10 October 2016
by
Retention is essentially money promised that is held back by the client to ensure themselves against contractor failure. Usually, retention is set at 3% or 5% of the total work value. That money is deducted from payments made to the contractor, who then deducts it from payments made to any subcontractors. It is then paid to the owed party in two stages during the project cycle:
  • The first payment provides half the money held upon the subcontractor’s completion of their portion of the work. This is known as the first moiety of retention.
  • The second moiety of retention is paid once the defects liability period has ended. This period can last anywhere from six months to over a year.

Problems despite the rules

The Construction Act

Before 1 October 2011, one of the primary problems subcontractors faced was that the release of retention monies could be delayed by an act or event occurring under another covering contract. For example, a contractor could withhold money owed a subcontractor as the result of an event within the main contract not actually addressed in the subcontract or related to the subcontractor’s work. After 1 October 2011, the Construction Act was changed to state that release of retention to subcontractors could not be linked to an unrelated occurrence within a main contract but must be triggered by a specific occurrence related to the subcontract. While this change to construction law was intended to prevent unreasonable holds on retention money, contractors immediately began exploiting loopholes and finding other ways to avoid paying retention in a timely manner.1

Housing Grants Construction and Regeneration Act

The Housing Grants Construction and Regeneration Act 1996 should also serve as a deterrent for delayed and unpaid retention money because it prohibits “pay when paid” clauses within contracts. However, examination of common practice shows that retention money is rarely released on time or in accordance with the contract. While the changes to the Construction Act helped with this to some extent, exploitation of retention is still a significant issue within the industry.2

How retentions are meant to work

While a variety of terms can be used to describe the end of work on a subcontract, the one most often used is “practical completion”. At this point in the overall contract, the subcontractor who has completed the work should receive a portion (typically half) of their retention monies back. After that, the subcontractor enters the defect liability period, where they are required to address any faults or defects that occur in their work. Once the liability period ends, the subcontractor’s work is re-inspected and a schedule of defects is created. If there are no defects present, second moiety of retention is paid out. If defects are present, the contractor and relevant subcontractor make them right and a second inspection is performed. Once all parties are satisfied, the client issues a certificate of making good defects, and the second moiety is paid out.

How they really work far too often

While the Construction Act 2011 helped with some issues, unscrupulous contractors still find ways to delay subcontractor retention payments. This includes lengthening the time between contract start and release of retention monies, sometimes on purpose and sometimes as the result of poor organisation and management. Unfortunately, when money is withheld long enough the subcontractor, who is now focused on current jobs, stops trying to collect the retention money; opting to mark it as a loss, and move on. This happens often enough that some contractors have made it part of standard operating procedure to count retention money as part of their own profit; with no intention of releasing that money whatsoever.3

There is also a problem when a main contractor fails. Held subcontractor retention monies end up going to creditors instead of to the subcontractor, even though the reason for failure is not subcontractor related.

Mostly good for main contractors, rarely so for subcontractors

While main contractors usually benefit from retention via improved cash flow, there are times when a main contractor faces problems recovering retention money from the client. This is often related to a misunderstanding where the client interprets works information incorrectly and wrongly identifies something as a defect.

Still, by far, it is the subcontractor that suffers the most from retention practices:

  • It debilitates their cash flow. The main contractor typically holds onto as much as 2.5% of the turnover for as long as a year or more after the project is complete, and they are often extremely slow to release what is due. A recent subcontractor survey found that approximately one third of most subcontractor’s retention money for past projects was still outstanding and long overdue.
  • It causes administrative problems that include: keeping record of what is still outstanding, chasing up release at the end of the liability period, trying to find out who is actually authorised to release the money.
  • It increases the risk of non-payment due to contractor insolvency.

Handling retention in contracts

JCT contracts

When the Construction Act changes came into effect, the JCT 2011 sub contracts were amended to reflect them.

  • A minimum retention amount was set at £250. Anything below that does not require retention to be held.
  • The default retention percentage was set at 3%.
  • The first moiety of retention was set at practical completion.
  • The second moiety of retention was linked to the retention release date stated in item 9 of the contract or, in absence of a date, six months after the main contract rectification period ends.
  • Once the release date has been reached, outstanding monies are due in the next interim payment (within two months) and final payment is due 28 days after that.
  • This is assuming that no defects are found. If defects still exist, the release date is put on hold until they are addressed.

Of course, often main contractors amend these amounts and dates to better suit their own purposes. For instance, the 3% is almost always raised to 5%, and the first moiety of retention date is amended to lengthen the time the contractor can hold the monies.

NEC3 contracts

NEC3 contracts do not have retention as a primary clause in their contracts. If the main contractor wants to hold retention money, they must submit a secondary option X16, which links retention release to the issue of the defects certificate and was, therefore, already Act compliant.

If not retentions, then what?

Retention is considered by many an outdated idea that proves far too harmful to subcontractors – usually smaller businesses with limited cash flow to start with – to be considered industry ‘good practice’. So what are the alternatives? Some suggestions still recognise the need for a retention mechanism whilst others propose to do away with retention altogether.

