Retentions are a standard method of protecting employers from the risk of defective works. They are subject to quite complex rules within the various standard form construction and engineering contracts. But are they fit for modern contracting and the current economic climate?
A “retention” is a sum of money withheld from a payment for work completed, usually until all defects have been rectified. It provides a “fund” for the Employer to rectify any defects should the contractor be unable or unwilling to do so.
Retention mechanisms try to balance risk. The JCT forms require the retention to be kept separate to avoid problems for the Contractor if the Employer becomes insolvent. Other forms specify that the money is held on a fiduciary basis for the Contractor – after all, it is his money unless, and until, a defect arises. In line with the NEC ethos of resolving issues in real time, their approach differs with retention included only as an Optional X clause. “Saving” money for possible future defects would not sit well with this.
Retention is often 5% of payment due which is probably insufficient for the Employer to cover serious defects and is likely to cause significant cash flow problems for the Contractor.
In April 2017, Alan Brown MP tabled a bill for the safeguarding and release of cash retentions in the construction industry. Whilst that Bill has been derailed by the general election, he raised some interesting points:
- In 2015 insolvencies in the supply chain caused small firms across the UK to lose £50million in retentions.
- Around £3billion of retention monies are withheld at any one time
- A BIS survey found that 25% of SMEs felt a debt of £20,000 or less was enough to jeopardise their business
As banks will not generally allow companies to borrow against sums due to them, this can easily stifle productivity and innovation across the industry, hitting contractors’ cash flow and profits.
Mr Brown MP noted that the 1964 Banwell report, the 1994 Latham Report, the 2002 and 2007 Business Select Committees and the 2016 Enterprise Bill Committee, recognised that cash retentions in the construction industry are outdated and often unfair and called for reform. But what is the answer?
In the long term, legislation is probably the only way to change industry practices. In the short term, for both parties’ benefit, the money should be held in a separate bank account in trust for the Contractor with clear rules about how and when it can be used. Alternatively, a retention bond could facilitate cash flow while still protecting the Employer. Ensure interest penalties for late payment cover the retention and are sufficient to discourage one party keeping money that is due and owing.