Retention in Construction Contracts: Purpose, Process & Best Practices
Retention in construction contracts is a widely used mechanism that safeguards the interests of clients and project owners. It serves as a financial assurance that contractors or subcontractors will fulfill their obligations, including addressing any post-completion defects. While beneficial to clients, it can cause significant financial strain for contractors if not handled transparently or fairly.
This article explores what retention means in the context of construction contracts, how it works, its legal implications, standard practices, and tips for managing it effectively.
What is Retention in Construction Contracts?
Retention is a contractually agreed-upon percentage of payment withheld from a contractor’s or subcontractor’s earnings. The money is held back by the employer (client or main contractor) until the project is completed and, in many cases, until any defects identified during the Defects Liability Period (DLP) have been resolved.
Retention is a risk management tool embedded in construction contracts to protect against:
- Poor workmanship
- Project delays
- Failure to complete
- Defects discovered after completion
Why Retention is Used in Construction Contracts
Retention clauses are included in construction contracts for several important reasons:
1. Performance Guarantee
Withholding money ensures that the contractor has a strong incentive to complete the job properly and within the agreed timeframe.
2. Defect Remediation
Retention provides a financial fallback in case the contractor fails to fix issues during the defect liability period.
3. Mitigation of Risks
Retention protects the client against the financial risk associated with contractor insolvency or non-performance.
4. Encouragement of Quality Work
Knowing that part of the payment depends on performance quality pushes contractors to maintain high standards.
How Retention Works in Construction Contracts
Retention usually works in two stages:
1. During the Project
A certain percentage (commonly 5%) is withheld from each progress payment or interim certificate.
2. After Practical Completion
Half of the retention is released once practical completion is achieved. This means the work is substantially complete and can be used as intended.
3. After Defects Liability Period
The remaining half is released at the end of the Defects Liability Period, provided all defects have been remedied.
Sample Timeline for Retention Release
| Milestone | Action | Amount Released |
|---|---|---|
| Interim Payment | 5% retention withheld per progress payment | 0% released |
| Practical Completion | Contractor substantially completes project | 50% of total retention |
| End of Defects Liability Period | All defects resolved | Remaining 50% of retention |
Legal Basis for Retention in Contracts
Retention must be clearly outlined in the contract documents. Most standard contract forms provide for retention, including:
- FIDIC (International)
- NEC (UK)
- JCT (UK)
- AIA (USA)
In addition, local construction laws or security of payment legislation in countries like the UK, Australia, and parts of the US regulate how and when retention is held and released.
Components of a Retention Clause
A proper retention clause in a construction contract should specify:
- Retention percentage (e.g., 5%)
- When and how retention is deducted
- Conditions for partial release at practical completion
- Defects liability period duration
- Timeline and conditions for final release
- Dispute resolution mechanisms
Financial Implications of Retention
Retention impacts all parties financially. For contractors and subcontractors, it reduces cash inflow during the project. If poorly managed or unfairly withheld, retention can lead to:
- Cash flow shortages
- Delayed payments to suppliers or labor
- Potential insolvency on large-scale projects
For clients, failure to release retention fairly can damage business relationships and may lead to litigation.
Retention and Subcontractors
Main contractors often apply the same retention terms to their subcontractors, which can create a long waiting period for payment—especially if the subcontractor’s work finishes early in the project. This is known as “back-ended risk” in the payment cycle.
Challenges Associated with Retention
| Challenge | Impact |
|---|---|
| Delayed release | Causes financial stress and trust issues |
| Insolvency of the client | Contractors may lose retained funds |
| Unclear contract terms | Leads to disputes and payment uncertainty |
| Administrative complexity | Difficult to track and manage across multiple contracts |
Alternatives to Traditional Retention
Several alternatives and improvements to traditional retention are gaining traction, especially in countries with advanced construction regulatory systems:
🔹 Retention Bonds
A retention bond replaces the cash retention with a guarantee from a bank or insurer, ensuring the client is financially protected without impacting contractor cash flow.
🔹 Escrow Accounts
Retention is deposited in an independent escrow account, offering security for both client and contractor.
🔹 Project Bank Accounts (PBAs)
PBAs safeguard all construction-related payments, including retention, and are accessible under agreed conditions.
Best Practices for Retention Management
✅ For Clients and Employers:
- Be transparent with retention terms and payment schedules.
- Release retention promptly based on contract terms.
- Avoid unnecessary withholding to maintain good contractor relations.
✅ For Contractors and Subcontractors:
- Understand the retention clause before signing the contract.
- Track all withheld amounts and monitor deadlines for release.
- Consider negotiating for a retention bond instead of cash withholding.
Comparison Table: Traditional Retention vs Retention Bond
| Aspect | Traditional Retention | Retention Bond |
|---|---|---|
| Cash Flow Impact | Negative (withheld from payments) | Minimal (no cash withheld) |
| Risk to Client | Low | Low (bond protects against contractor default) |
| Risk to Contractor | High (in case of delayed release) | Low |
| Administration | Moderate | Slightly more complex (requires bond issuance) |
| Usage Trend | Common, especially in smaller projects | Growing, especially in large-scale contracts |
Conclusion
Retention in construction contracts is a vital but sensitive financial control mechanism. It ensures that work is completed properly and any post-completion issues are addressed. However, if poorly managed, it can strain contractor finances, lead to disputes, and delay project closeouts. Clear contract terms, good communication, and fair application are essential to making retention work effectively.
As the construction industry evolves, the adoption of alternatives like retention bonds and project bank accounts can help reduce friction, protect stakeholders, and promote more equitable project environments.
FAQs on Retention in Construction Contracts
1. What is retention in a construction contract?
Retention is a portion of payment withheld from a contractor to ensure project completion and defect correction. It’s usually released in two stages: after completion and after the defect liability period.
2. How much is usually withheld as retention?
Typically, 5% of each interim payment is withheld, though this amount may vary by contract.
3. When is retention released?
Usually, 50% is released at practical completion, and the remaining 50% is released after the defects liability period ends.
4. Is retention mandatory in construction contracts?
No. Retention is not a legal requirement but a contractual one. Parties may choose to waive it or use alternatives like retention bonds.
5. What is the defects liability period?
It’s a set period (often 6–12 months) after project completion during which the contractor must fix any identified defects.
6. What happens if retention is not released on time?
Contractors may face financial strain and may seek legal remedies depending on the contract and local laws.
7. What is a retention bond?
A financial guarantee that replaces withheld cash retention. It assures the client that funds are available if the contractor fails to rectify defects.
8. Can subcontractors also face retention?
Yes. Main contractors often withhold retention from subcontractors based on their own contract terms.
9. Are there alternatives to cash retention?
Yes. Alternatives include retention bonds, escrow accounts, and project bank accounts, which provide more security and liquidity.
10. Are there laws governing retention?
Yes. In many countries, security of payment legislation governs how retention must be handled to protect contractors and subcontractors.
