Industry Watch – Payment Retention – How the Construction Industry is Acting to Reduce the Impact of Contractor Insolvency

Since the failure of the UK’s second largest construction company, Carillion, the construction industry has been actively seeking to change the way progress payments are made.  In the wake of Carillion’s failure, hundreds of sub-contractors and suppliers were left unpaid.  The effect this had on the industry rippled throughout the UK.  According to this article in creditstrategy.co.uk, Carillion’s liquidation left over £5B in debt with only £29M in reserves.  As a result, industry leaders have been actively considering different alternatives to mitigate the impact of contractor insolvency in the future.

I’ve previously discussed the concept of Project Bank Accounts (PBA) and how these banking alternatives could solve many of these problems.  PBA’s are more likely to become an option in the near future, but another industry leader is showing us that there are things that can be done now.

Network Rail is the UK’s Owner of Great Britain’s public rail system.  They Own and operate commuter rails throughout the Country.  Their public works projects flood Billions of dollars into the construction industry every 5 years (a period they call their control periods).

Network Rail has historically been a progressive employer in construction.  Even before Carillion, Network Rail was working to reduce contractor payment terms from 60 days to 28 days.  Now Network Rail is stepping up again and writing provisions into their contracts to outlaw payment retention for sub-contractors.

Payment retention is a form of withholding that is typically done by Owner’s to ensure Contractors complete their work.  Typically the Owner withholds 10% (or some other agreed upon percentage representative of the GC’s fee) on each invoice.

Unfortunately, the practice of “trickle-down” contract terms has also evolved.  This concept means that Contractors pass down the terms of their contract with the Owner onto their sub-contractors.  This trickle-down of terms also includes retaining 10% from the sub-contractor’s invoice.

This should not work this way!

The idea behind retaining a portion of an invoice was always to withhold enough of a sum to create an incentive for the Contractor to complete the work.  Withholding just the GC’s fee was meant to create an incentive without impacting the flow of payments downstream.  So Network Rail is now trying to right this by writing into their contracts provisions to outlaw the practice of GC’s withholding from their subcontractors.

Contractors may argue that they too need provisions to incentivize performance.  They are certainly free to do that, but the Owner’s retention of the Contractor’s fee, should not automatically mean that a sub-contractor that has completed their portion of the work remains unpaid.

Network Rail is making this provision a soft one with no firm penalties for Contractor’s who fail to comply.  I suspect this will be an interim solution that in the future will become more firm.

To me this feels like a good immediate step that can help minimize the exposure of not only sub-contractors, but also Owner’s.  This does little to solve the actual risk of Contractor insolvency, but it could reduce the financial impact on the supply chain.  This provision also corrects a condition that has persisted for far too long.  For those reasons, I support this approach and will be sure to recommend it in my next project.

What do you think?  Is Network Rail on the right track?  What provisions have you added to your contracts as a result of the fall of Carillion?  Tell me your stories.

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