Construction Industry: Cash Retentions

Alan Brown Excerpts

Thursday 27th February 2020 Westminster Hall

[Alan Brown (Kilmarnock and Loudoun) (SNP)]

I beg to move,

That this House has considered the use of cash retentions in the construction industry.

It is a pleasure to serve under your chairmanship, Mr McCabe. We all know the procedure for Westminster Hall—you know it better than I do, Mr McCabe. I move the motion and, at the end, everybody agrees that this House has considered the matter. In this case, however, the subject matter has been considered several times, yet for some reason the Government choose to do nothing about it, which becomes ever more frustrating. Small companies continue to suffer cash-flow issues because of late payment by retention or, even worse, non-payment, often because of insolvency of the larger company.

I intend to focus on the lack of Government action, but I should first explain what a cash retention is. An October 2017 report by the Department for Business, Energy and Industrial Strategy and Pye Tait Consulting defined a cash retention as

“a sum of money withheld from the payments of a construction sector project in order to mitigate the risk that such projects are not completed…to the required quality standard.”

Effectively, a retention is a cash bond withheld by the main contractor to cover any snagging defects in an agreed maintenance period of one to two years, and is intended as a lever to hold subcontractors to their legal contractual obligements to make good any defects in a set timeframe. The typical value is 5% of the works, which can create significant cash-flow issues.

At any one time, it is estimated that in England alone, between £3 billion and £6 billion of retention money is withheld. There is a logic to the origin of cash retentions, however, as an insurance policy or bond to ensure that work is completed to the desired standard. Of course, at one time, the only way to operate contracts was the use of cash, so there is a historical logic.

I fully understand, having worked in the construction industry, that retaining half of the retention money until the works are initially completed, and then releasing it, is a good incentive to ensure that work is done without leaving odds and ends. I also realise that during the snagging period, it can be hard to get a subcontractor back on site immediately to rectify snagging issues, because they have moved on to other projects and their resources are allocated elsewhere.

On the whole, however, the subcontractor will always return to remedy defects at their own cost, as per the contractual terms and conditions. As the retention money is seldom required to pay for snagging issues, it is due to be paid to the subcontractor at the end of a defect period. That is when subcontractors expect the money owed to them to be released.

History also shows us problems with cash-based retentions. Too often and for various reasons, the retentions are not released in a timely manner, or even worse, are not released at all. The most common reason for non-release is a company going into liquidation, but if the subbies fully comply with the terms and conditions in their contracts, why should their money not be released in a timely manner? Why, in the 21st century, are we dealing with unprotected cash retentions?

The worst recent high-level example of the effects of lost retentions was the collapse of Carillion in January 2018. Estimates of lost cash for companies are in the region of £250 million to £500 million. Just think how many small and medium-sized companies went bust as a consequence? How many training opportunities were lost because of the resulting cash-flow issues? How many subcontractors just decided that enough was enough, packed up and got out of the game?

[John Spellar (Warley) (Lab)]

The knock-on effect is even worse than that. The great long chains of subcontractors mean that a company that was not even involved on the site may be dependent on getting payment, for a completely different project, from the company in liquidation. The ripple effect, which basically undermines the ecosystem of our construction industry, has been considerable over many years.

[Alan Brown]

I fully agree with the right hon. Gentleman; that ripple effect can go all the way down to builders’ merchants and those who supply goods. It has a massive effect and we need the UK Government to do something about it.

I highlighted Carillion, and a further disparity is that for public sector contracts, for which tier 1 contractors are engaged, retention money is safe because the public sector will not go bust. Retention might cause tier 1 contractors some cash-flow issues, but their money is protected. In the case of Carillion, however, public sector clients will have retained Carillion’s retention money, which effectively included the subcontractors’ retention money. The subcontractors cannot get that money because they are legally creditors of Carillion. That shows an imbalance in the procurement process, because there is no regulation or guidance on how retention moneys are held or protected. If an employer enters into insolvency before the retention money is paid, the money is used to pay off creditors first—that is why changes are required.

