In construction contracts, the employer and the contractor often agree that the employer may retain a specified percentage of payments due to the contractor from each interim payment as the project progresses – this is called ‘the retention’. When the project reaches practical completion, the employer pays half of the retention to the contractor. At the end of the defects rectification period, the employer releases the second tranche of the retention. The amount to be withheld is often a percentage amount and can vary between 3% and 5% depending on the value of the building contract. In the JCT suite of building contracts the default amount is 3% (unless otherwise stated in the JCT Contract Particulars section of the building contract).
The rationale behind the mechanics of retention is to protect against insolvency prior to practical completion and the costs of downtime/re tendering and also employers like to have a sum of money to further incentivise the contractor in the lead up to practical completion. The argument advanced by employers and their advisors is that it is a positive incentive rather than a negative incentive (such as liquidated and ascertained damages). The rationale for retention during the defects rectification period is again to incentivise the contractor to return to site and to deal with snagging items and minor defects emerging during this period. Essentially, the retention is used as a tool by the employer to underpin the contractor’s contractual performance.
The practice of retention has come into criticism in recent years especially due to its impact on cash flow through the whole supply chain. A main contractor will often pass on the retention to its subcontractors and sometimes on much longer time periods and more onerous percentages. Many subcontractors complain about the percentages and length of time it takes to recover retention and its adverse effect on cash flow.
Some employers are starting to take a revised view on this practice. They either rely on other methods to underpin contractual performance and insolvency risk (robust stress test of financials, zero defects/soft landings policy up to practical completion, enforcing contractual provision in a timely fashion, bonds, parent company guarantees etc) or put in place a retention bond which retains the principles and mechanics of retention but removes the cash flow effect (but does come at a cost to place a bond that may well be passed to the employer).