Cash is King: Get ready to report on your retentions?

Summary

New legislation will require large companies in the construction industry to report on certain payment practices and policies, specifically the proportion of retention sums withheld from suppliers. This is one of several measures to be introduced by the Government which aims to improve payment practices in the UK and increase transparency, benefiting the supply chain.

The new Regulations are set to come into force on 1 March 2025, with the reporting requirements applying to financial years starting on or after 1 April 2025. If companies do not comply, they risk criminal sanctions and reputational impacts. Qualifying companies should therefore take steps to prepare for the changes now. This Note intends to provide general information on some of the main features of the Regulations as they currently stand, in the context of the industry.

1. Introduction

Late payments are an important and significant issue for UK businesses, causing cash flow problems that hinder operations, investment and innovation. They affect liquidity, limit investment potential, and can ultimately force businesses out of the market. It has been recognised for some time that prompt and fair payment is especially problematic in parts of the construction sector.

It is a long-standing practice in building contracts and subcontracts to include provisions allowing the employer (under the main contract) or a contractor (under a subcontract) to withhold a percentage of the value of completed work until the project is finalised or defects are rectified, by way of a retention. Retention is less common (although not unheard of) in consultants’ professional appointments.

The Reporting on Payment Practices and Performance (Amendment) (No. 2) Regulations 2024 (the Regulations), which were laid before Parliament on 7 October 2024, define a retention clause in a qualifying construction contract as one that allows a party to withhold a certain percentage of payments for works, services, or goods supplied under the contract, the contract sum, or an interim payment, until certain conditions for release are met.

2. New Regulations, new reporting requirements…

Starting next year, large companies in the UK construction sector, such as contractors and consultants, will be required to report the proportion of retention sums withheld from their suppliers. The Regulations are part of a series of measures to be introduced by the UK Government to tackle late payments in the industry.

The Regulations amend existing reporting regulations and introduce new requirements for qualifying companies/entities to disclose specific details about their practices, policies, and performance concerning retention clauses in qualifying construction contracts with their suppliers. The overall objective is to foster improved payment practices and enhance transparency concerning retention policies and performance. This initiative is expected to benefit the supply chain, particularly SMEs, operating within the construction sector.

3. Summary of the reporting requirements

• Interpretation: The Regulations include definitions and explanatory notes that assist in interpreting and applying the new requirements.
• Qualifying Companies: The reporting requirements relate to a “qualifying company” threshold as defined in the Regulations. It will therefore be important to ascertain whether the company or LLP will be caught by this definition. In summary, companies will be impacted if they exceed two or more specified thresholds on their balance sheet dates. These thresholds currently include a turnover of over £36 million, a balance sheet total of over £18 million, and more than 250 employees. Adjusted thresholds apply if a company is a parent company as defined in the Companies Act 2006. It appears that both a subsidiary company and a parent company must report if they each meet the relevant thresholds. However, a company is not considered a qualifying company for the purposes of the Regulations in its first financial year.
• Qualifying Construction Contracts: The requirements also apply to “qualifying construction contracts”. These pick up contracts for the carrying out of construction operations within the definition and meaning of the Housing Grants, Construction, and Regeneration Act 1996 (Construction Act). This covers those contracts and appointments which are subject to statutory payment requirements and where the statutory right to adjudicate applies. It also includes contracts for performing construction work such as building, altering, repairing, maintaining, and demolishing structures; arranging for the carrying out of construction operations; or supplying labour as defined under the Construction Act. However, the Regulations expressly do not apply to construction contracts with residential occupiers. Further, those within excluded sectors, such as oil and gas, or excluded operations, will not be caught by the requirements.

Developers, contractors, consultants, and other entities procuring construction works and which meet the definition of a qualifying company must also comply with these reporting requirements.

Where group companies are involved in procuring projects, the reporting requirements will need to be carefully reviewed on a specific basis and to determine whether any intra-group agreements fall within the scope of this definition.

• Disclosure requirements: When a qualifying company indicates that retention clauses are incorporated into their qualifying construction contracts with suppliers, the Regulations require that it must provide the following supplementary information:
  • A statement on whether retention clauses are included as standard practice for all qualifying construction contracts with suppliers, only applicable to some qualifying construction contracts entered into, or used solely with suppliers in specific circumstances, along with a description of those specific circumstances.
  • A statement on whether a maximum contract value exists below which no retention clause is included, and details of that contract sum.
  • A statement on the standard percentage rate used in retention clauses in qualifying construction contracts between the qualifying company and its suppliers, specifying the percentage/rate.
  • A description of whether there is any practice of ensuring that of using retention clause is no more onerous than any retention clause in a qualifying construction contract between the qualifying company and its client within that relevant supply chain.
  • A description of the mechanism or process for the release of retention monies that are deducted or retained by the qualifying company pursuant to any retention clause, including the specific stages at which these funds will be released.
  • A statement presented as a percentage ratio representing the overall value of monies deducted or retained pursuant to retention clauses between the qualifying company and its suppliers, compared to the overall value of monies deducted or retained pursuant to retention clauses between the qualifying company and its clients. (The Regulations contain a formula for calculating this percentage.)
  • A statement of the percentage ratio of the overall value of monies deducted or retained pursuant to retention clauses from payments made by the qualifying company to its suppliers and the overall value of monies paid by the qualifying company to its suppliers. (Again, the Regulations contain a formula for calculating this.)

