Ban on financial retentions could have major repercussions

First published in The Business.

Financial retentions have long been used as a form of security against a contractor’s failure. It is common practice for a client to retain either 3 per cent or 5 per cent of the contract price, release half of this amount at completion, and hold the balance for at least 12 months. That may be about to change, as the Commercial Payments Bill introduces a ban on the use of such retentions in construction contracts.

The objective is to improve cashflow in the industry – which is much-needed and would be widely welcomed – but if the ban became law it would also have many other ramifications, including for certain property transactions.

The bill is still working its way through Parliament. If it is enacted there will be a transition period, but given that its implications for the construction and commercial property sectors could be significant, those effects need to be considered now. For example, any retention sums that are still held by the end of a transition period will fall due for payment; for any that are not, an implied term would entitle the contractor to an additional sum.

Naturally, businesses will respond to any change. In the construction world, we may start to see an increase in the use of security mechanisms such as bonds and guarantees – although it is not certain that the bond market has the capacity to cover such increased exposure. We may also see greater focus on quality control through projects, and also on the valuation process. And a debate about whether this will trigger a shift to milestone payments has already begun.

The bill does not yet provide clear guidance on allowable alternatives. We may not fully understand the ban’s implications until such matters are tested in court.

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