
GD was forced to go to court to enforce the adjudicator's decision; the JV defended the enforcement proceedings.
Their defence had nothing to do with whether or not the £200 000 was outstanding. During the adjudication the JV had maintained that the adjudicator had no jurisdiction because there was no contract when, in fact, they had ignored numerous attempts by GD to complete a NEC3 subcontract. During the enforcement proceedings – when pressed by the court – they changed their tune. There was a contract albeit on their terms. Mr Justice Fraser enforced the adjudicator's decision.
Finally, excluding VAT, the parties collectively spent a total sum by way of costs in these proceedings in excess of £55 000, arguing about the enforceability of a sum of about £207 000, which was potentially repayable in any event because of the temporarily binding nature of adjudication. That is over one quarter of the sum the subject of the decision. It cannot pass without comment that this is contrary to the purpose of Parliament when it imposed this alternative, and temporary, process of dispute resolution upon parties who enter into construction contracts.
The £55 000 would not have included the amount spent by the parties on legal fees incurred during the adjudication.
Therefore a key element in the statutory framework initiated by Latham has lost some of its original gloss. Adjudication is essential for dealing with the everyday type of disputes that revolve around set‐offs, often spurious counterclaims and recovery of outstanding retentions. However, its benefits have to some extent been subverted by the increasing costs relating to the fees and expenses of adjudicators and the legal costs associated with legal representation.
This is not to ignore some of the enduring benefits of the Act such as the limited ban on pay when paid, the right of suspension for late payment, and the statutory payment notice procedure introduced in the 2011 amendments to the Act.
Concerned about the inefficiencies and waste in an industry responsible for 7% of GDP the (then) Labour Government commissioned Sir John Egan (ex‐chairman of Jaguar cars) in 1997 to report on how clients and the industry should change delivery models to ensure cost effective and value for money outcomes. Egan didn't pull his punches. Delivery had to be more integrated and collaborative. A follow‐up report in 2001, Accelerating Change, sought to put in place a targeted programme of activities aimed at achieving an integrated delivery process. Accelerating Change was the product of a newly established Strategic Forum for Construction chaired by Egan and comprising representatives from government and industry:
Payment practices should be reformed to facilitate and enhance collaborative working.
The forum was charged with producing models for payment mechanisms and key performance indicators for payment within supply chains to establish and benchmark best practice. Needless to say these initiatives either lost their impetus and/or were never implemented. This is the way of many good initiatives in the industry aimed at inducing long‐lasting change. Both parties – government and even some industry bodies – have been guilty of blocking positive change where it doesn't suit their own vested agendas or, like a child with a new toy, have lost interest and moved on to something more interesting.
In 2016 Mark Farmer was commissioned by the Construction Leadership Council (in reality the Business Department) to carry out a review of the UK construction labour model. The outcome, a report titled Modernise or Die, echoed the industry's failings that were canvassed in previous reports. Farmer put his finger on the reason for the lack of progress in improving the industry's delivery processes:
There is no strategic incentive or implementation framework in place to…initiate large scale transformational change.
He advocated the use of project bank accounts (PBAs) and ‘a move away from a culture of using other people's money to make money’. The Government's response to Farmer was fairly non‐interventionist. The industry had to sort its own problems out. Such exhortation is ‘pie in the sky’. The industry is incapable of sorting out its problems unless there is in place some external driver.
In the meantime the plundering of supply chain financial resources, especially by the largest UK contractors, continues. All sorts of scams and whizzes are deployed to extract cash from supply chains or to create reasons for justifying late or non‐payment.
So‐called main contractor discounts are common but other impositions such as pre‐bates or rebates (not necessarily geared to the volume of work generated) are slapped on unwilling or reluctant firms. Whether all this discounting is revealed to clients – especially where there are target cost arrangements in place – is open to question.
In some cases conduct verges on sheer dishonesty. For example, subcontractors sometimes find that they have been sucked into contracts under which they are being paid the correct amounts on time. This continues for a period. The firms are given more work. Then as time wears on – and after having been given a large amount of work by the same company – payments start to slow down. They become irregular and never reflect the correct amounts. Eventually the firm in question has to go into insolvency. The company responsible for this act of dishonesty then hoovers up the resources of the company to complete the work and gets away with not paying the vast amounts of cash that were owing.
