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The Problem With Retention Monies And How It Can Be Solved

Recovery of retention is a problematic area for all parties in the contractual chain, with non-payment of retention often the cause of cash flow problems. With insolvency rates currently at a record high, it is vital that contractors and sub-contractors focus on recovering retention monies in a timely manner.

The Problems with Retention

Firstly, retention is often not released on time and in accordance with the contract. This is a problem for all parties in the chain. In a typical construction contract, the level of retention can often be more than the level of profit margin; therefore, until retention is paid, it essentially means that the party having their retention withheld may be operating at a loss.

Secondly, in the case of sub-contractors, the release of retention is often dependent on circumstances outside of the sub-contractor’s control, such as the remedying of defects under the main contract by other parties.

Recovery of Retention

It is becoming more and more unusual for paying parties to release due retention when they are required to; therefore, a clear strategy needs to be formulated in relation to recovering retention monies. The contractual position regarding recovery of retention will vary; however, in all cases it is vital that parties who are owed retention ensure that they are organised and have maintained their records properly. To promote good record keeping and increase chances of obtaining retention payment, it is beneficial to produce an appropriate spread sheet for each contract which specifies notable information relating to the contract. For example, the project name, start date and practical completion. Against applicable milestones, it should be highlighted when and how much retention is due to be released.

Parties owed retention monies should be persistent in chasing payment, resorting to formal applications for payment (with interest) if necessary. If the above steps do not help, it might then be necessary to take formal legal steps to recover retention.

Main Contractors

Sub-contractors face the majority of retention problems, however some contractors still encounter problems with recovering retention from employers. Employers often seek to withhold retention based on an incorrect interpretation of the works information (and therefore incorrectly identify a defect). As such, it is vital for contractors to establish the precise nature of any alleged ‘defect(s)’ preventing release of retention, as they may be challengeable.

Problems Faced by Sub-Contractors

Retention is a particularly challenging area for sub-contractors. Many sub- contracts state that retention is released on Practical Completion and after the Making Good of Defects Certificate (MGDC) is issued under the main contract meaning that sub-contractors can be left waiting for retention money long after their works have completed.

In Pitchmastic v Birse [2000]. Pitchmastic, a roofing sub-contractor, was employed by Birse on a supermarket development project. Under the sub-contract, the balance of retention would be released when the Making Good of Defects Certificate had been issued under the main contract. Pitchmastic achieved Practical Completion of its sub-contract works in March 1998. Following the expiry of the defects liability period, no MGDC was issued. Since Pitchmastic’s own works were free from defects, it argued that it was entitled to receive its retention.

The court found that the only way Pitchmastic could overcome the terms of the sub-contract was if it could show that Birse had prevented the issue of the MGDC by failing to proceed with reasonable diligence to make good the defects.

Whilst Pitchmastic had failed to provide enough evidence to establish that the contractor was not remedying defects with reasonable diligence, the case provides useful advice to sub-contractors in similar situations.

For example, identifying the reasons why the MGDC is being delaying is essential. Sub-contractors need to establish that none of their own defects are outstanding. Sub-contractors need to try to establish what the defects under the main contract are and how they can be remedied. With this information, the sub-contractor will be in a better position to be able to assess whether the contractor is not proceeding with reasonable diligence. In such circumstances, an adjudicator may instruct the contractor to release the retention, even without a MGDC having been issued.

It is always worth checking whether the defects alleged to be in existence are actually defects. If all parties have complied with the works information, then the paying party cannot rely on the existence of a defect to withhold any due retention.

Changes to the Construction Act

Under the Housing Grants, Construction & Regeneration Act 1996, as amended by the Local Democracy, Economic Development and Construction Act 2009, payment under sub-contracts entered into after 1 October 2011 cannot be conditional upon the performance of obligations under a separate contract. This is beneficial to sub-contractors entering into new sub-contracts as it means the release of their retention can no longer be dependent on milestones under the main contract.

Sub-contractors should be aware that contractors are beginning to stipulate retention release dates in sub-contracts which are far into the future (e.g. 18 months after practical completion of the sub-contract works). Whilst these clauses are compliant with the law, they clearly allow contractors the opportunity to have received their own retention under main contracts before they are obliged to pay retention to sub-contractors.