In addition to the potential £500 million Carillion retention loss, the Specialist Engineering Contractors Group estimates that, in the last four years, £670 million of cash retentions has been lost to upstream insolvency, so for small and medium-sized enterprises, more than £1 billion has been lost in the system in that time. That highlights the need for Government action.

A micro-sized electrical business in the west of Scotland, which held a subcontract with Carillion, lost £40,000 in retention money when Carillion collapsed. Carillion’s client was the Ministry of Defence, which, ironically, did not hold retention money from Carillion. Carillion, however, took retention from the guys working for it. That subcontractor was lucky to survive, but could only do so by using reserves to plug the shortfall, cutting back on training, and cancelling plans to take on an apprentice. That single example shows the current imbalances in the procurement system and the impracticalities of using cash retentions.

The research paper “Retention in the Construction Industry”, published by BEIS and Pye Tait Consulting, found that 44% of the contractors surveyed had experience of retentions not being paid in the previous three years due to insolvency. In addition, 50% of contractors had their cash flow affected over the previous three years when their retentions were held, while they did not hold retention money themselves. Looking at the issue in the round, half of solvent contractors still suffer cash-flow issues because cash retentions are withheld. It should be noted that in more extreme cases, retention money is withheld for years. Why, in the face of such blatant evidence of those harmful effects, have the UK Government not taken action?

To illustrate the scale of the problem, the credit management company Creditsafe recently reported that 22 construction companies went bust in January 2020 alone. A further 158 firms were involved in varying stages of liquidation. Creditsafe predicts 4,000 construction insolvencies in 2020. That underlines the need for action.

Beyond the cash-flow issues, additional effects of withholding retentions include further insolvencies; job losses; cuts to training budgets and the inability to take on new apprentices; resources being wasted to chase up late payments, which leads to higher overheads for the company, an impact on productivity and unpaid hours for a non-chargeable activity; a possible inability for some companies to bid for other retention-based contracts or to expand because of cash-flow issues; and, if pressure bites, a desire to cut corners in other jobs to try to claw back money. Following the Grenfell tragedy, Dame Judith Hackitt’s “Building a Safer Future” report said

“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.”

There is of course a human element to this, because cash pressures bring personal stress. An industry survey before Christmas revealed that 90% of SME owners and senior managers were experiencing mental health issues, ranging from stress and anxiety to suicidal thoughts. Cash-flow issues clearly contribute to that stress.

[John Spellar]

Is there not an additional factor here? We have seen this: in any upsurge in demand, the construction industry has to go abroad for companies and skilled labour. The United Kingdom economy suffers a real loss in capacity, which impacts on private and public contracts, so the Government and in particular the Treasury should have a real interest in resolving this. Unfortunately, there does not seem to be much of a sense of urgency about solving it.

[Alan Brown]

Again, I agree with the right hon. Gentleman’s intervention, and I thank him for it. Apart from the skills issue in the UK, it is another reason why we use labour from abroad, as he said. Also, we have relied on EU labour, but now the UK Government are ending free movement, so that will cause another issue and certainly underlines why we need to resolve the matter.

If the late release of retentions is such an issue, why do the sub-contractors not do something about it, such as adjudication or arbitration? They are caught between a rock and a hard place—they need their money, but they are often frightened to rock the boat, perhaps losing a vital pipeline of work from the contractor they are in arbitration with. That was the case for a local contractor in my constituency who approached me, as the MP, on the issue of cash retentions.

The processes also cost money in terms of resource time, often valuable resource. Therefore, it is not as easy a process for sub-contractors to follow as Ministers have suggested in the past. According to the recently published Government response to a consultation, the average cost borne by firms in adjudication over the past five years is £28,000, which is cost-prohibitive for small companies.

[Mr Philip Hollobone (Kettering) (Con)]

I congratulate the hon. Gentleman on securing this debate and on his superb speech. Brian Griffiths of Griffiths Air Conditioning in Burton Latimer wrote to me on exactly that point:

“When monies are held for long periods (often years), SMEs simply do not have the time, resources or legal skills to chase or recover, and have to take it as loss.”

