The Government proposes a number of major reforms to tackle late payments, with the construction industry likely to be significantly impacted by a number of the proposals.
This article provides a summary of the key changes expected to come into force and what you need to do to prepare.
How big of an impact do late payments have on the UK economy?
According to the government response to the consultation, late payments are estimated to cost the UK economy almost £11 billion per year. The Government states that businesses are owed a staggering estimated £26 billion in late payments at any given time, which equates to £17,000 on average per affected business.
The construction industry is no stranger to the devastating impact of late payments to businesses. Around 28% of all construction insolvencies in 2023 were caused by late payments. (source?)
Which of the Governments proposed measures will have the biggest impact on the construction industry?
So, what are the most salient measures to the construction industry intended to be implemented by the Government, and what do industry players need to be aware of?
We take a deeper dive into the cons and pros of some of the proposed measures, below:
A ban on retention payments under construction contracts
Perhaps the most controversial measure is that the Government intends to ban the practice of deducting and withholding retention payments under the terms of a construction contract, and is consulting on its implementation.
Cons
Those with experience in the construction industry are all too aware of the persistent issues with retentions including:
- Frequent late payment, partially or not at all. This slows down cashflow across the supply chain.
- Retention money is often not ringfenced and is instead used as working capital by payers. Those funds are difficult to recover in the event of payer insolvency, exposing those lower down the supply chain to insolvency risk on money already earned.
- Despite the prohibition in section 110(1A) of the Housing Grants, Construction and Regeneration Act 1996, contractual triggers for the release of retention often do not correspond to completion of a contractor's work, causing disputes and administrative delays.
Pros
Despite the above issues, there are strong arguments to be found against banning retentions, including:
- Without a retention, payers lose significant commercial leverage which can compel contractors to return to site to fix snagging and defective works.
- In the absence of retentions, payers may solely rely upon bonds or guarantees, which could add to project costs and introduce banking complexity. Alternatively, payers may adopt a more adversarial or thorough approach to valuations, which may undermine the stated goal of increasing cash flow.
- Retentions are embedded in standard forms, such as JCT, SBCC, NEC, and FIDIC. A wholesale ban may require a substantial, widespread and otherwise unnecessary redrafting of popular standard forms.
- There is precedent showing that properly managed retentions can work. For example, under New Zealand’s Construction Contracts Act 2002, and specifically through the Construction Contracts (Retention Money) Amendment Act 2023, retention money is held on trust for the party from whom it is withheld. That means it cannot be used as working capital by the main contractor. Retention money must be kept in a separate bank account and contractors holding retentions must provide a statement of retention funds to the other party when money is first withheld, and then at least every three months thereafter.
- Retentions have been in use in the UK construction industry for nearly 200 years. They are simple, easy to understand, and, albeit bluntly, do a good job of achieving the stated goals of ensuring snagging is completed in good time.
A strict 60-day maximum payment term
The Government proposes to strengthen maximum payment terms in a bid to better protect smaller businesses who often face perceived unfair payment terms. The Government intends to set a maximum payment term of no longer than 60-days, with the possibility of reducing this to 45-days after five years.
Cons
Of course, there are some cons and possibly unintended consequences, namely:
- The imposition of shorter deadlines on payers, especially main contractors who may not fall into the "small business" category, could strain their cashflows if they are not paid upstream quickly enough. Stricter obligations at one level may create insolvency and cashflow pressure at another.
- If disputes must be raised within 30 days, maximum terms may inadvertently incentivise buyers to dispute invoices more frequently, or defensively, to avoid being locked into automatic payment.
- Companies, especially larger ones with complex supply chains, will need to revise payment systems, reporting processes, and oversight mechanisms to comply.
Pros
There are several pros to this proposal from the perspective of those in the construction industry:
- Shorter, enforceable payment deadlines would help ensure money reaches suppliers (particularly SMEs) faster, improving liquidity and business resilience.
