Retention in Construction: Definition, Purpose, and Best Practices

In the construction industry, financial management is as critical as project execution. One of the most essential financial mechanisms used to protect client interests and ensure contractor performance is retention. Whether you’re a contractor, subcontractor, developer, or client, understanding how retention in construction works is vital for managing project cash flow, ensuring quality, and avoiding disputes.

This comprehensive guide explains everything you need to know about retention in construction — what it is, why it’s used, how it’s calculated, and best practices for handling it effectively.

What is Retention in Construction?

Retention refers to a percentage of the contract sum withheld by the client (or main contractor) from payments due to the contractor (or subcontractor) during the course of a construction project. The retained money acts as a financial security to ensure that:

• The contractor completes the project as agreed.
• Any defects are rectified during the Defects Liability Period (DLP).
• The final work meets the required standards.

Purpose of Retention

Retention serves multiple protective purposes in construction contracts:

1. Incentivize Completion

Withholding a portion of payment encourages the contractor to complete the work to specification, on time, and to high quality.

2. Cover for Defects

If defects emerge after completion and the contractor is unwilling or unable to fix them, the client can use retention money to fund the repairs.

3. Ensure Compliance

Retention ensures the contractor abides by the agreed terms, specifications, and timelines.

4. Risk Mitigation

Construction projects involve risks like bankruptcy or poor workmanship. Retention minimizes financial loss to the client in such scenarios.

How Does Retention Work?

Retention is typically split into two stages:

🧱 Stage 1: During Construction

A percentage (commonly 5%) is deducted from each interim payment.

🏁 Stage 2: Practical Completion

Half of the retained amount is released when the project achieves Practical Completion — meaning the project is usable, albeit with minor defects.

🔧 Stage 3: End of Defects Liability Period

The remaining 50% is paid once the Defects Liability Period (usually 6 to 12 months) ends, assuming all defects have been rectified.

Typical Retention Percentages

These percentages can vary based on project complexity, contract negotiation, and legal jurisdiction.

When is Retention Released?

Retention is released in two stages:

1. Half at Practical Completion
   • When the work is substantially completed and usable.
2. Half at Final Completion
   • After the Defects Liability Period, assuming defects have been resolved.

Retention release should be explicitly defined in the construction contract with clear timelines and conditions.

Retention and Cash Flow

Retention can significantly affect contractor cash flow, especially on long-term projects. Since a portion of every invoice is withheld, contractors must plan and budget accordingly.

Delayed or unfair withholding of retention can strain a contractor’s working capital, affect wages, and even cause insolvency in extreme cases.

Retention in Subcontracting

Retention doesn’t stop at the main contractor level. Main contractors often pass retention down to subcontractors. This practice is legal but must be governed by the subcontract agreement.

However, issues can arise if:

• The main contractor receives retention but delays paying the subcontractor.
• The subcontractor finishes their work early in the project and waits a long time for retention release.

Legal and Regulatory Framework

Retention practices are often governed by construction law, contract law, and specific regulatory frameworks, depending on the country or region.

For example:

• UK: The Construction Act (Housing Grants, Construction and Regeneration Act 1996) governs retention.
• USA: State-level lien laws and public contract regulations.
• Australia: Security of Payment Acts in various states.

Some regions are moving towards retention trusts or project bank accounts to protect retention money from misuse.

Problems with Retention

While retention serves a protective function, it’s not without issues:

1. Delayed Payments

Clients or contractors may delay releasing retention without valid reasons.

2. Loss of Funds

If the client becomes insolvent, contractors may never receive the withheld retention.

3. Administrative Burden

Tracking retention over multiple projects and contracts increases admin workload.

4. Disputes

Unclear contract terms or unjustified withholding often lead to disputes and legal action.

Alternatives to Retention

To address the challenges of traditional retention, some projects adopt alternatives:

🔐 Retention Bonds

A retention bond is a financial instrument (often from a bank or insurer) that guarantees payment of the retention amount in case the contractor fails to perform. The client doesn’t hold cash — instead, they hold a bond.

💼 Project Bank Accounts (PBAs)

PBAs hold payments (including retention) in a secure, transparent account jointly managed by stakeholders, protecting subcontractors.

🤝 Performance Bonds

Though broader in scope than retention, performance bonds ensure the client has financial protection against contractor failure.

Best Practices for Managing Retention

1. Clear Contract Clauses
   • Define the retention percentage, release stages, and timeframes in the contract.
2. Transparent Record-Keeping
   • Maintain records of deductions and releases to avoid confusion or disputes.
3. Timely Defect Resolution
   • Contractors should resolve defects promptly to ensure quick release of the final retention.
4. Cash Flow Planning
   • Contractors must factor retention into their financial planning and pricing strategy.
5. Consider Negotiation
   • On low-risk projects, consider negotiating lower retention or use of retention bonds.

Sample Retention Clause (Simplified)

“5% of the value of each interim payment shall be withheld as retention. 50% of the total retention shall be released upon practical completion of the works. The remaining 50% shall be released after the defects liability period, subject to rectification of any notified defects.”

Conclusion

Retention in construction is a double-edged sword — it protects clients from poor performance but can also burden contractors financially if misused. Properly implemented with transparent contracts, fair practices, and timely release, retention serves as a useful tool to balance project risk between parties. As the industry evolves, alternative solutions like retention bonds and project bank accounts are being explored to reduce misuse and improve cash flow, especially for small and mid-sized contractors.

FAQs on Retention in Construction

1. What is retention in a construction contract?

Retention is a portion of payment withheld by the client to ensure project completion and cover potential defects.

2. How much is typically held as retention?

Typically, 5% of the contract value is withheld, though this can vary based on the project or contract negotiation.

3. When is retention money released?

Usually, half at practical completion and the other half at the end of the defects liability period.

4. What happens if the client goes bankrupt before releasing retention?

Contractors may lose the retention unless secured through bonds or project bank accounts.

5. Can retention be negotiated?

Yes. Parties can agree to reduce, waive, or replace retention with a bond depending on the project risk and trust levels.

6. What is a retention bond?

A financial guarantee issued by a bank or insurer that replaces the need for cash retention.

7. Are there laws regulating retention?

Yes. Many regions have specific laws or contract acts governing retention timelines and rights, like the Construction Act in the UK.

8. How does retention affect subcontractors?

Subcontractors may face delayed payments if the main contractor delays retention release, even after they’ve finished their scope.

9. Is retention applicable to all types of contracts?

Retention is common in construction and infrastructure contracts but may not apply in smaller private contracts unless specified.

10. Can contractors claim interest on delayed retention?

In some jurisdictions and under certain contracts, yes — delayed release beyond agreed timelines may entitle the contractor to claim interest.