Is Mr Griffiths not spot on?

[Alan Brown]

He is absolutely spot on—I thank the hon. Gentleman for his intervention, which illustrates the point that I was making. For the record, I think it is the first time ever that he has said he is enjoying the speech I am making.

I stated that there is a historical logic to the origins of cash retentions, but there is no logic—and plenty of history—to UK Governments ignoring evidence and recommendations that time is up for the use of cash retentions. As long ago as 1964, the Banwell report, published through the Ministry of Public Building and Works, stated that:

“Where sensible methods of selecting contractors are used, the entire elimination of retention moneys could…be accomplished without any unreasonable risk”.

The report also suggested as an incentive that this

“might well lead to a reduction in tender prices.”

That possible carrot was not enough for the industry and the Government to take action.

A further 30 years down the line, in 1994, we had the Latham report. This was a joint construction industry and Government report that recommended that cash retentions should at least be protected in a trust account—recommendation 27 of the report. We have a tenancy deposit scheme to protect individuals in the private renting sector, and yet for some reason there has never been the will to do something with the deposits, in effect, in construction.

Why have delays continued for nearly another 30 years since the Latham report? In 2002, the Trade and Industry Committee looked at the matter of retentions, compiling the report, “The Use of Retentions in the UK Construction Industry”. It concluded that the use of retentions in public procurement should be phased out by 2007. That deadline came and went, so it is no surprise that in 2008 the Business and Enterprise Committee produced a report called “Construction matters”, which looked at cash retentions. That report noted that the system undermined team working, damaged the cash flow of small companies and impacted on training and innovation, and that it should be ended at least in all parts of the public sector. The theme is consistent, but we are still waiting for action.

Moving forward to 2016, the industry again hoped for action. In a Westminster Hall debate on 27 January, the then Business Minister Anna Soubry assured us that the matter would be addressed following a review by Andrew Wolstenholme, to be completed by the end of that year. Due to cynicism in the Chamber, she confirmed that

“this Government”

will not

“prevaricate in any way or seek to knock things into the long grass.”—[Official Report, 27 January 2016; Vol. 605, c. 149WH.]

The following month, when the Enterprise Bill was going through its stages in the Commons, the same Minister said of cash retentions:

“I think they are outdated and I do not think they are fair. They are particularly unfair to small businesses.”

Yet the Government still defeated amendments proposing to eliminate the use of cash retentions, including one that I tabled on Report. When I expressed concern in Committee about timescales, the Minister also stated that

“the hon. Gentleman can be assured that this Minister gives absolutely her word that this matter is not going to be kicked into any long grass. In fact it is very short grass, which has only just grown, because the review will be completed by March and then recommendations will go out to public consultation. If legislation is required as a result of that consultation, I will be happy to be the Minister to take that through.”––[Official Report, Enterprise Public Bill Committee, 9 February 2016; c. 47-48.]

We now know that the consultation process did indeed end up in the long grass. In 2017, I tried to take through a private Member’s Bill on the subject. Although the election killed that Bill, it is fair to say that the Government would have blocked it anyway, given that they did not back the Bill of the hon. Member for Waveney (Peter Aldous) in the last Parliament. We had both had considerable cross-party support for our Bills, so it was disappointing that neither made any progress.

The only action taken by the Government since were the BEIS consultations on “Retention payments in the construction industry” and on “2011 changes to Part 2 of the Housing Grants, Construction and Regeneration Act 1996”, undertaken between October 2017 and January 2018. To be fair, three meetings with industry and stakeholders were held, and those groups agreed that the status quo and doing nothing were no longer regarded as a viable option.

With the last consultation closing in January 2018, I have been getting frustrated—two years later, and no sign of anything happening. Then mysteriously, the day before this debate, the Government magically publish the responses to the consultation. Who would have thought it? Luckily for the thrust of my debate—I had already written some of this speech—that did not change what I planned to say, because we only have publication of the consultation responses. There is no hard evidence for what the Government will do next. Sadly, I fear for industry and the SMEs that the long grass is once again being prepared.

