The current practice of withholding cash retentions is hugely damaging for many Scottish construction SMEs and is leading to insolvencies, says Scottish member companies of BESA
Retentions are usually charged at 5% of the total contract value with at least half of the amount often withheld until two or even three years after completion. This practice is making it increasingly difficult for Scottish construction SMEs to survive, say BESA members.
Contractors have considerable upfront project costs to cover before they can apply for the withheld payments, including materials, equipment and labour costs as well as tax charges incurred on external and internal payments.
In addition, the fact that clients often apply 60-day payment terms on subcontractors’ further stifles crucial cash flow and, as Stacey McKinlay, managing director of Ductform HFE explains: “You are in effect funding your project for four months plus at any given time.”
McKinlay also pointed out that most subcontractors’ profit margins are between 0.5% and 1% – so a 5% retention leaves SMEs considerably in deficit. Although half of the retention held is normally paid once all contract works are considered complete, this in many cases is only following a negotiation process that often results in the subcontractor agreeing to reduce the final sum charged.
McKinlay said: “The remaining half of the 5% retention is normally to be released 12 months following the contract end date, although we have noticed an increase in the number of projects now imposing 24 or in some cases a 36-month delay.
“If this were not difficult enough, on many occasions the retentions held from you can be lost indefinitely if the client folds during this process.
“This domino effect is extremely common and explains the high level of insolvencies in our sector,” she added. “Financial institutions are also reluctant to support a business this far down the supply chain, as they are fully aware of the level of risk involved.”
Gordon McArthur, managing director of WMQ Building Services, said his firm had around £900,000 currently tied up in retentions that, instead of being available for investment in the business, was “being deducted for something that might happen”.
McArthur stated: “The fact that you are contracted to undertake specialist services is because clients know you can carry out the work to a good standard. To be penalised with a 5% reduction through the duration of the project and then held for up to two years is, therefore, just wrong.”
McArthur said he understood there needed to be a level of protection for the client, but there must be a better way of doing that than stifling SME growth and leaving perfectly good companies and their employees at risk.
“We are at the mercy of when and if main contractors want to pay retentions,” he added.
“We push hard for all retentions we are due, but this takes up a lot of time and effort that just adds to costs/overheads.”
Put an end to withholding cash retentions
The Scottish Government is currently carrying out a consultation about the practice of cash retentions and BESA believes Scotland could be the first nation in the UK to put an end to what has become a serious social and economic injustice.
A recent survey found that in the fourth quarter of 2019, 75% of BESA’s Scottish member companies had part of their turnover tied up in retentions. Within that, 22% reported between 6-20% of their turnover locked away in retentions, and of even more concern, 3% said over 20% of their turnover was tied up.
BESA director of legal & commercial, Debbie Petford, commented: “We have written to the Scottish Government encouraging them to lead the way on this issue – and have urged our hundred-plus Scottish members to take part in the consultation so that their daily struggles are heard.”
The Scottish consultation seeks views on a retention deposit scheme, similar to a tenancy deposit scheme, as a solution to protect construction SMEs from abusive retentions practices, and from upstream insolvencies like those seen after the Carillion collapse.
“Scotland has a golden opportunity to lead the rest of the UK with sensible and urgently needed reform,” added Petford.
“If Holyrood passed legislation to protect the retentions money owed to SMEs it would set a positive precedent for the rest of the UK to follow.”