- A statutory maximum payment term introduces consistency across industries, improving commercial predictability. reducing disputes and protracting negotiations over “acceptable” payment periods.
- Shorter payment deadlines protect smaller businesses that lack the capital reserves and negotiating leverage to tolerate long payment terms imposed by larger buyers.
- The Housing Grants, Construction and Regeneration Act 1996 and Scheme for Construction Contracts have already gone far in standardising construction payment provisions. Changing the number of days from the due date, to the final date for payment, is not a complex administrative task.
A statutory time limit to raise disputes
The Government proposes to set a statutory limit of 30 days for disputing invoices. Failure to do so will require a business to pay the invoice sum in full within the agreed payment terms (plus any statutory interest if late).
Cons
- A blanket 30-day window may not be suitable for large projects, heavily engineered contracts, late submitted supporting documents or where there are multiple subcontractor layers. The deadline may increase errors or force rushed approvals/disputes.
- To avoid liability, contractors might dispute invoices even when unsure. The rule that disputes must be raised within 30 days, or the invoice must be paid, may incentivise protective disputes. This could result in more disputes, not fewer, especially on large construction packages.
- Main contractors must verify subcontractor invoices quickly, even when upstream payments (e.g. from a developer) are delayed. Cashflow problems upstream are a known driver of downstream payment delays. This could lead to main contractors having to pay subcontractors before they receive payment from the client. This could increase working capital requirements, raise project finance costs or prompt more expensive tenders to compensate.
Pros
- In construction, invoice disputes are ‘commonly used strategically’ to delay payment, particularly in complex and multi‑tiered supply chains. The 30‑day window aims to stop firms raising late or artificial disputes to push payment far beyond contract terms.
- SMEs dominate construction (especially subcontractors). Faster dispute resolution means: (i) subcontractors receive payment sooner if no dispute is raised; and (ii) reduces exposure to insolvency risk caused by late payment - an issue the Government identifies as forcing closure of 38 UK businesses per day.
- The 30‑day deadline obliges contractors/employers to promptly justify reductions, e.g. concerning measured works, variations or defects.
- The 30-day deadline will presumably also apply to the final account process, which may speed up this often delayed process.
Mandatory interest of 8% above the Bank of England base rate on late payments
The consultation response proposes to make it a requirement that all commercial contracts will contain a right to statutory interest at 8% above the Bank of England base rate.
Cons
- Project margins may be impacted by the payment of interest on overdue sums, increasing the financial burden on contractors.
- In a bid to mitigate potential interest risk, contractors may choose to inflate costings when anticipating potential interest payouts.
- If payments are held up by developers or funders, contractors may have to pay interest to subcontractors on amounts they have not yet received. This may exacerbate working capital strain at this level of the supply chain as an unintended consequence.
- Where a payer becomes insolvent, the mandatory interest provision for late payment offers little meaningful protection to the payee.
Pros
- An 8% statutory interest (over the Bank of England's base rate) plus compensation creates a tangible cost for late payers, discouraging strategic delay, a prevalent issue in construction cash flow practices.
- Added financial consequences can incentivize parties to resolve invoice disputes faster.
- The introduction of mandatory interest aligns with the intention of the Late Payment of Commercial Debts (Interest) Act 1998 by removing ambiguity, even if the contract is silent on interest.
Key take aways
It is important to remember that the proposed measures have not yet come into force. The Government has said that it will take forward legislation when parliamentary time allows. That doesn’t mean that players in the construction industry, can or indeed should, be complacent. Actions that can be taken now, to make the transition easier if and when it is implemented include:
- Reviewing and revising existing agreements and procurement templates to incorporate the mandatory interest and capped payment terms and anticipate the proposed ban or safeguarding of retentions.
- Tightening invoice processing systems, including adopting efficient digital invoicing and tracking to trigger reminders before the 30-day dispute deadline.
- Forecasting interest liabilities and building in buffers to help guard against upstream payment delays.
- Raising awareness and accountability internally about prompt payment practices to reduce disputes and non-compliance.
