What are the proposed changes?
Changes are being mooted to retention arrangements. The Government has announced that a "deemed trust" arrangement is their proposed solution to protect subcontractors from circmustances like those that followed Mainzeal’s collapse. Retention funds won’t need to be held in a separate bank account though so whether the funds are truly protected is questionable. Tracing and identifying the relevant funds will be a complex job for a liquidator following insolvency. For developers and main contractors, new fiduciary duties are imposed as a result, so although it might seem like carrying on business as usual is possible, that would carry with it a new legal risk.
What happens at the moment?
Retentions are one of a number of tools used by a developer to create some security over the performance by the contractor. Retentions are directed at protecting the developer from the risk of defective works. Cash retentions are usually held by a developer, with half the retention released on practical completion and the balance held during the defects period and released at final completion/issue of the defects certificate. More often than not, the contractor holds retentions on the subcontractors for a greater amount than those held by the developer, because the developer’s retention is usually capped. For some subcontractors retentions are held for significant periods of time – they might have left site many months before practical completion, but their retentions will be held to match the arrangements in the head contract with the developer.
Retention bonds are increasingly common, especially through the defects period. These can be difficult for some parties to obtain and often tie up working capital to the same extent as a cash retention. Larger contractors and subcontractors might be able to fund these more efectively than a cash retention though and so will often prefer them. On demand bonds are essential for developers for there to be any value in the bond. In light of the proposed changes to cash retentions, we might see more bonds being proposed by developers rather than their contractors as is currently the norm.
Retention bonds should be distinguished from the main performance bond on the project. Those have a different purpose. Performance bonds are intended to provide security for the overall performance on the project. Ideally they cover the developer for the down time and likely costs if the contractor fails and a new contractor needs to be put in place. The way most modern performance bonds are written, they can serve a wider purpose than this and might potentially cover defective work or other losses.
Retentions are needed because one expects a certain level of defective or incomplete work in a project. Focus is on "practical completion" i.e. accepting there will be minor defects or issues that require remedy post this sign off. Another way to look at this would be to promote a zero defect culture, that minor issues are not going to be signed off and accepted by a developer. That would be a massive step for the development community, so massive that one sees little talk of this being an option. Developers pay for retentions and the funding cost of these for each member of the supply chain. In the same way, the costs of the various retention bonds will also all be passed on. Is there a better way?