Nonetheless, many sub-contracts have not yet been amended; therefore, for any sub-contracts entered into after 1 October 2011 with non-compliant retention clauses, the Scheme for Construction Contracts will apply.

Retention Bonds

Avoiding the problems associated with retention recovery is often achieved by the use of retention bonds.

What is a retention bond?

A retention bond is a formal agreement between the contractor, sub-contractor and a third party surety. The surety acts as a guarantor between the contractor and the sub-contractor. The retention bond states that the surety agrees to pay the contractor the value of a cash retention if the sub-contractor fails to remedy any defects.

How does a retention bond work?

The retention bond only takes effect if the sub-contractor does not achieve practical completion and/or prevents a certificate of making good defects from being issued. In these circumstances, the contractor can ‘call’ on the retention bond.

Usually, a retention bond will stipulate that the sub-contractor is allowed the opportunity to rectify any defects within a fixed period of time from being notified of the defect. If the sub-contractor fails to remedy the defect, the contractor can call the retention bond and the surety will remedy (or pay for the remedy of) the defect. The surety will then pursue the sub- contractor for the cost of the defect.

Why use a retention bond?

If drafted correctly, the use of retention bonds is generally considered to be beneficial to a construction project.

Where an insurance company acts as the surety, sub-contractors will need to pay for the surety’s premiums. However, sub-contractors conversely benefit from not having any retention monies withheld. Many sub-contractors feel that the benefit of their cash flow being unaffected by retention is more valuable to them than the cost of a retention bond. In addition, retention bonds usually contain a fixed expiry date so all parties are clear when the sub-contractor is released from its obligations. Most importantly, the sub-contractor is free from having to chase retention monies at the end of a job.

For the contractor, a retention bond provides the same level of security as a cash retention would. However, the added benefit is that the retention bond is improving the cash flow and financial stability of the sub-contractor.

Want to know more?

Cruse MS Ltd offers a specialist Retention Recovery Service which provides fixed cost solutions to parties who are struggling to recover retention.

If you would like to discuss any of the above, please contact Ian Cruse at ian.cruse@crusemanagement.co.uk

Cruse Management’s Retention Recovery Service

Our specialist Retention Recovery Service provides solutions to contractors and sub-contractors who are struggling to recover retention monies. Our Retention Recovery Service offers:

• Letters of demand drafted by a chartered surveyor with a wealth of experience in the recovery of retention monies.
• Effective commercial advice on the legal options available to you for the recovery of monies owed.
• Commercial and risk management of adjudication proceedings conducted by chartered surveyors who are experts in dispute resolution, with additional legal support provided by construction solicitors where appropriate.

All of these services are available at a fixed cost, enabling you to work out a cost effective means of recovering outstanding retentions.

Interested and want to find out more?

For further information and assistance, please contact Ian Cruse on 07780 616563 or by e-mail on ian.cruse@crusemanagement.co.uk for further information.

Securing payment on time is crucial to survival in the construction industry. We answer 10 frequently asked questions about securing payment.

1. What can I do if the final date for payment passes and payment has not been made?

The Housing Grants, Construction & Regeneration Act 1996 (as amended) (the “Construction Act”) provides that payment must be made by the final date for payment, provided that a “pay less notice” has not been issued by the paying party in accordance with the terms of the contract.

The first step in the event of late payment is to immediately remind your employer that the payment is outstanding. It is appropriate for this initial reminder to be quite informal (e.g. by email). If this informal reminder is ineffective, then you should send a more formal letter of demand for payment.

If corresponding with your employer yourself does not yield results, the next step is usually to instruct a chartered quantity surveyor (“cqs”). A cqs can send further letters of demand, which may be more convincing and effective than a letter you have written yourself, or, if this is still not successful, the cqs can advise on whether some form of legal action (such as adjudication or litigation) is required. However, it is often viewed as inappropriate or risky to commence formal action whilst a project is on-going, due to the negative effect this can have on the parties’ working relationship.