The ‘condition precedent’ clause has now become de rigueur in many subcontracts. Often they are used to deny any entitlement to payment unless certain bonds or warranties are signed. However, contracts are entered into without subcontractors being given sight of the relevant documents that they may be required to sign up to. The example below is of a condition precedent clause, which is even more perfidious:
Notwithstanding any other provision of this subcontract, no payment is due or is made…if performance of the obligations of the Subcontractor in terms of this subcontract is not in compliance with this subcontract or otherwise to the satisfaction of the Contractor acting reasonably.
This, potentially, could provide the contractor with countless reasons for not making payment; even where such reasons lack substance.
Cross‐contract set‐off is fairly popular.
The Contractor shall be entitled to set‐off against payments due to the Sub‐Contractor any amounts which the Contractor has claimed against the Sub‐Contractor or to which the contractor has become entitled to under any other contract between the Contractor and Sub‐Contractor.
Section 110(1A) in the Construction Act outlaws such clauses:
The requirement…to provide an adequate mechanism for determining what payment become due under the contract, or when, is not satisfied where a construction contract makes payment conditional on –
- the performance of obligations under another contract, or
- a decision by any person as to whether obligations under another contract have been performed.
Avoidance techniques to get around the Construction Act are now commonplace. Here is an example of a clause aimed at avoiding Section 110(1A).
The first moiety of retention will become due within twenty eight (28) days of the attendance by the Subcontractor at the Main Contractor's meeting prior to Practical Completion (or equivalent) of the Main Contract works. The second moiety of retention will become due within twenty eight (28) days of the attendance by the Subcontractor at the Main Contractor's meeting prior to the Certificate of Making Good Defects (or equivalent) under the Main Contract. (emphasis added)
Here the release of retention is made conditional on attendance at the main contractor's meeting (rather than on performance of the main contract obligations or issue of a main contract certificate, both of which would be outlawed by Section 110(1A)).
There seems to be a belief in the industry that one can amend statutory provisions by the simple expedient of inserting a different provision in the contract. Here is an example of one such clause:
Where the Sub‐Contractor intends to exercise its right of suspension for non‐payment under Section 112, Housing Grants, Construction and Regeneration Act (as amended) the Sub‐Contractor shall issue a notice of suspension at least 42 days prior to the date on which it intends to suspend. (emphasis added)
The Construction Act only requires that the notice is issued 7 days prior to suspension.
This is only a small part of the story. The UK construction industry is riven by payment abuse and bullying that, in the worst cases, amount to fraudulent behaviour. Outstanding payments are used to extract or leverage concessions that would not otherwise have been granted. One such example is the case of a specialist contractor that had completed work under a letter of intent. The final payment under the letter of intent would not be made unless the contractor agreed to sign the proffered subcontract. It is also fairly well‐established practice to hold back payment due on a final account or not release an outstanding retention unless 10% (or possibly more) is knocked off the final account.
Over the years following the Construction Act reforms and the amendments made to the Act (which were implemented at the end of 2011) both Parliament and governments of various hues have sought to address these issues, particularly where they impacted on public sector construction. For example, in 2002 the Trade and Industry Committee in the House of Commons carried out an inquiry into the practice of retentions. It advised that the practice was ‘outdated’ and ‘unfair’ and that they should be phased out in the public sector as soon as possible. This recommendation was echoed in a later report, Construction Matters, published by the Commons Business and Enterprise Committee in July 2008. These recommendations were ignored.
Many (including governments) have believed that the problem will be solved by voluntary charters and codes. Those that believed this failed to recognise that payment abuse is the result of strongly embedded commercial policies. In 2008 the (then) Government published, to great fanfare, the Prompt Payment Code. Some signatories to this Code have been amongst the worst offenders. One can have a contractual obligation to pay within 150 days and still be within the Code, provided that one did not pay late.
