By Calum Melville, CEO of Edison Capital
Is there a strategy within the construction industry in Britain to drive contractors out of business? This is not some mad conspiracy theory. The tragedy for the sector is that it has to be asked as a serious question.
What makes me say this? Well, nobody in construction will be surprised to learn that I am talking about cash retentions, the issue which has bedevilled small- to medium-businesses throughout living memory and is still killing them off with depressing regularity.
We need to be explicit about the shocking behaviour of big companies holding on to money that doesn’t belong to them and the fact that unscrupulous outfits are not paying what is owed to their suppliers in the hope that they will go under, and resolve the issue for them. Everyone who goes bust in this business has on their books a customer who hasn’t paid them.
Unfair behaviour by the big boys remains rife. Only last week (October 8), a major Scottish-based contractor was ordered by the High Court to pay a subcontractor £1.1 million when the judge ruled it had mounted a “frivolous defence” and that its arguments were “entirely without merit”.
This is not a new problem. Retentions, which are still the main bugbear, have been a part of the construction industry in the UK for more than 100 years and, in recent times, there has been a growing divide between major companies, which regard them as a useful mechanism, and smaller firms which almost unanimously see them as a company-destroying blight.
A rational analysis of the matter probably lies somewhere in between, but the focus of the construction sector, in which I have become increasingly involved over the past two years, must surely be on whether retentions have a place in a modern industry or whether Government should be legislating to get rid of them.
First of all, what are retentions? Essentially, they are a percentage of payment held back typically by a client or main contractor under a construction contract to act as security, or an assurance that the project works will be completed and that defects which may subsequently develop are remedied.
On the face of it, this seems reasonable, since it would appear to ensure that the contracted works are defect-free and that, in theory, the sub-contractor’s payment is protected until it is released at the end of an agreed period.
That is how it would work in an ideal world. However, in the mud and breezeblock world of the sub-contractor, things can often be seen from a different and significantly more jaundiced perspective.
The time between the contract start and the release of the held-back payment can inexplicably lengthen, frequently to the point where the subbie, now fully engaged on other projects, stops trying to collect and writes it down as a loss.
It is widely believed in the industry that less responsible contractors have made it a practice to count retentions as part of their own profit, or as an aid to cashflow, and have never had any intention of releasing the sums in question. Or contractors go bust, and the retention monies held go to primary creditors, rather than those to whom it was owed.
Let’s also factor in that, if clients keep 5% of the contract value as job retentions, that could equate to 50% of the profit the contractor expects to make. It could even be 100%. Margins are tight across the board, so it makes it even harder to swallow.
Even when contractors are calculating their returns from a job, they often don’t include existing overheads and, while overlooking this clearly is their fault, it shows they are so desperate to win the work that they are not pricing it properly, and it adds more pressure.
Also, contractors legally need to be on site the whole time, accruing further costs, especially if money is being held back. If they leave, they will be breaching contract and could be in more trouble legally, so they are stuck between a rock and a hard place.
Industry veteran Rudi Klein, former CEO of the SEC Group, said recently that SMEs had lost more than £2.5 billion of retentions, at a conservative estimate, as a result of upstream insolvencies. The Pye Tait Report from seven years ago reckoned that £5 billion was being withheld annually – a figure that will only have risen in the intervening period.
Just last year, in a less-than-festive Christmas message, Scotland’s Construction Industry Collective Voice said that 73% of respondents to a survey had experienced severe difficulties in securing the release of their retentions.
There have been innumerable Government initiatives over the years, at both Scottish and UK levels, to address the issue – from Build UK’s “roadmap to zero retentions” by 2025, the Get It Right initiative and the 2018 Hackitt Inquiry on building safety – but the practice remains as firmly entrenched in the construction industry psyche as ever.
This month’s damning Grenfell Inquiry report is long on improving standards – which, it is generally recognised, removing retentions would do – but the best advice would be not to hold your breath on that one.
One potential answer to what is clearly a convoluted and intractable problem might be an adoption of some of the more realistic elements of the Industry Behaviours Charter introduces by Oil and Gas UK’s Efficiency Task Force in 2015.
As well as a collective commitment to work effectively, efficiently and co-operatively, the charter suggested that differences of view on retained money could focus on the individual part of the contract at issue.
Thus, if the matter in dispute was worth only 5% of the whole contract, then that would mean that 5% wouldn’t be paid rather than holding onto all the monies in the meantime while it was resolved.
The GVA of the construction industry in the UK was £108.7 billion, according to number-crunching site Statista, compared to a contribution of £30 billion by the oil and gas sector, which admittedly is winding down.
Action on retentions will eventually have to be at a legislative level. If it can raise standards across the board, create greater transparency and co-operation and avoid the annual cull of small firms who haven’t been paid for the work they’ve done, then surely it’s worth a try.
