Abolition of retentions in UK construction sector may have ‘unintended consequences’

Retentions are commonly used as a payment mechanism in standard form construction contacts in the UK, including those issued by the JCT and NEC, to incentivise contractors to fulfil their contractual obligations, particularly in relation to build quality and rectification of defects.

Historically, retentions are a percentage of the contract sum – usually 3% to 5% – that is withheld from each interim payment or, where relevant, milestone payment. Half of the contract sum is often released back to the contractor at practical completion, while the rest is withheld to the end of the defects liability period, which is typically 12 months later. 

However, on 23 March the government announced tough new measures to “ban the withholding of retention payments under the terms of construction contracts” with the intent to “prevent small firms losing retentions to insolvency or non-payment”. 

The proposed ban on retention in construction contracts forms part of a wider package of proposals aimed at protecting small and medium-sized enterprises (SMEs), which also includes a 60-day maximum payment period and a mandatory interest rate on late payments where larger companies are paying smaller companies. This package is seen by the government as the biggest reform to address late payments in a quarter of a century.

The government says this approach will help ease cashflow issues for SME owners, reducing insolvencies, leading to “fairer contract terms” and strengthening relationships across the construction supply chain.

However, as we identify below, introducing a blanket ban on cash retentions raises several questions and may also have a number of unintended consequences for the construction industry.

Perception of inequality

There has long been a perception that cash retentions being withheld by the employer and then passed down the supply chain have created an unfair situation whereby the smallest companies furthest down the supply chain had the greatest exposure to the insolvency of other parties. This is because they are exposed not only to the insolvency risk of employers, but also to the insolvency risk of the main contractors, as well as any upstream subcontractors.  

That perception was crystallised by the impact of the Carillion insolvency in 2018 on Carillion’s supply chain, and particularly the impact this had on SMEs. 

There have also been behavioural issues with how some employers have treated cash retentions. Cash retentions have been released late, or not released at all, when, contractually, they should have been. Losing a cash retention can have a huge impact on a contractor’s profit margin on a project – or even wipe it out completely – and can also create material cashflow issues for contractors and suppliers at all levels of the supply chain. 

As part of broader ambitions within the construction industry to improve payment practices and make them fairer for all parties, there have been strong advocates for reducing the use of cash retentions for a very long time. However, no other approach has emerged as a widely accepted and adopted alternative to cash retentions within the industry. Consequently, the use of cash retentions is still very widespread notwithstanding the issues it can cause suppliers and, in particular, SMEs. 

In that context it appears the government has now decided to take action and legislate against cash retentions. In July 2025, the government announced a consultation on the reform of retentions, which examined two options:

• an outright ban; 

• mandating the protection of cash retentions, either through segregating the retained sums in a separate bank account, or through a security instrument, such as a bond or insurance. 

Following the announcement in March, it is clear that the government has chosen to introduce an outright ban.

This approach has the virtue of simplicity in comparison with the option for protecting retentions. However, retentions also currently serve an important role in securing performance. Consequently, a blanket ban on cash retentions could give rise to a number of unintended consequences.

Loopholes and alternatives to cash retentions

The precise scope and wording of the proposed ban on retentions is not clear from the government’s announcement. In that context, there is an overt risk that any ban on retentions could be circumvented by parties making contractual arrangements that achieve a similar result to a cash retention. 

The obvious example would be milestone payments, stage payments or works packages being “back loaded” so that more of the contract price is paid towards the end of a project. Parties may also try to describe what is, in effect, a retention as something different in order to avoid the precise wording of the ban, or otherwise “hide” what is effectively a retention arrangement within the contractual agreement to try to circumvent the ban.

There is also the question whether the retention ban will extend to a scenario where employers pay retention amounts into a project bank account. That could mitigate some of the insolvency risk while also keeping contractors incentivised regarding defects. However, this would not address the cashflow issues that the government’s proposed changes are intended to resolve, and so it seems likely such a scenario would be caught by the ban.  