In 2007 the Office of Government Commerce (OGC) – which was then responsible for public sector procurement policy – published its Fair Payment Charter with endorsement from the construction industry. This charter set out eight ‘Fair Payment Commitments’ including 30 day payment cycles. This model fair payment charter was included in a Guide to best ‘Fair Payment’ practices issued by OGC. Within the list of commitments there was included the following:
- Companies have the right to receive correct full payment as and when due. Deliberate late payment or unjustifiable withholding of payment is ethically not acceptable.
- The correct payment will represent the work properly carried out, or products supplied, in accordance with the contract. Any client arrangements for retention will be replicated on the same contract terms throughout the supply chain....
The Guide went on to recommend the progressive use of PBAs and that evidence of good payment performance should be used by public sector bodies as a key pre‐qualifying criterion for the selection of lead contractors. Public sector clients were invited to sign the charter at the outset, while contractors and their suppliers would be expected to sign before appointment.
However, subsequent experience indicated that the charter was either not being signed up to by project participants or, if it was, it was subsequently ignored. The Government Construction Clients Board (GCCB) – which was now in the procurement driving seat – decided to be rather tougher. The Cabinet Office published Procurement Information Note 2/2010, which advised that all payments on government works contracts would be made within 14 days of due payment dates under the main contract and to subcontractors within 19 days of the main contract due dates and to subsubcontractors within 23 days of the main contract due dates.
The Note stated that the GCCB had agreed that central government departments, agencies and non‐departmental bodies would move to a position where PBAs were adopted unless there were “compelling reasons not to do so.” This still remains the policy of government as a construction client.
Nonetheless it seems that there are some who still never learn from experience. At the beginning of 2013 the Department for Business, Innovation and Skills (as it was then known) was developing a sectoral industrial strategy for construction. This was launched in July 2013 as Construction 2025. However, out of nowhere, there appeared in this glossy document a proposal for a Supply Chain Payment Charter. There had been no prior discussion with the industry about this. Again this charter was intended to be voluntary and was officially published in April 2014 by the Construction Leadership Council, a Government appointed body.
The charter had all the usual platitudes including the ‘ambition’ of getting rid of retentions by 2025. This charter was revised to re‐set its targets with the objective that, by the beginning of 2018, everyone would be paid within 30 days. Needless to say this was not achieved. Unfortunately this ‘pie in the sky’ charter was pedalled by certain industry bodies that either possessed a naivety of child‐like proportions or were deliberately seeking to obstruct real improvement.
In October 2012 the (then) Prime Minister, David Cameron, announced that his Government would be promoting its Supply Chain Finance Initiative. This was aimed at small enterprises and SMEs. A supplier, on payment of a small fee to the bank nominated by the paying party, would be able to access its cash earlier. However, Cameron didn't anticipate how the construction industry would respond to this. One large company doubled its payment cycles and then invited its suppliers to pay a fee to access their monies within the original payment timescale. Other large companies followed suit and in the process generated large cash bonuses for themselves.
In May 2013 Cameron's small business adviser, Lord Young, recommended that payment terms on all public sector contracts and subcontracts should be standardised. The opportunity to implement this came with the introduction of the 2015 Public Contracts Regulations. Regulation 113 obliged public bodies to ensure that 30 day payment clauses were inserted in all contracts, subcontracts and subsubcontracts.
Statutory guidance accompanying Regulation 113 advises that in construction contracts the 30 days should commence from the expiry of the 5 days from the contractual due date for payment. The five days are the statutory period (under the Construction Act) during which either party must issue a payment notice informing the other of the amount of payment considered to be due.
Unfortunately the means of enforcing Regulation 113 is very weak. The absence of a 30 day payment clause in a supply chain contract only gives a contracting party a right to complain to the Mystery Shopper Scheme. This is a complaints process managed by Crown Commercial Services. Unfortunately this scheme lacks enforcement powers. It may be that, in time, such complaints would be dealt with by the recently appointed Small Business Commissioner, who also lacks ‘teeth’.
