Commercial Payments Bill: Change is coming to payments in construction and beyond
The Commercial Payments Bill (the “Bill”) proposes significant changes to payment processes and a ban on retentions. Construction businesses need to be aware of the proposed changes and should start to consider how they will impact day-to-day operations now.
The Government estimates that late payment costs the UK economy roughly £11 billion per year and, on average, closes 38 UK businesses every day1. The response is the Bill. The Bill was introduced to the House of Lords in May this year and reached the House of Lords report stage on 15 September. An amended version of the Bill has now been published and is awaiting its third reading in the House of Lords.
The Bill is not expected to receive royal assent until 2027 at the earliest.
What does the Bill mean for the UK construction industry, if given royal assent in its current form?
Abolition of retentions
As long ago as the Banwell Report in 19642, there has been criticism of retentions and Sir Michael Latham’s report3 recommended scrapping them in the 1990s. Whilst retentions can impact cash flow within the supply chain, and that may well be part of the reason for the ultimate ban on retentions generally, some parties to a construction contract view the typical 3-5% retention as an established contractual mechanism for securing performance and the rectification of defects. Whatever your views on the arguments, it appears that retentions are going to come to an end in their current form.
The Bill proposes a gradual move away from retentions rather than an immediate ban. Following royal assent, there will be a two-year transition period during which parties may continue to enter into contracts containing retention provisions4.
Following the two-year transition period, new retention clauses will be void5.
However, parties should be cautious about the use of retentions during the transition period. Any retention clause that is agreed for the first time, or amended, during the transition period will cease to have effect one year after the transition period ends on the somewhat apocalyptically named “last retention day”6. In practical terms, this means that a retention provision introduced or amended during the transition period could still operate for up to three years but would then become unenforceable.
Note that in addition to repayment of the retention (which will be triggered at the end of the transition period), there are fixed amounts payable in respect of retentions withheld in contravention of the new restrictions, of the higher of £40 or 50% of the retention debt.
Existing retention provisions that remain unchanged during the transition period will not be affected by the Bill. However, those parties proposing to amend a contract during the transition period should carefully consider whether any proposed changes they may be implementing could bring the clause within the scope of the new regime (and therefore subject to the ban rendering the retention clause void).
It remains to be seen whether the transition period brings with it an increase in the number of disputes we see within the industry.
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Definition of retention
The definition of retention in the Bill is broad, covering:
“the practice by which one party to a construction contract (“A”) deducts or retains sums of money equating to a percentage of:
(a) the amount payable to another party to the construction contract (“B”) for any goods, services or works supplied by B, in accordance with the terms of the construction contract between A and B,
(b) an interim payment payable to B in accordance with the terms of the construction contract between A and B, or
(c) the contract total of the construction contract,
until any condition for release or partial release of the sums to B (whether included in the construction contract or in an agreement relating to sums payable under that contract) is met.”
This definition is a little unclear - it cannot be the case that the retention of any amount subject to conditions being met later is caught. We would expect that the terms “deducts” and “retains” should be interpreted narrowly so as to refer to the practices of retentions that the construction industry commonly uses. No doubt the extent of the definition above will be further debated and, if it becomes law, may need to be tested by the courts.
Alternatives to retention
The construction industry must now use this relatively short window presented by the coming into force of the Bill and the transition period in which to review its existing arrangements and explore alternatives to retention.
Retention has historically been deducted as security for the contractor’s obligation to properly complete all activities required under a construction contract including its obligation to return to the site to rectify defects during the defects liability period.
The alternatives to retention may include forms of security such as retention/warranty bonds and parent company guarantees or escrow arrangements. However, bonds or escrow arrangements will come at a cost. The market for bonds is particularly difficult for smaller contractors, who risk tying up their credit lines when they are required to provide bonds.
During report stage, the Government confirmed that the Bill does not prohibit the use of a bank or escrow provider merely to facilitate the transfer of funds. However, an arrangement where a third party holds money back as security for contractual performance may still amount to a prohibited retention. The substance of an arrangement, rather than its label, will therefore be important.