One of the just published documents on cash retentions states:

“Our aim is to work with the construction industry and its clients to achieve a consensus within the industry on how to resolve the problems associated with cash retentions. Several policy options are under consideration, a possible retention deposit scheme, and phasing out of retentions completely, and work continues to assess the viability and potential impact of these.”

It feels like we are going in circles, but will the Minister at least confirm that the status quo is no longer an option?

Why was there no acknowledgement in the consultation publication that a deposit retention scheme is the preferred option of respondents? Separately, the Scottish Government are consulting on retentions, including the possibility of introducing a deposit retention scheme. Their consultation closes on 25 March, but a key premise of the consultation is based on Pye Tait research, which states:

“The research particularly noted that retention money held in trust in a separate, ring-fenced account until it is either used to rectify defects or becomes due for payment or in some form of retention deposit scheme would meet almost all of the serious criticisms of the current retention system.”

That would allow a statutory solution to help prompt payments and deal with problems with cash flow. It has certainly given hope to SMEs that action will be taken in Scotland, and I urge the Scottish Government to follow through on that. Given their early adoption of project bank accounts, I expect them to be more receptive. It is fair to say that their consultation is a stage ahead of the UK Government’s.

The thing is that a working deposit retention scheme solution is at hand. Industry bodies and a major tier 1 contractor have been working collaboratively with academics, banking and financial experts, insurers and software developers to develop an IT platform as a digital solution to ring-fencing cash retentions. The key features in the proposed retention deposit clearing house scheme are that the aggregate of the retention moneys handed over to the client will held in a bank account and ring-fenced by a trust, and allocated to all supply chain firms as is relevant to their deductions. Also, firms will be able to use an app for online checks of the amount of their retentions held in the scheme. An insurance policy will be made available to the client to cover any shortfall in the scheme in case there is non-compliant work that is not rectified, because of insolvency, for example. The scheme will be regulated by the Financial Conduct Authority. The costs of administering the scheme are estimated at just £23 per £10,000 of main contract value, so cost is clearly not a barrier to introducing it.

It transpires from the responses that have just been published that the retention deposit scheme is the preferred option. Additionally, as I am sure the Minister is aware, the BEIS roundtable meeting of client and industry stakeholders in May 2019 voted for work to begin on the feasibility of a retention deposit scheme. I want therefore to ask the Minister what Government progress there has been to date, in relation to that work. What is the Department’s timetable for taking action on protecting cash retentions? Those are the key issues on which I am looking for an answer from the Minister—but by way of a conclusion there are some other questions I should like to put to him. Why did it take so long to publish the responses to the consultation? Does he agree that tier 1 contractors should not use subcontractor retentions for their own cashflow purposes? Will he definitively rule out the status quo? I have outlined Scottish Government recognition of the need for legislative measures on retentions, so what plans does BEIS have for legislative solutions? What is the Government position on retentions within their own projects? For example, will BEIS confirm that retentions will be removed from all Government-funded projects, as has been recommended for decades?

I genuinely hope that the Minister can give positive responses. Maybe he will be the one to cut through the long grass that cash retention has been hiding in for a long time. I assure him I would be happy to work with him to help him cut that grass, and help companies to get the money they deserve.

--- Later in debate ---

[Nadhim Zahawi]

The hon. Gentleman makes a powerful point. He is right that we have to make a decision, but it is complex and we do not want to create perverse incentives in a different direction. Consensus is necessary, as costs are driven by the extent to which industry adopts or resists change. If the industry does not adopt it, one sees a perverse incentive. It is clear that cash retentions in construction are a complex issue. I may be new to this job, but I spent many more years in business than I have spent being a Member of Parliament or a Minister. Sometimes the wrong decision can create a perverse incentive.

