Construction Payment Reform 2025: Retentions, Late Payment Sanctions, and the Fair Payment Code Explained
Retentions in Construction
THE NATURE OF RETENTIONS
Retention clauses permit an employer or main contractor to withhold a proportion of the contract sum—commonly 3 to 5 per cent—until the work is complete or until the expiry of a defects liability period. The original purpose was to secure performance, provide a fund for remedying defective work, and protect against insolvency. In practice, retentions often operate unfairly:
Sub-contractors face prolonged non-payment and loss of working capital.
Retention monies are not segregated, so insolvency of the payer may leave the payee without recourse.
Release of retentions is often delayed well beyond contractual deadlines.
The Government has described these practices as distortive of fair competition and inimical to supply-chain resilience.
PROPOSALS FOR REFORM
The DBT proposes to amend Part 2 of the Housing Grants, Construction and Regeneration Act 1996 in one of two ways.
Outright prohibition: Retention clauses would be rendered void. Employers and contractors would be unable to withhold sums by way of retention. Parties wishing for assurance would need to resort to other mechanisms such as insurance, bonds, or guarantees.
Retention protection: Retentions would remain lawful, but retained sums must be protected either by segregation in a designated bank account or by insurance/surety. If a contract fails to include adequate protection, statutory provisions would imply the necessary terms. Retentions could only be applied once, at final payment, in respect of the rectification period.
LIKELY EFFECTS
The ban would eliminate the systemic risk to sub-contractors but would transfer risk to employers, who may incur additional costs in arranging alternative security.
The protection option would preserve the mechanism whilst ensuring that funds are safeguarded. This may impose administrative and financial burdens: banks and sureties may charge fees, and contractors may need to reorganise their cash-flow management.
Either reform will require wholesale amendment of standard forms such as JCT and NEC, which presently provide for retentions. It will also necessitate industry adaptation: employers may demand stronger pre-qualification checks, and insurance markets may see increased demand for performance products.
Late Payment Sanctions
THE SCALE OF THE PROBLEM
The Government estimates that late payment costs the UK economy £11 billion annually and that some 38 businesses close each working day due to poor payment practices. Although statutory rights to interest exist under the Late Payment of Commercial Debts (Interest) Act 1998, they are under-utilised and lack deterrent force.
THE NEW PROPOSALS
The consultation proposes the following:
Mandatory maximum terms: Payments must be made within 60 days, reducing to 45 days in due course.
Invoice dispute deadlines: Disputes must be raised within 30 days; otherwise, the invoice becomes automatically payable with statutory interest.
Compulsory statutory interest: The base rate plus 8 per cent under the 1998 Act will apply mandatorily; parties cannot contract for lower interest.
Board-level accountability: Large businesses will have to disclose payment performance in their directors’ reports, with audit committees responsible for oversight.
Fines for systemic delay: The Small Business Commissioner may fine businesses that pay more than 25 per cent of invoices late within a six-month period. Fines may reach twice the statutory interest otherwise due.
IMPLICATIONS
The proposals shift late payment from a civil wrong, enforced at the discretion of the creditor, to a regulated behaviour subject to public enforcement. Large contractors will be compelled to upgrade payment systems, monitor disputes rigorously, and allocate board attention to payment culture.
For SMEs, the reforms promise greater certainty and reduced exposure to liquidity shocks. Yet there may be unintended consequences: larger firms might tighten supplier selection, preferring fewer sub-contractors of greater financial strength, and prices could rise as contractors adjust for the loss of liquidity advantages.
The Fair Payment Code
ORIGINS AND PURPOSE
In December 2024 the Government launched the Fair Payment Code (“FPC”) to replace the Prompt Payment Code. It is administered by the Office of the Small Business Commissioner and is intended to embed good practice voluntarily whilst complementing statutory reform.
STRUCTURE AND AWARDS
The FPC operates a 3-tiered award system. Awards last for two years, after which businesses must reapply:
Gold Award: At least 95 per cent of invoices paid within 30 days.
Silver Award: At least 95 per cent paid within 60 days, and at least 95 per cent of invoices to small suppliers paid within 30 days.
Bronze Award: At least 95 per cent paid within 60 days.
PRINCIPLES
Awardees must demonstrate compliance with three principles:
Clear: Transparent and comprehensible terms; prompt communication of any delay.
Fair: Payment within agreed terms; acceptance of consequences such as statutory interest if payment is delayed.
Collaborative: Commitment to resolve disputes quickly and constructively.
OVERSIGHT AND SACTIONS
The FPC remains voluntary but incorporates mechanisms to secure credibility:
Complaints: Suppliers may lodge complaints with the OSBC; non-compliant awardees may be removed.
Public register: Awardees are listed publicly; removal damages reputation and may affect eligibility for tenders.
Senior responsibility: Applications must be endorsed by a director or equivalent, ensuring board-level accountability.
Transparency: Large firms must continue to report payment practices under statutory reporting regulations, and the data informs FPC oversight.
Enforceability rests on reputational consequences rather than legal penalties. Yet reputational damage, exclusion from the Register, and potential procurement disadvantages operate as powerful incentives.
Combined Effects and Future Outlook
SYNERGY OF MEASURES
The interaction of statutory reform and the FPC will produce a new payment landscape. Retentions will either disappear or become ring-fenced. Late payment will attract not only statutory interest but also fines and public censure. The FPC will reward excellence and expose poor practice.
IMPLICATIONS FOR LEGAL PRACTICE
Lawyers will need to:
Revise standard form contracts to remove or adapt retention provisions.
Advise on new compliance frameworks for payment systems, interest, and dispute timelines.
Counsel boards on disclosure obligations and audit committee responsibilities.
Anticipate disputes concerning the interpretation of “dispute” under the 30-day rule, and the calculation of statutory interest.
Dispute resolution practice may expand as parties test the boundaries of these reforms.
POTENTIAL UNINTENDED CONSEQUENCES
The reforms may lead to increased bid prices, tighter sub-contractor vetting, and greater demand for insurance products. Smaller firms might find the administrative requirements challenging, even while benefiting from more secure payment flows.
Yet the broader aim is to improve industry culture. If reforms succeed, payment certainty may improve sectoral productivity, reduce insolvency, and foster long-term collaboration.
Conclusion
The Government’s consultation marks the most ambitious attempt in decades to reform payment in construction. By abolishing or protecting retentions, introducing fines and mandatory interest for late payment, and promoting the Fair Payment Code, the Government aims to rebalance risk, protect smaller suppliers, and foster a fairer culture.
For the legal profession, these developments herald substantial change in contract drafting, advisory practice, and dispute resolution. The reforms may carry costs and risks, but they represent a determined attempt to resolve problems that have dogged construction for generations.
This article is intended for information purposes only and provides a general overview of the relevant legal topic. It does not constitute legal advice and should not be relied upon as such. While we strive for accuracy, the law is subject to change, and we cannot guarantee that the information is current or applicable to specific circumstances. Costigan King accepts no liability for any reliance placed on this material. For further details concerning the subject of the article or for specific advice, please contact a member of our team.
Julian Critchlow
Construction Specialist
Related Articles
