Barrister Professor Rudi Klein explains the term ‘putting retentions into trust’ and gives an overview of some recent developments concerning these cash retentions.
It is almost 21 years since Sir Michael Latham published his famous report on procurement and contracts in UK construction. ‘Constructing the Team’ was a joint government/industry report that came out of the ravages of the recession in the early 1990s. Lost in the depths of that report was a recommendation that cash retentions, if insisted upon, should be put into trust.
To date, this has never been actioned.
Trust status for retentions
What is meant by ‘putting retentions into trust’? A trust arrangement involves a party holding certain assets for the benefit of another party and, thus, does not treat those assets as entirely belonging to him. Therefore a main contractor who requires a cash retention would be the trustee of the cash, which, by law, must be put into a separate account for the use of the beneficiary.
The director of an electrical contracting company recently told me she had lost £56,000 by way of a cash retention following the collapse of a main contractor. Her point was that it was wrong that the administrator of the insolvent main contractor could use those monies for the benefit of the contractor’s creditors. She had not intended that this money could be used to enrich the other party’s creditors. In fact, her argument was that the money was hers and that the main contractor should have looked after it by putting it into a segregated account. Once the defects liability period had elapsed, the money should have been returned to her subject to any right that the main contractor had to use all or part of the money to remedy defects (in the event that the electrical contracting company did not return to remedy them).
I have often received desperate telephone calls asking me whether anything can be done to safeguard retention monies held by a party who is likely to go into insolvency within the next few months. In practical terms there is little that can be done, but if there is a large retention pot outstanding one could challenge this state of affairs.
Let’s go back to my director of the electrical contracting company. She is right. The retention money belonged to her because it was deducted from payments that she had already earned. Although the money was hers, it was held by the main contractor until such time as it had to be handed back (unless, as I said, some or all of it has been properly used in accordance with the contract). In these circumstances English law would say that the very nature of this arrangement was that it constituted a trust.
The money has been handed over to somebody else who should be expected to act as a trustee of the money and ensure that it is kept safe so that it is available at the time when due for release. Therefore the main contractor should be required to put the monies in an account separate from his own assets. If this is not done, the matter could be referred to an adjudicator. The adjudicator could be asked to decide that the monies be separated and put into a trust account. If the adjudicator makes such a decision, which is then ignored, one could have it enforced in the courts by a mandatory injunction. Alternatively, if the situation is urgent – because the other party is on the verge of insolvency – an application to a court to issue a mandatory injunction could be done. There have been a couple of English cases which would support this approach and, indeed, there was a very recent court of appeal decision in Malaysia (which shares the same legal system as England) which directed that the retention should be placed in a separate trust account. I hasten to add that this is worth trying out if you have a large retention pot with a particular company.
Legislation to put retention monies into trust
On behalf of my organisation, I recently drafted an amendment to the Small Business Bill currently going through Parliament which would have required retention monies to be placed in trust. Similar legislation is currently going through the New Zealand Parliament and regulations to the same effect are likely to be issued in New South Wales in Australia. A diluted version of my amendment was put down in the House of Commons, but, unfortunately, it failed to get through both the House of Commons and the House of Lords.
However, we must persist with this. There is a general election coming up and this allows us an opportunity to contact our MPs and prospective MPs to get their support for putting cash retentions into trust. The likelihood is that if this was to be done, the retention system would collapse since it would be no longer possible to bolster one’s working capital with somebody else’s cash retentions.
This would also support the ambition in the government’s Supply Chain Payment Charter which is for retentions to be phased out by 2025. At the time of writing, I can say that there is a possibility that regulations to be issued under the Small Business Bill could require large companies to reveal the time taken to release retentions from handover, and the amount (in percentage terms) of retention deducted. Whilst such information would be useful it would not deal with the major problem which is the protection of the monies so that they are not mixed with a company’s working capital.
Other matters relating to retentions
By law all contracts should make clear the due date for retention release and the final date by which they have to be handed over. If a cash retention is being deducted it is always useful, at the outset, to confirm the due and final dates for retention release.
Furthermore it is contrary to the law (under the amended Construction Act) to make the release of retention conditional upon some event or occurrence under another contract. It is still the case that main contractors will not release a cash retention until a Certificate of Making Good is issued under the main contract. Such clause is now illegal. But the downside is that some main contractors have extended the period for release of retention to two, three or more years following handover of the subcontract works and, in a few cases, have increased the amount of the retention that is deducted. On public sector projects these practices will be considered as bad practice and there is an opportunity to complain anonymously through the Mystery Shopper Scheme run by the Cabinet Office. The scheme can be accessed via the website of the Cabinet Office.
The priority now is to end the cash retention system, which was declared to be “unfair” and “outdated” by a House of Commons Select Committee over 12 years ago. Obtaining legislation to put cash retentions into trust will help to achieve this aim. Let’s get some commitment from the political parties to support this aim.
In the meantime, if you have a large retention pot it might be worth contacting the other party requesting that they put it into a segregated account. If they refuse, ask an adjudicator for a decision to this effect.
Lastly, if you are having retention problems or on public sector projects it is possible to complain anonymously about this through the aforementioned Mystery Shopper Scheme. If you have any horror stories regarding retentions on public sector projects, please let me know by email Rudi.Klein@secgroup.org.uk as this could provide evidence to justify legislation. I will not have time to issue advice but having the evidence could prove to be very helpful in lobbying for change.