[Alan Brown]

As the right hon. Member for Warley (John Spellar) pointed out, are the Government not incentivising companies to dig their heels in and keep saying no? If the Government wait for consensus, that incentivises the wrong behaviour for contractors. As has been outlined in this debate, this situation has been going on for decades. We are not getting anywhere because the Government are waiting for a magic, 100% consensus.

[Nadhim Zahawi]

I opened by saying that the Government are committed to tackling the problem of late and unfair payments, so I hope that answers the question whether we are going to do something about the issue.

To respond to other points that were raised, the hon. Member for Kilmarnock and Loudoun and my brilliant hon. Friend the Member for Waveney both mentioned their private Members’ Bills. It is important that any action we take is robust, proportionate and evidence based, which is where we are at the moment. Several policy options are under consideration, including the retention deposit scheme. It would be premature to commit to anything at this stage while several policy options are under consideration.

--- Later in debate ---

[Nadhim Zahawi]

I do not agree. I hope I have built a reputation over the past decade of being someone who is evidence led; it is important that we do that. My hon. Friend the Member for Kettering talked about the inability of small firms to pursue unpaid moneys because they do not have the time or the resources. The 2011 amendments to the Housing Grants, Construction and Regeneration Act 1996 were introduced to ensure fair and prompt payment through facilitating better payment, adjudication and arbitration processes, particularly for small businesses. I wanted to put that on record as well.

[Alan Brown]

Going back to timescales, the Minister is not willing to commit to a month—forget that—but surely to goodness he could give us an idea of a programme and also explain why it took two years, following the responses to the consultation, for them to be published? That does not give confidence that there is any clear programme for the Government.

[Nadhim Zahawi]

I refer the hon. Gentleman to the answer I gave earlier. We are absolutely committed, but it is a complex issue. My hon. Friend the Member for Waveney rightly asked the Government to agree that action should be taken. It is important to remind ourselves that we have now published the summary of responses to the consultation on the practice of cash retention. We will continue to work with him, with others and with industry on these issues and on policy options to address the problem. We are committed to addressing it.

My hon. Friend’s final question was about a pilot scheme. My officials have met with representatives of Pay2escrow on several occasions to discuss the proposal for a deposit retention scheme, and the meetings have been helpful in clarifying and understanding its work. We remain in dialogue with industry to try to build consensus on the future policy. As I said, given the complexity, it is important that we make the commitment when we think it is the right thing to do. I want colleagues to understand that we are committed to that process.

--- Later in debate ---

[Alan Brown]

Thank you again for your chairmanship today, Mr McCabe. I thank all hon. Members who have contributed. This is an important matter, but unfortunately, having the 3 pm slot on a Thursday afternoon has probably prevented other hon. Members from taking part, given that they will be back in their constituencies.

In terms of Back-Bench contributions, we had fantastic interventions from the right hon. Member for Warley (John Spellar) and some key examples from the hon. Member for Kettering (Mr Hollobone). I pay particular tribute to the hon. Member for Waveney (Peter Aldous), not only for his contribution today, but, more importantly, for the work he has undertaken with his Bill and in making progress on finding consensus on a deposit retention scheme. I am beginning to think that it is his willingness to get things done that keeps him on the Back Benches rather than the Government Front Benches.

We have heard, and we know, that cash retentions are costing jobs, training, opportunities and productivity, and ultimately—maybe the Minister should think about this—when companies go bust, it costs the Government in tax take. Yet today I am disappointed. I must say it is very disappointing. I know that the Minister is new in his post, but we are still hearing about options, about how complex the issue is and about how we need to find consensus on the way forward. He seems to be finding the long grass that his predecessors grew. I ask him to try to take hold of this situation.

There is a solution: a deposit retention scheme. There is a Bill there, and we can go on and get this done. As a minimum, at the very least, let us get a pilot up and running and let us get it done. The Government mantra that we keep hearing is about levelling up. Let us level up for the wee guys in the construction industry and sort this problem.

Question put and agreed to.

Resolved,

That this House has considered the use of cash retentions in the construction industry.