The reason why retention is used in construction contracts
Learn the principles of retention used in construction contracts and throughout the industry, why it’s important, how much is being held and what to do about the release of retention. This is designed to help you, the subcontractor with your business.
Construction contracts are a major part of the construction industry. They are used to establish obligations between parties and clarify responsibilities, rights, and liabilities.
A retentions clause is an important component in many JCT construction contracts. Retention is best described as a sum of money held by one party that is due to another party on a future event or date.
It is common for retention clauses to be included in construction agreements when there is risk of insolvency during the course of work between both parties or if it involves a specialised trade where costs may increase unexpectedly at some point during the contract.
This blog post will explore why retention clauses are often used in construction contracts, how much should be retained from payments, what happens when retentions cannot be paid due to insolvency, the alternatives to retention and the industry practices.
Let’s dig into it!
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What is retention in construction?
Retention is used in construction contracts because it provides a measure of protection for both parties involved in the contract
It is usually used in the case of a contract where there may be risk of insolvency, or specialised trades that might see costs increase unexpectedly.
Why is construction retention used in contracts?
Retention is used to protect both parties in the contract. It provides security for a contractor who may be unable to complete their work, or requires additional funds to do so. There are also risks of higher costs due to unforeseen circumstances and retention protects against this by securing funds for any increase that might occur.
Retentions are also used for the protection of a client if they have given out money in advance, such as land or materials, that cannot be recovered because the contractor goes bankrupt before work on the contract has reached practical completion.
The amount of retention money to be held?
Retention should be set between 3% – 5% (percentage) of total cost depending on how much risk you want to take on as well as your budget.
The retention can be held in a number of ways. It will generally be held by the main contractor and built up through the contract and then payment will be made once the correct milestone has been achieved. You should also consider how quickly your client will release retention and what form this takes.
The retention money is for the contractor in case of an unforeseen circumstance such as increased costs, or defects that come about in the defects period.
When should retentions be paid?
The timings of when retention money should be released are covered in the Construction Act 1996. This covers all construction project in England and Wales and explains the legal agreements between a client and main contractors and also the relationship between contractors to sub contractor.
The retention monies are split in half, with half of the agreed percentage due when practical completion of the subcontractors works. Many contractors will try to preserve their own cash and hold onto their retentions. This sort of practice is simply the contractors trying to preserve their own cash and nothing else.
What is the defects liability period?
The defects liability period is the period where the sub-contractor is liable to the employer for any defects in the work they have completed. The following are an example of when this would be applicable:
– Retention money must only cover items that the contractor is liable for, it must always be released when a defect cannot be found in time.
– This period will differ depending on the contract clauses and what they have specified. However, it will normally be 12 months from the date of practical completion.
When should a contractor not hold retention funds for a project?
Generally the smaller the project the less risk involved. For example, if the project is worth a sum of £20k plus and retention money was to be held it would not cover a large amount of repair or replacement work. This does not mean smaller projects cannot have retention money, just they should only use this in extreme circumstances where there are significant risks involved.
The smaller projects with minimal risk should not have money held against them, this would also include subcontractors who carry out temporary works, such as scaffold, CCTV, Temp site setups etc.
What are the alternatives to retention being held?
Retention Bond:
– Retention monies can be released by agreement with the client but only after reasonable notice given to them. It may also be released when the retention money has been earned, or it is due for release under a construction contract which requires periodic payments of sums in accordance with its terms.
The bond is essentially insurance that your business puts in place with your employer on each of your projects and payment would be made upfront similar to any other insurance policy.
This type of approach has been suggested as a way for the construction industry as a whole to take on an industry-wide alternative.
A Project Bank account can often be used on larger government projects, the employer will make a payment into a team bank account for one project. Payment due to the main contractors and all subcontractors in the supply chain will be made from this one account. All retention monies will be held in this account providing security for the whole construction team.
Using a deposit scheme:
In some situations, a deposit scheme can be used to provide retention. The deposit scheme will typically be a bank account in the name of the contractor who is behind on progress payments. In this way, when payment is not made for work completed to date or scheduled outages etc., that money can be drawn from the retentions account as necessary.
Problems with the release of retention
Unfortunately, it is common in the industry for retention to not be released on time and Subcontractors often have an issue in getting paid the retention release on their construction project, Many contractors may not be aware of the requirements for retention release, or they are unwilling to make payment in line with the requirements of the JCT contract or law.
Non-payment of retention money from the main contractor will often occur when they have not yet received the final certificate of their work under the main contract.
This can be due to the main contractor working to the old practice of pay when paid, the ability to work in this way has been removed by The Construction Act.
Read through the contract!
Make sure you read through all terms and conditions before signing any contract so there are no surprises later down the line when things go wrong
Often contractors can add terms such as retention into their contracts, which can be a cause for concern. This is because retention clauses or terms may not always have been thoroughly read and understood by all parties involved in the construction process.
A list of questions you should ask before signing on any contract with a potential builder or developer
– How will the retention be calculated?
– What is the release clause in case of insolvency?
– Is there a cap on how much can be retained?
– Are you obliged to pay tax or VAT if you are only holding money for another person and not being paid directly yourself. If so then it may be better to use a retention bond.
– When should I get my retention money back in the event of insolvency?
– What happens if you have not yet reached completion of your work under the main contract, but are being asked for retention as part of it?
– Would retention bonds be acceptable?
What happens if a main contractor goes bankrupt?
In this case release of any retention, monies would be governed by the Insolvency Act 1986.
– If the main contractor goes bankrupt, there is still hope that you may see some of your retention monies again as long as it was not paid to creditors and they are just in liquidation or administration proceedings. This will depend on what their insolvency practitioner’s responsibilities are.
Thank you for taking the time to read this blog post.
The information here is invaluable and can be applied to any construction contract throughout the industry, regardless of who it was drafted by or what type of project it pertains to.
We hope that we’ve helped you understand why retention clauses are used in contracts and how they work, as well as given some insight into alternative solutions like retention bonds.
If after reading this, and our other articles you still don’t feel confident about your knowledge and would like more information about recovering retentions then please contact us so we can help with ongoing training sessions. If you’re unsure about how to get your money back, then don’t hesitate to reach out and contact us for advice on the best way forward.
Before signing any contract, be sure to understand all terms relating to retaining your money.
However, retention has its drawbacks too and these have been pointed out here in this blog post – so make sure you’re aware before using it!
To find out more relating to contracts then we suggest How to read a Construction Contract – A Quick Guide
We’ve got an article to highlight the frequently asked questions in relation to Payments for Construction Subcontractors click this link
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