Another effective option is to suspend performance of your works. Section 112 of the Construction Act gives a payee the right to suspend performance of its obligations under the contract in the event of non-payment. If complete suspension of performance sounds too extreme, it is possible to suspend performance of certain obligations and continue fulfilling others. However, in all cases the right of suspension cannot be exercised without giving at least 7 days’ notice of intention to suspend performance.

Anyone considering exercising the right of suspension must first check the contract to determine (a) how much notice must be given and (b) how notices should be served. It is also essential to be sure you are validly entitled to payment. Any error in suspending performance could put you in repudiatory breach of contract, allowing your employer to terminate your contract and claim damages.

2. Can I claim interest on late payments?

Under the Late Payment of Commercial Debts (Interest) Act 1998, you are entitled to charge interest on any late payments at the rate of 8% above the base rate. Please note however that many contracts will vary the rate of interest which is applicable to late payments, so you should always check the contract to find out the rate of interest which is applicable.

3. What happens if the payment terms in my contract don’t comply with the Construction Act?

If the payment terms in the contract do not comply with the Construction Act, the Scheme for Construction Contracts (the “Scheme”) will apply.

The extent to which the Scheme applies depends on the extent to which the contract does not comply with the Construction Act. The Scheme stipulates due dates and final dates for payment (if these are not specified in the contract) and sets out the dates by which the paying party must issue a ‘payment notice’ and/or a ‘pay less notice’. It may be necessary to refer to the Scheme when establishing that payment is late, but typically legal advice is required to determine whether or not the Scheme applies (and to what extent).

4. What can I do to improve my chances of getting paid what I apply for?

You should comply exactly with the requirements of your contract. Ensure your applications are in the correct format, provide the appropriate level of detail and are accompanied by the necessary supporting evidence (e.g. signed timesheets).

5. What can I do if payment is withheld because a party up the line has become insolvent?

The Construction Act permits clauses in contracts, which allow payment to be withheld in cases when a party up the contractual chain has become insolvent. Unfortunately, if there is a “pay when paid” clause in your contract which allows your employer to withhold payment when an upstream party is insolvent, there is nothing you can do (although see question 10 below). It is therefore essential to ensure you also have a “pay when paid” clause in your downstream contracts to ensure that you are not left in the financially crippling position of having to make payments to others when you will not be receiving any yourself.

6. Do I have a right to be paid for goods and materials on site?

There is no general right to payment for goods and materials simply because they have been delivered to site. Your right to payment for goods and materials is governed by the contract. Many contracts will permit payment for on-site materials and goods provided that certain conditions are satisfied (for example, if they are stored correctly and are not on site prematurely).

7. Is there a legal limit on how long payment periods can be?

No, the Construction Act states that the contracting parties are free to choose the due dates and the final date for payment. In practice, the length of payment periods will be governed by commercial negotiating positions. The tendency in the current climate seems to be towards ever increasing payment periods, particularly for sub-contractors.

8. Can my employer withhold payment on the grounds that I have failed to satisfy a condition precedent?

Yes, provided your employer has issued a ‘payment notice’ or a ‘pay less notice’ confirming that payment is being withheld. Conditions precedent are legally binding and payment can be withheld for failure to fulfil a condition if the contract states that payment is conditional on fulfilling that condition. It is essential to check for conditions precedent at the outset and put procedures in place to ensure they are complied with.

9. Am I entitled to recover the administrative and legal expenses I incur chasing late payments?

The Late Payment of Commercial Debts (Interest) Act 1998 states that you are entitled to claim a fixed sum to represent compensation for the late payment. The fixed sums are:

• £40 where the unpaid sum is less than £1,000;
• £70 where the unpaid sum is more than £1,000 but less than £10,000; or
• £100 where the unpaid sum is more than £10,000.

Other than this fixed sum, the administrative and/or legal costs you incur in sending letters of demand are generally unrecoverable.

If you do commence legal or arbitration proceedings, the successful party will usually recover most of its costs from the unsuccessful party. However, there is almost always an element of unrecoverable cost.

The costs of adjudication are not recoverable, even if your claim is successful. For this reason, the unpaid sum would have to be significant to justify incurring the expense of instructing a chartered quantity surveyor to handle the adjudication on your behalf.