Note that the Regulations will not require further information to be published where the statement on the company’s payment practices and policies do not include the use of retention clauses.

• Approvals: The name of the director of the qualifying company or limited liability partnership who has approved the reporting information must be supplied. It is therefore important for that director to understand the relevant reporting requirements and to ensure that all information supplied is accurate and complete.
• Reporting timeline: The report must be published within 30 days of the last day of the relevant reporting period.

4. Implementation timeline

The requirements are scheduled to come into force on 1 March 2025. These Regulations extend to England and Wales, Northern Ireland and Scotland and will apply to each financial year beginning on or after 1 April 2025 (previously 1 January 2025 was targeted).

5. Sanctions for non-compliance

The Government has stated that the purpose of the open reporting is to motivate businesses to comply and improve their payment practices. Public transparency and responsible companies demonstrating good payment behaviour can also set a standard for other businesses to follow.

Companies that fail to report this information will face sanctions under the regulations [1]. It will be a criminal offence by a business, and every director of the company or designated member of an LLP, if the business fails to publish the report with the necessary information within the 30-day specified filing period. According to the DBT, anyone who publishes a report or makes a related statement which is misleading, false or deceptive will commit a criminal offence if they knew, or were reckless, about it being false or misleading at the time it was made. This point applies to both businesses and individuals. These offences will be punishable on summary conviction by a fine. However, there may be a defence for a director to prove that they took all reasonable steps to ensure that the business submitted a report before the end of the filing period.

According to early indications, the Department for Business and Trade (DBT) will seek to encourage compliance by companies caught by the requirements before seeking to take steps to prosecute. However, other earlier consultation documentation issued by the Government suggests that formal enforcement has been initiated against several companies neglecting their statutory duty to report under the existing regime, leading to full and swift compliance[2].

There may also be additional contractual and reputational consequences for non-compliance with the reporting requirements and/or agreed payment provisions.

6. Additional measures

On 19 September 2024, DBT published updated guidance to reporting on payment practices and performance[3].

The DBT plans to introduce other initiatives, such as the launch of a new Fair Payment Code (the Code) on 3 December 2024[4], and consult on additional measures to improve payment practices. The DBT states that the Code, underpinned by fair payment principles, will help smaller firms to identify reliable and trusted partners. It intends to boost cash flow, by tackling late payments and lengthy payment terms that can cause financial strain.

Businesses of any size will be eligible to join the Code by applying for either a Gold, Silver, or Bronze Award, depending on their payment practices. By way of example, a Gold Award is designated for those companies paying at least 95% of all invoices within 30 days. The Bronze Award will apply to those paying at least 95% of all invoices within 60 days. Additionally, every business granted an Award under the Code also agrees to follow and abide by the Code’s principles of being Clear, Fair and Collaborative with their suppliers.

During the application process, businesses must provide evidence demonstrating their adherence to the Code’s requirements and compliance with its principles. This tiered system therefore intends to reward best practices and drive improvements, for instance by encouraging businesses to progress from Bronze to Silver, and ultimately to Gold over time. The Awards will last for two years, after which businesses will be required to reapply.

There will also be a complaint system in place, allowing businesses to notify the Small Business Commissioner (overseeing the Code) about Award holders who may not be meeting the requirements of their Award category or complying with Code principles.

Commentary

It is crucial for contractors and consultants subject to these requirements to understand the nature of the reporting that will be published and ensure their readiness to comply from the effective date of the Regulations.

The sanctions above demonstrate the importance of compliance. The Regulations requiring that the name of the director who approves the information be provided creates a real sense of ownership. This is another example of a growing global trend where governments and regulators are seeking to pierce the corporate veil and introduce greater accountability for individual directors and officers.

Any criminal proceedings brought against individual directors are likely to fall for cover (at least for defence costs; any fines levied are no likely to be covered) under Directors’ and Officers’ policies. However, in circumstances where deliberate or reckless intent is established by a Court or other Tribunal then it is likely that Insurers could seek reimbursement of any defence costs which have been advanced up to that point.

It is important therefore that companies and their boards of directors have policies in place to ensure that the information is readily available for reporting purposes. Insurers might also wish to explore the company’s policies in this regard at renewal time.

In any event, this is another piece of legislation which potentially increases the exposure of directors and officers, and their insurers, to another regulatory risk.

For more information, please contact Will Buckby, Nathan Penny-Larter or Kayleigh Rhodes of Beale & Co.

[1] Duty to report: guidance to reporting on payment practices and performance – GOV.UK

[2] Payment and Cashflow Review: The Reporting on Payment Practices and Performance Regulations 2017 and the Limited Liability Partnerships (Reporting on Payment Practices and Performance) Regulations 2017, page 10

[3] Updated DBT guidance, Duty to report: guidance to reporting on payment practices and performance

[4] New plans revealed to help small firms and improve access to cash – GOV.UK