What is Retention in Construction?
Retention is a financial mechanism widely used in construction contracts to manage risk and ensure project quality. It acts as a safeguard for clients and developers by withholding a portion of the contractor’s payment until the completion of work and resolution of any defects. Though simple in concept, retention can significantly impact project cash flow, contractor-client relationships, and overall project outcomes.
This article explores the concept of retention in construction, including its definition, function, practical implications, legal considerations, and common industry practices.
Definition of Retention in Construction
Retention in construction refers to a predetermined percentage of the payment that is withheld from a contractor’s or subcontractor’s interim payments. This amount is retained by the client or main contractor to:
- Ensure work is completed according to contractual terms.
- Cover the cost of any rectifications needed during the defects liability period.
- Provide financial leverage to the employer in case of contractor default or underperformance.
Retention is typically stipulated in the construction contract, with clear provisions outlining how much will be withheld, when it will be released, and under what conditions.
Purpose of Retention
Retention serves several purposes in the construction industry:
1. Encouraging Completion
By withholding a portion of payments, retention incentivizes contractors to complete the project fully and on time.
2. Assurance of Quality
Retention ensures that the contractor is held accountable for any defects that appear during the defect liability period after practical completion.
3. Financial Security for the Client
In the event of contractor insolvency or failure to address issues, the retention money can be used to hire others to complete the work or fix problems.
How Retention Works in Practice
Retention is usually applied as a fixed percentage (commonly 5%) of each interim payment throughout the project. It is held in two stages:
- First Half: Released upon practical completion of the project.
- Second Half: Released at the end of the defects liability period, typically 6 to 12 months after completion, subject to satisfactory resolution of any defects.
Example Scenario
Assume a construction contract worth $1,000,000 with a 5% retention clause. Here’s how the retention would work:
- Total Retention: $50,000
- Released at Practical Completion: $25,000
- Released After Defects Liability Period: $25,000
This staged release ensures the contractor remains engaged throughout the project lifecycle, including post-completion responsibilities.
Retention in Subcontracting Chains
Retention does not only affect the main contractor. It is also commonly applied in subcontractor agreements, where the main contractor withholds retention from subcontractors’ payments.
This can create a “pay when paid” scenario, where subcontractors may have to wait long periods for retention release—especially problematic if their work finishes early in the project timeline.
Key Terms Related to Retention
| Term | Definition |
|---|---|
| Retention Sum | The total amount of money withheld as retention. |
| Practical Completion | The stage at which the project is substantially complete and usable. |
| Defects Liability Period | Time after completion during which the contractor must fix any identified defects. |
| Retention Bond | A financial guarantee that replaces the need to hold retention in cash. |
Legal Framework and Standards
Retention practices are generally regulated through:
- Construction Contracts: Most standard forms (e.g., FIDIC, JCT, NEC) include retention clauses.
- Local Legislation: Some jurisdictions have specific laws regarding retention practices and timelines.
- Security of Payment Acts (in countries like Australia and the UK): These laws protect subcontractors from unfair payment delays.
Common Issues with Retention
While retention is intended to protect stakeholders, it can also cause complications if mismanaged:
1. Delayed Release
Clients may unnecessarily delay release, leading to cash flow problems for contractors.
2. Insolvency Risks
If a client becomes insolvent, the retained funds may be lost to the contractor or subcontractor.
3. Unclear Terms
Ambiguity in contract clauses regarding retention release can lead to disputes and litigation.
4. Administrative Challenges
Tracking and managing retention payments across multiple projects increases the administrative burden.
Alternatives to Traditional Retention
Several mechanisms are used to replace or supplement traditional retention:
🔹 Retention Bonds
A financial instrument issued by a surety company or bank, allowing clients to avoid holding retention money while maintaining protection.
🔹 Project Bank Accounts
Joint accounts held in trust for the project stakeholders. Funds, including retention, are kept secure and paid according to contract milestones.
🔹 Escrow Arrangements
An independent party holds the retention amount and releases it per the contract terms.
Best Practices for Retention Management
- Clear Documentation: Contracts must explicitly state retention percentages, release stages, and timelines.
- Prompt Defect Rectification: Contractors should address defects swiftly to avoid delays in retention release.
- Open Communication: Regular updates and discussions between client and contractor help prevent retention disputes.
- Financial Planning: Contractors should plan for retention-related cash flow shortfalls during the project.
Pros and Cons of Retention
| Pros | Cons |
|---|---|
| Protects the client against incomplete or poor work | Delays payments to contractors and subcontractors |
| Encourages quality and timely completion | Can strain cash flow for small contractors |
| Helps fund defect rectification | Risk of non-payment if the client becomes insolvent |
| Creates a safety net for post-construction issues | Administrative complexities in tracking and releasing |
Conclusion
Retention is a powerful tool in construction contracts, designed to protect the interests of clients while ensuring that contractors remain committed to delivering quality work through to project completion. However, retention must be carefully managed and fairly applied to prevent unnecessary financial pressure on contractors and subcontractors. When properly implemented, supported by clear contract language and prompt payments, retention serves as an effective risk management strategy that benefits all parties in a construction project.
FAQs on Retention in Construction
1. What does retention mean in construction?
Retention refers to a portion of the contract payment withheld by the client to ensure the contractor completes the project and addresses any defects.
2. How much money is typically held as retention?
Usually, 5% of each payment is withheld as retention, but it can vary depending on the project and contract terms.
3. When is retention released?
Retention is typically released in two stages: half at practical completion and the remaining half after the defects liability period ends.
4. What is a defects liability period?
It’s a fixed period after project completion during which the contractor is responsible for fixing any issues or defects in the work.
5. Are subcontractors also subject to retention?
Yes. Main contractors often apply the same retention terms to subcontractors, which can cause delays in payment release for them.
6. What is a retention bond?
A retention bond is a guarantee issued by a bank or insurance company that replaces the need for cash retention, offering the same protection to the client.
7. Can retention be waived in construction contracts?
Yes. If both parties agree, retention can be waived or replaced with alternative guarantees like bonds or escrow accounts.
8. What happens if a client refuses to release retention?
If unjustified, the contractor may seek legal remedies, especially if the contract or local laws mandate release upon fulfillment of conditions.
9. Does retention affect project cash flow?
Yes. Since a portion of payments is withheld, contractors must budget accordingly to maintain liquidity during the project.
10. Is retention a legal requirement?
Not always. Retention is a contractual tool, not a legal obligation, but local laws may govern how it’s applied and managed.