10. How do I recover payment if my employer becomes insolvent?

It is extremely difficult to try and recover payment in cases where your employer is insolvent. You will rank as an unsecured creditor, meaning that all secured creditors (e.g. lenders) take priority over you. Unsecured creditors rarely get any payment when the insolvent company’s assets are distributed. Notwithstanding this, you should always lodge a proof of debt with the administrator or liquidator just in case a dividend does become available for distribution to unsecured creditors. This typically involves filling in a form (which you can obtain from the administrator or liquidator) with details of the sum you are owed.

If you have provided a collateral warranty to a third party, they may have the right to step in to the contract in place of your employer. However, this is entirely at the third party’s discretion and it is not necessarily the case that the third party will assume responsibility for unpaid sums even if they do exercise step in rights.

This article contains information of general interest about current legal issues, but does not provide legal advice. It is prepared for the general information of our clients and other interested parties. This article should not be relied upon in any specific situation without appropriate legal advice. If you require further advice on any of the issues raised in this article, please do not hesitate to contact Ian Cruse at Cruse MS Ltd

The recent Court of Appeal judgement in Aviva Insurance Limited v Hackney Empire Limited acts as a useful reminder of the need for clarity when drafting side agreements.

The facts of the case

Hackney employed building contractor STC to renovate a theatre under a JCT contract. STC subsequently put in place a performance bond in favour of Hackney with insurance group Aviva. The project was severely delayed, and STC submitted several unsubstantiated loss and/or expense claims and threatened adjudication.

To assist STC and the project, Hackney ‘loaned’ the contractor £750,000 under a separate agreement. In the event that STC’s loss and expense claims were substantiated under the building contract, the money could be retained as payment.

STC went into administration before the works were complete. Hackney terminated the contract and appointed another contractor to complete the works. Hackney then claimed the full value secured by the bond on the basis that its losses exceeded that total.

Aviva disputed the claim and argued it was discharged from liability given Hackney’s extra-contractual payments to STC. Further, it argued that, giving effect to clause 27.8 of the contract, Hackney could either operate the clause 27 machinery or claim damages for breach of contract, not both; ie it had to elect between the two remedies.

Judgement leads to Court clarification

At first instance, dealing with questions of liability, the judge held that Aviva was not discharged from liability under the bond as Hackney had not acted in a prejudicial manner to Aviva in relation to the contract. Aviva appealed against the decision.

On analysis of the relevant case law, the Court of Appeal clarified that a bondsman could be discharged from its liability under a bond where its interests had been prejudiced by a material variation of the original contract, or where the employer had made advance payments of the contract price, in either instance without the consent of the bondsman.

On the facts, the payment made to STC was made outside the building contract under a separate side agreement. The requirement on STC to prove its entitlement under the contract remained. As the payment was not made under the building contract, Aviva’s interests under it had not been prejudiced and its liability was therefore not discharged.

Turning to the issues of quantum, it was common ground that Hackney could recover liquidated damages. The court disagreed with Aviva’s argument that Hackney had lost the right to recover any general damages by electing to determine STC’s employment.

“The case also strengthens the position of subcontractors in instances where a contractor becomes insolvent”

The court held that clause 27.8 of the contract did not demand an election between the two remedies. If it were intended to require an election, it should have stated so in terms.

The court also recognised an employer’s contractual right to pay subcontractors directly in respect of work done after a contractor has left site, and held on the facts that this did not give rise to an unlawful preference.

Importance was placed on the fact that STC was in administration not liquidation and the administrator had given no notice of a proposed distribution at the time.

Aviva’s appeal was therefore dismissed.

Decision highlights need for clarity

The case acts as a useful reminder of the need to have clarity when drafting side agreements.

It may have an impact on the approach taken to drafting performance bonds in the future. The law reviewed in the judgment was based on 19th century cases and it was recognised that modern commercial life may mean industry needs to adopt a different approach in the future.

It also strengthens the position of subcontractors in instances where a contractor becomes insolvent, as the court recognised the employer’s right to pay subcontractors directly under this JCT form and rejected the suggestion that to do so in such circumstances gives rise to an unlawful preference.