In any event, project bank accounts haven’t proved too popular across the industry due to the additional costs and administration required to set them up and operate them. 

Contractors could also be required by employers to hold an equivalent amount to a retention in an escrow arrangement until practical completion or until the end of the defects rectification period. 

Retention bonds are currently available in the surety market as an alternative to cash retentions. However, it seems doubtful that there would be capacity in the surety market to support retention bonds being put in place across the whole industry. Retention bonds would also attract a material cost that would presumably be passed on to the cost of the project.

Also, if retention bonds or other security instruments are seen as the mitigation of the retention ban by employers and SMEs find it more difficult than larger companies to access those kinds of performance security – either through not having as much credit with the sureties or the necessary access to the surety market – or because of the cost of the performance security if they are not able to pass on that cost to the project – it is possible that some SMEs may find it more difficult to win contracts following the reforms. 

If the late payment reforms only apply to SMEs, main contractors may also find themselves in a position where they need to pay an SME subcontractor earlier than they receive payment from their employer, which again may impact main contractors’ enthusiasm for engaging SMEs in future. 

Other unintended consequences 

While they may have the potential to be used unfairly, cash retentions also play an important role in securing performance obligations. The government will need to carefully consider how best to mitigate the risk of any potential unintended or negative consequences, which include: 

• contractor valuations of interim payments are likely to be challenged more robustly by employers and project managers;
• incentivisation for contractors to rectify defects and comply with other obligations post-practical completion will be impacted;
• the ban could result in more tension during the course of projects, as there is likely to be more focus on raising issues with quality and defects during the carrying out of the works;

• quality issues during the project may be more fiercely contested earlier in projects if employers and project managers will be concerned there will not be a sufficient incentive for a contractor to rectify defects later on;

• the absence of a post-practical completion retention could also result in tighter approaches and more prescriptive requirements around practical completion;

• the unavailability of cash retention is also likely to have a commercial impact on the approach to funding, procuring and pricing projects and the risk allocation under construction contracts and other agreements – such as development agreements – in that context;

• the government’s proposed reforms regarding late payment are targeted at the protection of SMEs from cashflow issues and insolvency risk that arise from cash retentions on a project. However, if employers or main contractors on projects have a less robust performance security position because of the cash retention ban, it may become more difficult for SMEs to win work in the first place if they are seen as too much of an insolvency risk themselves.  

These issues have the potential to result in a more adversarial approach and less collaborative behaviours on projects following a ban on retentions.

Consultation

The government has acknowledged that the ambitious nature of its proposal to ban cash retentions requires further consultation with interested parties on the impact of the proposed ban before taking a final decision on implementation. 

In particular, the government recognises the need to address concerns around build quality and surety alternatives. It says it is also committed to working with the Construction Leadership Council and construction clients to develop practical approaches to minimising defects, as well as working with the financial services sector to identify ways of developing the surety market for the construction sector. 

It will be interesting to see whether this further consultation process results in any changes to the government’s proposals, to take account of any of the issues identified above. 

Impact on employers and wider industry

The industry has understood for a long time that there are material issues with cash retentions, both in principle and the way that they are treated in practice by some employers. Many in the industry will see the proposed ban as being welcome in protecting the cashflow at all levels of the supply chain and also protecting those with the smallest shoulders from carrying the burden of upstream insolvency risk.  

Equally, however, retentions have served an important purpose in the industry particularly around incentivising rectification of defects after practical completion and protecting the interests of employers and end users in respect of build quality and other aspects of contractor performance. While it is certainly not a perfect solution to the matters it is addressing, it is at least a simple and functional one that is easy to understand and operate.  

As and when the retention ban is implemented, whether or not it is a net benefit to the industry as a whole is likely to depend on how the industry reacts and adapts to procuring and managing projects without the option of a cash retention, as well as the availability of accessible and affordable alternatives to a cash retention that still protect the legitimate interests of employers, funders and end users. 

Co-written by Tom Botterill of Pinsent Masons.