Alternatively, genuine staged and interim payments appear to remain permissible where those sums are not being withheld for completed work. However, care will therefore be needed when drafting the payment mechanisms that govern the contract so as not to fall foul of the ban on retentions.
Whether the ban on retentions will improve cashflow in the construction industry remains to be seen. It is likely that employers will pay an increasing focus on delay, variation and final account issues.
Maximum payment periods and periods for service of pay less notices
Moving on to the other important changes proposed, the Bill sets out maximum payment periods of 30 days for public authority purchasers and 60 days for all other purchasers, with limited exceptions7.
In construction contracts the requirement to agree a final date for payment no later than 30/60 days after the due date now forms part of the test of what constitutes an “adequate mechanism for determining what payments become due” under section 110 HGCRA.
60 day payment terms in the private sector are atypical and so we would have expected most parties to be comfortable with this change. There may be a concern that the 60-day maximum for payment terms is legitimised by the Bill and so longer timescales could become an industry norm, which is not the intention of the proposals. That said, the proposals are consistent with the Fair Payment Code.
The Bill was amended at report stage to give the Secretary of State power to shorten these maximum payment periods. The Secretary of State must consult on whether the periods should be reduced within five years of the relevant provisions coming into force. This creates a route by which the 60-day private sector limit could subsequently be reduced to 45 or 30 days. This may therefore remove the ability of parties to create a new industry norm of 60 day payment terms.
Careful consideration and scrutiny of how the 30/60-day payment terms (or whatever is ultimately agreed) may operate alongside the HGCRA requirements for payment / pay less notices will also be required in the House of Commons readings and thereafter by the construction industry. Detailed provisions are contained in the Bill in respect of the implementation of these payment terms, particularly with regard to public sector organisations who will have specific processes to get to grips with.
In respect of pay less notices, pursuant to which a paying party can rectify the amount that it is required to pay on the final date for payment, the ability for parties to agree how late such a notice can be issued has been replaced by a requirement for it to be issued no later than 7 days before the final date for payment8. Given that parties were previously free to agree a period as short as 1 day, this appears a sensible proposal.
Mandatory statutory interest
The ability to agree the rate of interest which applies to late payments, pursuant to which parties will be used to agreeing an interest rate which represents a “substantial remedy” and is typically around 2-4% above a reference rate, is to be outlawed. Parties will be prohibited from contracting out of mandatory interest on late payments, at 8% above the Bank of England’s base rate9.
Adjudication
A further key proposal of the Bill is that a small business will have the right to pursue a payment dispute with a larger business through adjudication – you can read our article on that here.10
At report stage, an amendment proposing a statutory 60 day period for determining disputes was withdrawn.
What to do before the Bill becomes law
The Bill represents one of the most significant proposed changes to payment practices in recent years. For the construction industry, the proposed abolition of retentions is likely to attract the greatest attention.
However, the wider reforms, including mandatory payment periods, restrictions on pay less notices, statutory interest requirements and a new adjudication process for payment disputes could have a substantial impact on how parties negotiate and administer their contracts.
Do not wait for royal assent to map your exposure:
Review contracts that contain retention provisions
Identify any clauses likely to be amended during the proposed transition period
Test whether alternative security would be commercially workable
Check whether payment and pay less notice processes could meet the proposed deadlines
Repeat the review when the Bill completes its remaining parliamentary stages
If you have any questions or queries regarding the contents of this legal article, please get in touch with Jon Baker or Brittany Cox in our Construction & Engineering team.
Footnotes
The Banwell Report 1964
The Latham Report 1994
New section 113B HGCRA
New section 113C HGCRA
New section 113B HGCRA
Section 2D CPILPA and amendments to section 110 HGCRA
Section 111 HGCRA
Section 6A CPILPA
Commercial Payments Bill - The need to be ready for the rough and tumble of adjudication
The content of this page is a summary of the law in force at the date of publication and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.
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