Introduction
On 24 March 2026 the UK Government released the findings of a consultation undertaken with UK businesses in relation to late payment issues and what steps can be taken to address these (the Consultation).
Whilst both the Consultation and the proposed legislative changes had cross-sector breadth, there were specific parts focused on the construction industry.
The underlying Late Payments Research published by the Department for Business & Trade in July 2025 states that late payments cost the UK economy almost £11 billion per year. The econometric analysis estimated that over 14,000 businesses close every year as a result of these late payments.
The Government has accordingly committed to introducing new legislation as soon as Parliamentary time allows to tackle late payments. In particular, the Government has proposed, amongst other steps, to:
- Impose a maximum payment term of 60 days, with limited exemptions, to ensure smaller business are paid promptly;
- Make commercial contracts contain a right to claim statutory interest at 8% above the Bank of England base rate; and
- Ban the practice of deducting and withhold retention payments under construction contracts.
Retention payments are commonly used in construction contracts, so much so that many standard form contracts are drafted to account for these deductions (see for example Option x16 in NEC4, and clauses 4.16 to 4.18 in the JCT D&B 2024 edition). The retention withheld typically accounts for 1.5% to 5% of the contract sum. This mechanism has traditionally been used as a means of incentivising the contractor to return to site to remedy any defects identified in the works. This prohibition will therefore mark a significant shake up in how parties have contracted in recent years, and standard form contracts will need to be amended accordingly.
In the addition to applying a prohibition on retention payments, the Government has stated it will give the Small Business Commissioner additional powers to investigate suspected poor payment practices, to adjudicate over payment disputes and issue fines to large companies that persistently make late payments to its suppliers.
Consultation outcomes
The Consultation ran from 31 July 2025 until 23 October 2025, and received 867 responses from a wide range of businesses across the UK of various sizes and within different sectors.
As part of the Consultation, respondents were presented with two proposals in respect of how retention payments should be managed. These were broadly:
- Option A: prohibit the use of retention clauses in construction contracts; or
- Option B: allow the use of retention clauses within construction contracts and require any retention sums withheld to be protected.
The Consultation responses demonstrated broad agreement that retention practices contribute to unjustified late, partial, or non‑payment, with a disproportionate impact on small and medium‑sized contractors. The withholding of retention sums was widely seen as undermining cash flow by restricting working capital and limiting the funds available for day‑to‑day operations and investment, increasing financial pressure across the supply chain.
Perhaps unsurprisingly, it appears many tier one contractors have been positive about the proposed amendments. Though housebuilders and developers may be less open to the proposed reforms, often being the parties sitting at the top of the construction payment chain.
Impact
The government has said that whilst they fully intend to introduce legislation prohibiting retention payments, they will “consult further with interested parties on the impact of this measure before taking a final decision on implementation“.
Whilst a ban on retention payments could help secure cash flow for small and medium sized contractors, it is unclear how this measure could impact relationships between employers and contractors, especially where retention payments have often been used as a way to encourage contractors to return to site to rectify snagging and defects. If the proposal goes ahead, it will likely bring other forms of security to the forefront, including, but not limited to:
- Performance Bonds: this provides the employer with third‑party financial security if the contractor fails to perform, without withholding sums otherwise due under the contract. Though requiring a bond typically increases the contract sum, as the contractor will look to pass on the increased costs associated with procuring the bond; and
- Parent Company Guarantees (PCGs): This may provide the employer recourse against the contractor’s parent company for non‑performance or insolvency, strengthening contractual security without restricting cash flow. PCGs can increase the contract price indirectly, particularly where additional risk is assumed or where corporate support is not routinely provided.
Paying parties will not freely give up a potential protection without seeking an alternative protection. Contractors are unlikely to provide those alternative protections without increasing prices to reflect the additional cost and risk, although employers are likely to argue that the absence of retention is already adequate compensation. The proposed reforms therefore represent a reallocation of risk through contract pricing and security mechanisms, rather than a removal of risk altogether.
Only time will tell whether a ban on retention payments has the intended impact of helping protect the cashflow of smaller contractors, whether alternative security measures take priority, or both.
Should you require any advice on retention payments, recovering unpaid retention, security measures or the preparation of your construction contracts, do not hesitate to get in contact with Anna Wood, Ashley Pigott or Maria Greener in the Michelmores’ Construction & Engineering team.
