After consulting on the matter, the UK Government proposes a ban rather than changing the rules under which such retentions can be made, say, by requiring that retention sums are held in trust in separate, designated bank accounts. This touches upon devolved matters and the UK Government will need the consent of the Scottish Government to legislate in this area. The Scottish Government conducted its own consultation on retention in construction contracts and the Short Life Working Group, which reported in July 2021, came out against a ban, favouring instead 'a custodial model which holds retention payments in an independently run, protected deposit scheme....'.
All that said on the basis that a ban is now likely to become law, what impact will that have on the construction sector in Scotland?
The legislation only addresses one side of the retention issue
Currently, the proposed legislation looks at the retention issue through the lens of the problems associated with late or non-payment of retention. Those problems need to be addressed, particularly because of the negative impact they are still having on SMEs, some of whom support a total ban. There is, however, another side to the retention issue which needs to be addressed and, preferably, at the same time. Many employers, main contractors and consultants consider that in their dealings with contractors or subcontractors, retention is a valuable commercial tool which can help to ensure that defects in works are addressed timeously. The understandable drive to eradicate bad payment practices in this area is currently the main focus, although the UK Government says it will be consulting further on the implementation of the proposed ban. It is not clear, however, what the nature and extent of that further consultation will be. All that said, what are the likely consequences of a ban?
What will happen in the event of a ban?
What is clear is that, if there is a ban, employers and main contractors will have to consider what other means may be available to them to try and help secure their position. The final terms of the abolition legislation are not yet known (the details may well change as the Bill progresses through the UK Parliament) but, currently, the proposal is that there will be transitional provisions which will allow continued use of retention for a short period, probably two or three years, before the ban takes effect. While what is currently proposed in that regard may be considered by some to be somewhat cumbersome, it may be what is necessary to deal with ongoing projects and to try to be even-handed between the different interested parties as we move towards a ban.
Those affected by a ban may seek to protect their position by various means such as:
- trying to circumvent the final position in any legislation by contractual means;
- performance bonds;
- parent company guarantees; or
- defects insurance.
Trying to circumvent the final position in any legislation by contractual means
The problem with (a) is that, understandably, the legislation contains anti-avoidance provisions outlawing certain types of contractual provisions that might be used to try to get round the ban. An obvious example of that would be to try to extend out in some way the period after which the final payment becomes due so that there is a longer period within which defects could be picked up and addressed. However, such provisions are likely to be ineffective if the new payment regime set out in the Bill becomes law. Where there has been a ban on retention, for example, in New Mexico, where it's called 'retainage', experience shows that some can try to find ways round the ban via contractual terms which just lead to argument and costly disputes.
Even if contractual terms can be thought up which are not struck down by the legislation, there is always the likelihood that they may not be followed in practice and remedies for breach may be highly ineffective in securing proper, timeous performance, particularly in cases where, say, any defect is relatively small or there is a large number of small defects.
Further, the Bill envisages that after the period of any transitional arrangements has expired, attempts to bring about a retention situation will be met with a statutory penalty. Whether the size of the monetary penalty currently proposed will be enough to discourage abuse remains to be seen.
Performance Bonds
In the case of (b), requiring performance bonds in place of retention, these would need to be from financially sound third parties who will be able to make good any proper call made under such a bond when it is made, which may be years after it is granted. Experience shows that these bonds can prove difficult to obtain, with arguments over wording (for example, 'on demand' or not 'on demand'?) and the duration of the period within which a call can be made under the bond. Further, such bonds tend to be costly because of the charges that usually have to be paid out to third-party providers in order to obtain them.
While a whole new market in bonds may be created over time as a result of any ban, experience also indicates that it is not currently easy to obtain such bonds at a reasonable cost, so they may not be an effective alternative to contractual retention, particularly in smaller-sized construction contracts or where SMEs are involved.
Parent Company Guarantees
In relation to (c), a parent company guarantee ('PCG'), there is always the concern that the parent may no longer be around or able to meet a demand under a PCG at the point when a call needs to be made under it. Even leaving that to one side, the granting of a PCG will usually cause the parent to incur a cost either directly or indirectly, say, because of restrictions placed on its banking facilities.
Defects insurance
In relation to (d), such insurance should, preferably, cover both patent and latent defects in the works. Despite the hype in some quarters, defects insurance is traditionally difficult to obtain, particularly when trying to cover defects in workmanship rather than those due to design. Further, even if such cover is available, it can be costly and conditional on extensive checking of design and workmanship by third parties at various stages of the works.
Where will the additional cost lie?
Those asked to obtain a performance bond, parent company guarantee or defects insurance will inevitably seek to pass on the cost of obtaining them to those who will benefit from them. This will be yet another cost pressure pushing up construction costs.
Interaction of any legislation with other legal principles or concepts
It is not immediately clear how some of the provisions currently in the Bill will ultimately interact with other legal rules or principles such as the Scots law right of retention, which, strictly, has nothing to do with traditional percentage-based retention under the express terms of many construction contracts.
Next steps
The bottom line is that those who may seek greater security for proper performance as a result of a ban on traditional retention in construction contracts and those who might be asked to provide such security need to start thinking now about what their position will be about asking for it or responding to requests for it. That is likely to be affected by many things including the relative strength of the bargaining positions of the parties, the nature and extent of the work to be done under the particular construction contract and general market conditions, including those in the bond/insurance markets.
Many will consider that what is undoubtedly true is that a ban on retention is likely to have a massive knock-on effect, particularly in medium/large-scale construction projects. The effect of the proposed statutory changes might, strangely, make it more difficult for SMEs to operate and attract work. The problems associated with an outright ban may be the reason why SELECT, the trade body for electrical contractors in Scotland and the largest body of its kind in the country, came out in favour of retention being placed in a ring-fenced deposit scheme rather than an outright ban.
Is a fundamental change of approach still required by some?
Perhaps the above highlights that, whether or not there is new legislation on retention and no matter what the final terms of any such legislation might be, what is still required in the construction sector is a fundamental change of approach by some to timeous payment and delivering quality work. Many believe that good payment practices and producing quality work are inextricably linked. They should both be part of a well-regulated construction sector even if a well-regulated universe is beyond our control!
