Commercial Payments Bill would ban retention and late payments in UK construction

The Commercial Payments Bill introduced on 19 May, following the government's March announcement of measures to curtail late payment practices in UK construction, has had its second reading in the House of Lords. Key aspects of the bill were questioned and debated in the chamber on 9 June. Its most significant provision for the construction industry is a ban on retention payments, though reforms to payment periods and late payment interest will also have wide-ranging implications for the sector.

Retentions ban

As currently drafted, the bill would amend the Housing Grants, Construction and Regeneration Act 1996 to ban retention payments, which are broadly defined as the practice whereby one party deducts or retains a percentage of the amount owed until a condition for release is met, such as expiry of the defects notification period.

The ban would be implemented in two phases. A two-year transition period would apply first, during which any retention clauses including those in pre-existing contracts will become void on the date falling three years from the first day of that transition period. Following the transition period, any new or varied retention clauses will be automatically void, and an implied term will entitle the payee to the higher of £40 or 50% of the retention amount, together with statutory interest and late payment compensation under the Late Payment of Commercial Debts (Interest) Act 1998: £40, £70 or £100 depending on debt size, plus any difference between that fixed sum and the total reasonable costs incurred in recovering the debt.

Payment reforms

The bill also amends the Late Payment Act and the Construction Act to introduce a maximum payment period: 30 days for public sector payers and 60 days for private sector payers, with any contractual term extending this period being automatically void. For construction contracts, this period runs from the day after the payment due date, and the final date for payment must occur within these time periods. The ability of the parties to agree a time period within which a pay less notice must be issued is also being restricted, and must not be any less than seven days before the final date for payment.

Statutory interest at 8% above the Bank of England base rate would be implied into all commercial contracts, with any contractual provision purporting to alter this remedy rendered void. The bill does not alter the rate and the category of contracts to which it applies, which are broadly business-to-business contracts for the supply of goods or services. The new prohibition on contracting out of the application of the statutory rate means that parties will no longer be able to agree an alternative contractual remedy or lower interest rate in their contracts.

Industry concerns

While some industry bodies have broadly welcomed the bill, others have raised concerns that it lacks sufficient detail for complex construction transactions and that certain provisions may prove anti-competitive on a global stage and inadvertently disadvantage smaller parties.

The choice of 60 days as the maximum private sector payment period in particular drew criticism from peers during the second reading, with many arguing that a limit of 30 or 45 days would be more consistent with the bill's objectives. A related concern is that the 60-day period could in practice become a default payment date rather than a ceiling, potentially lengthening payment times for businesses currently paid within shorter periods. As regards payments under construction contracts, a lack of anti-avoidance measures set out in the current draft of the bill also means that payment cycles could in practice be extended well beyond the 30- or 60-day period by delaying the period at which a payment is considered "due" under the Construction Act (being the point at which the 30/60-day time limit begins to run).

There is also uncertainty around how effective the retentions ban will be as currently drafted. The precise scope of the wording used to implement the ban is likely to be tested in the courts. Parties may seek to achieve a similar commercial effect through alternative contractual arrangements, creating a period of uncertainty about which provisions will be treated as void. In anticipation of parties using contract drafting to circumvent the statutory definition, the bill reserves to the secretary of state the power to legislate on these definitions using secondary legislation.

In the absence of retentions, the market will look to alternative risk management mechanisms to ensure that contractors will return to site and remedy defects. Performance bonds, insurer-backed defect warranties, and project bank accounts or escrow arrangements are among the likely alternatives, though each carries its own costs and limitations, with some mechanisms potentially creating barriers to entry for smaller contractors. Upstream counterparties might also require letters of credit in lieu of retention.

The issue drew considerable debate during the second reading, with some members of the House of Lords questioning how the government intends to ensure that contractors remain liable for defects after leaving site, and whether an outright ban of construction retentions was the right answer to abusive retention practices.

Next steps

The bill is subject to change during the remainder of its passage through Parliament. The possibility of amendments is heightened by the government's own acknowledgement in its consultation response that it would "consult further with interested parties on the impact of this measure before taking a final decision on implementation." As no such further consultation has yet taken place, the final implementing legislation may look quite different to its current form.

The committee stage, where the detail of the bill's text will be considered, has not yet been scheduled.

Osborne Clarke comment

Despite the uncertainty about the final text of the bill, and the two-year transition period for the retentions ban, the breadth of the proposed reforms gives reason for businesses to review their position sooner rather than later.

Standard form contracts and subcontracts extending beyond the transition period may warrant attention, particularly with regard to removing retention clauses and ensuring payment, interest, and dispute provisions comply with the anticipated statutory requirements.

Businesses will also need to consider how to manage and mitigate defect and performance risk when retention clauses are no longer available, as well as update governance and reporting procedures for compliance with the new payment practice requirements. Shorter mandatory payment periods may require changes to invoicing and payment processing. Cash flow forecasts and working capital requirements will also need reviewing, given that retention funds will no longer be available to support liquidity.

Alice Smith, a trainee solicitor with Osborne Clarke, assisted in writing this Insight.