Reference has already been made to PBAs. In 2016 the Infrastructure and Projects Authority published its Construction Strategy 2016–2020. This stated:
PBAs are recognised as an effective mechanism for facilitating fair payment to the supply chain. Government departments have committed to use PBAs on their projects unless there are compelling reasons not to do so. Improving the financial position of SMEs, reduces the risk of insolvency which can in turn limit the capacity of the market to deliver good value. It can also help to improve the standing of government clients and foster collaborative relationships across the supply chain, leading to increased value for money across programmes of work.
The first PBA in the UK was set up on a Defence Estates (now the Defence Infrastructure Organisation) project at the turn of the century. The project was the Defence Logistics Headquarters at Andover in Hampshire. The Defence Estates required that the contractor, Citex, pay its supply chain as a condition precedent to payment by Defence Estates as the client. Citex – as is the case with many main contractors – did not have the funds to do this. A way around this dilemma was eventually negotiated. Defence Estates would lodge certified payments in a PBA out of which payments would be made directly to Citex's supply chain. During the course of the project Citex went into insolvency. The insolvency practitioner was unsuccessful in obtaining the funds in the PBA for distribution to Citex's creditors.
A PBA is a ring‐fenced bank account out of which payments are made directly and simultaneously to a lead contractor and members of its supply chain. The PBA must have trust status; monies in the account can only be paid to the beneficiaries – the lead contractor and named supply chain members. The bank account should be held in the names of the trustees, who are likely to be the client and lead contractor (but members of the supply chain could also be trustees).
The advantage of trust status is that an insolvency practitioner (administrator or liquidator) appointed to the lead contractor's company cannot have access to the monies in the account. This is because the monies are ‘owned’ by the beneficiaries of the trust, that is, both the lead contractor and members of the supply chain. The motivation for some clients using PBAs is that they minimise disruption when a lead contractor goes into insolvency.
A PBA may be suitable for a £1 million project or even smaller projects. At the beginning of 2013 the Northern Ireland government announced that PBAs would be used on public sector projects over £1 m although this was subsequently raised to £2 million. For projects of short duration, such as a few weeks, PBAs may not be necessary.
The benefits of having a PBA in place outweigh most other options for achieving fair payment (apart from direct payments from a client to the supply chain):
Since the lead contractor doesn't have access to its supply chain's cash the temptation to use it isn't there. This also applies downstream to tier‐two and tier‐three contractors. Thirty day payments will often end up being ninety day payments and longer by the time they get to the end of the supply chain. Table 5.1 illustrates this.
From the above it can be seen that a PBA removes a long‐winded, potentially abusive and hierarchical payment structure.
| Traditional payment arrangements | Project bank account | ||
| Days | Days | ||
| Client to contractor | 30 | Client to PBA | 30 |
| Contractor to subcontractor (usually much more) | 30 | Contractor and subcontractors | 5a |
| Subcontractor to subsubcontractor or supplier (usually much more) | 30 | 35 | |
| 90 | |||
a This is the maximum length of time for the money to be in the PBA.
PBAs do not cut across the contractual provisions governing entitlement to and discharge of payments. They are simply a safe receptacle for the cash. Once the lead contractor has agreed its application with the client the agreed amount is paid into the PBA. The contractor then issues the authority to the bank listing the names of the recipients and the individual amounts to be paid. The client will also sign off the authority. All payments in and out of the account are made electronically, which means that monies should not be in the account for more than five days. If, for whatever reason, there is a shortfall in the account, the lead contractor remains bound to pay what is due to its supply chain members. This is not a pay when paid mechanism.
To date no alternative to PBAs has been offered as providing a more effective solution to the persistent and endemic problem of late and non‐payment in construction. It does behove those who are critical of the concept to develop solutions that will have at least the same impact as PBAs.
The practice of retentions has been in existence for almost 200 years. It was originally introduced to provide a measure of security in the event that a contractor went into insolvency. Today it is claimed that retentions are necessary to ensure that a contractor returns to remedy non‐compliant work within a so‐called Defects Liability Period, although industry standard contracts do not define with any precision the reason for which retentions are withheld.
Research carried out for the UK government in 2017 indicated that the prime motive for withholding retentions is to boost the cash flow of the party deducting them. This even applies to many public bodies that require retentions to finance other works or activities.
