What are retentions in construction contracts and why are they under review?

Withholding payment at the end of a construction contract has long been a fixture of UK construction contracts.  It is often agreed at the outset and is a condition of the contract that a proportion of the agreed contract sum will be withheld (the “retention”).

A typical contract allows the client or main contractor to hold back usually 3-5% of the agreed price and half of this retention is released when the works have reached practical completion (ie the works have been substantially completed) and the other half released once the defects liability period ends.

The defects liability period is usually a 12 (or sometimes 24) month period after the works have been substantially completed, and where the contractor or sub-contractor is contracted to come back on site and rectify agreed defects or snagging items.

The retention is withheld to incentivise the contractor or sub-contractor to rectify defects where they are contracted to do so.   However, for many in the supply chain, that withheld sum can represent the difference between breaking even and running at a loss; cashflow suffers, and the retention monies are always at risk of delay, dispute or total loss.

When Carillion collapsed in 2018, industry bodies estimated that around £250 million of sub-contractors’ retention money was lost. And it is this that is still cited as a turning point in the industry’s appetite for reform.

Government Consultation – Department for Business & Trade – Late Payment ; Tackling poor payment practices

The government launched a consultation in July of this year on its package of proposed legislation to provide comprehensive support to SME’s and to ensure they are paid on time.  The government recognises that late payment causes harm to smaller businesses and retention reform in the construction industry is part of a wider effort to tackle late payment and improve cashflow across UK business.

The construction industry, with its complex chains of contracts and tight profit margins, has been singled out as one of the sectors most affected by slow or uncertain payments and the government are concerned that poor payment practices can increase the insolvency risk of many parties involved if monies owed to them are tied up in retentions.

The Department for Business and Trade has proposed two approaches – either banning retentions entirely or keeping them but introducing stronger protections for the payee

Option 1: Prohibit the use of retentions in construction contracts

The Housing Grants Construction and Regeneration Act 1996  (the “Construction Act”) would be amended so that new construction contracts could no longer include retention clauses.  The paying parties could seek alternative forms of insurance or surety, such as performance bonds, but at this stage it is not intended that this would be mandatory.

Supporters of this approach argue it would free up millions of pounds currently stuck in limbo across the construction sector and remove one of the main sources of cashflow tension between main contractors and sub-contractors. The money owed would circulate faster through the supply chain, improving liquidity and potentially reducing insolvencies.

Critics, however, worry that without retentions, clients will simply find other ways to protect themselves – perhaps by tightening payment milestones or imposing larger bond requirements.   For smaller firms, that could mean higher insurance costs or additional paperwork just to prove reliability.

Option 2: Protecting retention sums deducted and withheld under construction contracts

This alternative proposal would amend the Construction Act to allow retentions to continue but require that the withheld retention monies be held for the benefit of the payee- separated from the payer’s own accounts, held in a separate bank account, or covered by an independent guarantee or insurance policy.

The money would still be withheld, but it would belong to the payee and be clearly identifiable and recoverable, even if the business holding it became insolvent.

Proposals under discussion include setting up dedicated “retention accounts” for each project, automatic release of funds after a set period unless a formal notice is issued, and ensuring that any interest earned on those accounts is passed to the payee.

This approach would provide far greater security, while preserving the principle of holding a small sum back to encourage proper completion. However, it would also create new administrative duties for the payer, who would need to manage multiple protected accounts or guarantees, track release dates, and issue notices on time. Smaller firms might benefit most, but those administering the schemes could face more work and cost.

Transparency already on the rise – changes from March 2025

Change is already happening through new transparency rules.

Under the Reporting on Payment Practices and Performance (Amendment) Regulations 2025. new reporting requirements have been introduced and will apply to larger companies and limited liability partnerships that meet certain thresholds, such as turnover or balance sheet size.

These larger companies which use qualifying construction contracts must report (in financial years beginning on or after 1 April 2025) how they handle payment practices, including whether they use retentions, how much they hold, and how promptly they release the money.

For smaller firms, the data published by their main contractors or clients will offer a new window into how money flows, or stalls, at the top of the chain.

How reform could play out on site

If retentions are banned outright, payments would likely become simpler and faster. Contractors would be paid the full amount for completed work, and defect management would shift toward other contractual tools such as warranties or bonds. Those who can demonstrate reliability and quality would stand to benefit, while others might face tougher prequalification or insurance checks.

If retentions are retained but protected, the impact would be more subtle but still significant. Sub-contractors could rely on actually receiving their money once the defects liability period ends, rather than chasing release or fearing insolvency higher up the chain.

For the paying party, the challenge would be managing the extra process (eg, setting up accounts, monitoring timelines, and proving compliance) but the benefit could be greater trust and smoother relationships throughout the project.

Either way, the direction of travel is toward greater fairness and visibility. The government’s focus appears to be firmly on protecting the cash flow of small and medium-sized businesses.

Preparing for what comes next

For contractors and sub-contractors, it is worth taking stock now. Map where retentions currently apply in your contracts, and how much of your working capital is tied up in them. If the system moves toward ring-fencing or trust accounts, you may need to adapt your internal processes to track when retention money should be released.  For contractors and sub-contractors, the best preparation is to stay informed, tighten payment administration, and try to be ready to adapt quickly.

If a ban is introduced, review how you handle defects and completion obligations, because those risks won’t disappear, they’ll just be managed in different ways. Some clients may expect alternative forms of insurance.

It’s also worth looking at your main contractors’ payment practices, especially as new data becomes available. If their published reports show long delays in releasing retentions or high levels of unresolved disputes, that’s valuable information when deciding which projects to take on.

What to expect next

The consultation process is ongoing, with responses being gathered from across the industry.  The consultation opened on 31st July 2025 and closes on 23rd October 2025.  Once reviewed, the government will publish the consultation outcome within 12 weeks of the close date of the consultation so watch this space!