Retentions: will proposed deposit scheme help to rebuild trust?

Keith Emmerson

By Keith Emmerson, an associate in Gillespie Macandrew LLP’s dispute resolution team, specialising in construction

IN April 2020, I wrote on the Scottish Government’s consultation regarding the future of cash retentions as a means of ensuring compliance in construction contracts. There was a prevailing view across the industry that the retention regime is no longer fit for purpose (if it ever was).

Far too often, retentions are paid late, if at all. Employers are frequently accused of using retentions improperly to shore up their own finances, rather than holding them on behalf of the contractor, who is ultimately entitled to the payment.

As the retention is not ‘ring-fenced’, if the employer becomes insolvent, then there is a real risk that contractors or sub-contractors further down the chain will lose their retentions.  Many smaller contractors will write off, rather than pursue retentions they are contractually due.

As much as 5% of a contract sum could be written off from the outset of the project, reducing tight margins ever further. Less scrupulous employers may use their knowledge of this practice to their own advantage in selecting contractors.

The consultation has now concluded, and the Short Life Working Group has reported its recommendations.  The key recommendation is for a statutory custodial Retention Deposit Scheme (‘RDS’), similar to the Tenancy Deposit Scheme for private residential leases.  In such schemes, the tenant’s deposit is held by an authorised third-party scheme provider at no cost to landlord or tenant.

The landlord applies to the scheme provider at the end of the tenancy for any money they consider due for repairs etc. from the deposit; the balance is then repaid to the tenant.

An adjudication mechanism (also free to both parties) applies to any dispute over repayment of the deposit.

The scheme is funded through interest accrued on the deposited sums held by the scheme provider.

It is easy to see how, in theory, RDS could be applied to retention funds: rather than simply withholding the agreed percentage, the employer would pay this at each payment date to the scheme provider. The retention would then be released to the contractor in accordance with the RDS rules. However, before RDS can be implemented, a number of issues must be considered:

• Who pays for the scheme?  It is understandable that the scheme is free for use in a private tenancy context, which will almost certainly involve at least one private individual.  It is harder to argue for this in the context of commercial arrangements.

• What will the rules be for release of the retention? Will it be for the contractor to apply for release (similar to a payment application under the building contract), or following the Tenancy Deposit Scheme model, would the employer apply to hold on to the retention if necessary, with the balance being paid out to the contractor?

• How will disputes be resolved?  Would the existing construction adjudication regime apply? If so, there is still the issue of the legal cost of running (and, perhaps, enforcing) an adjudication, which may be prohibitive for cash-strapped contractors to pursue. Would there be a separate dispute resolution mechanism for dealing with retentions? The recommendation of the working group is that dispute resolution should be ‘rapid’ and ‘low cost’, but without any elaboration on how this might work in practice.

The use of RDS would certainly curtail an employer’s ability to use retentions as working capital, which is welcome.  We should also expect that alternatives to retentions might be more prevalent.

Whether or not such alternatives (such as performance bonds or parent company guarantees) will create greater cost-certainty and cashflow will remain to be seen, but hopefully RDS is a step in the right direction for the industry.