The abuse associated with the practice is well known. Retentions are rarely released on time and in many cases are never released. Many small firms give up chasing the monies. This was what Her Majesty's Revenue and Customs had to say:
In recent years, construction industry customers have become increasingly reluctant to pay retention monies, irrespective of whether there are defects to be made good. It is now common for such monies never to get paid.
Cash retentions also amount to a subsidy to financially strapped businesses in the industry. They subsidise incompetently run businesses. This was acknowledged by the New Zealand Government when recently passing legislation that required that retentions were to be placed in trust.
Retentions are also the antithesis of trust. It is a strange way to kick off a commercial relationship by suggesting to a contractor that you don't trust it to properly complete the job and therefore you are holding back 5% from its due payments. There is so much pre‐qualifying, accrediting and auditing of firms today that one would think that this would provide a measure of comfort when seeking a competent firm.
On the other hand there are no barriers to entry to the industry. The ability to offer the lowest price is often the dominant criteria in selection. No doubt some would view retentions as a small cushion should the firm that has offered the lowest price goes into insolvency or simply disappears.
Research commissioned by the Business Department in 2015 and published two years later in October 2017 revealed that £700 m of cash retentions (at 2016 prices) had been lost as a result of upstream insolvencies. This represents almost £900 000 lost each working day by the industry. Retention monies are legally owned by the party from whom they have been withheld. Consent to their withholding doesn't extend to their being made available to satisfy the creditors of the other party in the event of that party's insolvency.
This lack of security for retention monies also means that firms cannot, in turn, use their retention ledgers as security to increase their borrowing facilities. However, there are other costs. The bulk of these are expended by firms in chasing outstanding retentions; often they are not released until some years after handover. Some tier‐one contractors are known to release only a small percentage of outstanding retentions at handover (less than the standard 50%) and release the balance some two or three years after handover.
The late release of retentions also deprives firms of millions of pounds in interest. Whilst there exists a statutory right to interest for late payment, firms in the industry are often too commercially afraid to use it.
So what's to be done?
In Constructing the Team Latham recommended that cash retentions must be placed in trust. This never happened.
Whilst some in the industry will call for a statutory ban on withholding retentions there is likely to be considerable opposition to this. However, one state in the United States, New Mexico, has already outlawed retentions. Article 28 of the 2013 New Mexico Statutes states (Section 57‐28‐5):
When making payments an owner, contractor or subcontractor shall not retain, withhold, hold back or in any other manner not pay amounts owed for work performed.
This provision originally came into force in 2007 and was consolidated into the 2013 New Mexico statutes.
The easier way forward is to ring‐fence cash retentions in the way advocated by Latham. Using an existing model is always the better option. One such model is the protection offered to shorthold tenants under Section 215 of the Housing Act 2014. This requires that a landlord requiring a cash deposit from a tenant as security for the performance of the latter's obligations under the tenancy agreement must deposit it in a government approved scheme. To date there are three such schemes.
Equally legislation could provide that cash retentions are deposited in a retention deposit scheme. This would ensure that the monies are safe from upstream insolvencies and that they would be released on time.
UK construction is at a major crossroads. The UK's exit from the European Union is likely to have a significant impact on its cost base. Both public and private sector clients are increasing pressure on the industry to innovate, primarily through investment in digital and manufacturing technologies. The industry is being driven to make greater use of robotics, augmented reality tools and 3D printing.
These demands and pressures are unlikely to be fully addressed unless the industry's inefficient payment practices are dragged out of the nineteenth century into the twenty‐first century. This will mean a radical change in the business models of many companies, particularly the largest contractors. The use of digital tools such as blockchain technologies will need to come to the fore to create greater transparency in project payment systems, thus ensuring that cash flow is being constantly maintained to all participants in the delivery process.
In December 1993 Latham published an interim report titled Trust and Money. In that report he observed that instead of oil (money) the construction engine had grit in it. The engine still has grit and, whilst it remains, the consequent lack of trust in the industry will continue to obstruct the collaborative effort that is desperately needed to bring the UK construction delivery processes into the modern era.