Use a bond

In lieu of actual money being held by the main contractor, the fair payment campaign and other authorities suggest a bond instead.

A retention bond serves as a formal agreement between three entities: the contractor, the subcontractor, and a third party serving as guarantor (often a bank). The guarantor’s role and obligations will depend upon whether the bond is a true guarantee bond or an on demand bond:

  • With a guarantee bond, the contractor must legally prove breach of contract by the subcontractor before the guarantor is required to issue payment.
  • With an on demand bond, the guarantor is obligated to pay in any situation where the subcontractor has failed to perform, whether the contractor has legally proven breach of contract or not.
  • There are several types of bonds that fall within each category, including performance bonds, defects liability bonds and retention bonds.

In England and Wales, where retentions are standard industry practice, the retention bond serves in lieu of traditional retention, and the bond amount reflects the amount that would have been held back. At the point of practical completion, the bond is reduced to reflect the amount that would be retained during the defect liability period.1

With a retention bond, should the subcontractor fail to correct any defects in the work, the guarantor pays the contractor the amount required to correct the defect(s) and then pursues the subcontractor for that amount. This way, the main contractor is still covered should something go wrong, while the subcontractor gets to hold onto their money, improving cash flow and eliminating the threat of non-payment.

Trust account

Another proposal suggests putting retention money into a trust account, which still protects the contractor from risk whilst shifting control over the cash flow to an
impartial, independent agent. While in this scenario retention money is still withheld, the subcontractor is assured of payment in accordance with the contract. Countries that use retention trusts include France, Germany, Australia and the USA.

The idea of using retention trusts gets mixed responses from industry professionals, interested parties, and even the government. Advocates are in favour of the idea because it protects subcontractor money from administrators, liquidators, and bankruptcy trustees should the main contractor fail. The idea is that, if contractor failure happens, the client can still see that subcontractors are paid. Of course, those same administrators, liquidators and bankruptcy trustees are not fans of the idea, as it removes that money from the pot to be parcelled out to creditors when a project nosedives.5

Unfortunately, thus far, the idea of retention trusts hasn’t seen much support. On 20 March 2015, a government petition entitled “Protecting retentions in construction contracts by placing them in trust” was closed. At its closing date, it only had 1,783 signatures.6

30-day standard payment term

Two of the primary champions of 30-day standard payment term contracts are the Fair Payment Campaign and the Construction Supply Chair Payment Charter. Currently, only government contracts (England, Wales, Scotland) require 30-day payment terms be met.* The Campaign and Charter hope to make it an industry wide practice and eliminate retentions altogether.

30-day payment is the default payment term used in the UK for payment of goods and services. By moving to a net 30 system, a subcontractor’s capital working cycle is shortened, and they are better able to grow their company. Net 30 arrangements also provide a way to gain insight into a contractor’s payment track record, allowing subcontractors to better choose jobs where their employer is one who is known to pay on time and in full.

* Note: As of 25 July 2016, subcontracts must have a 30-day payment structure in accordance with recent reform to the Public Works Contracts and the provision of a definitive operation date for the Construction Contracts Act 2013. You can read more about that here: All change in public and private sector contracting? Karen Killoran of Arthur Cox for International Law Office.

Construction Supply Chain Payment Charter

The Construction Supply Chain Payment Charter is a joint effort by the Chartered Institute of Credit Management (ICM), the Department for Business innovation and Skills and the Construction Leadership Council (CLC) designed to promote the move away from retention practices (zero retentions by 2025), with all contracts being paid within 30 days of completion. Construction companies signing the charter agree to immediately adopt 60-day payment terms, with the goal of reducing it to 30 days by January 2018. Some of the first companies to sign include Barratt developments, Berkeley Group, British Land, Intec UK, Kier, Laing O’Rourke, Skanska and Stepnell.7

The Charter is designed to complement other existing legislation, including:

Signatories agree to comply with the commitments laid out in the Charter, including:

  • Never unjustifiably delaying or withholding money owed; only withholding a justified and proportionate amount of money back for non-delivery or defects.Making full and correct payment for all satisfactory work or products when it comes due.
  • Making payments within 45 days or less after the end of the calendar month in which the work or product was provided (applies to all new contracts from January 2015). As of January 2018, that time frame will decrease to 30 days or less.
  • Either removing cash retentions from contracts full stop or making retention terms no more burdensome than those laid out in Tier 1 contracts.
  • Adopting a collaborative, transparent and honest approach to dispute resolution.

The full set of commitments can be found here: Construction Supply Chain Payment Charter 

Fair Payment Campaign

The fair payment campaign is a product of the Build UK Group that is designed to help improve industry payment practices. It too calls for abolishing retention practices, with objectives including:

The complete elimination of retention practices

  • Payment certainty – contractors are fully aware of how much they are going to
    receive and when they are going to receive it.
  • 30-day payment terms on all construction projects

You can read more about the Fair Payment Campaign at www.fairpaymentcampaign.co.uk .

 

This article has been edited and repurposed from “Retentions: An Outdated Practice?”, written for the Construction Information Service.