Retention, sometimes referred to as retainage, is money held back by the client/employer as protection against contractor failure. Retention is normally set at 5% or 3% (for larger projects) of the total value of the works. The retention money is deducted from the interim payments made to thecontractor.
The purpose of retention
Retention exists to ensure that the contractor of a construction project finishes all the works as agreed upon in their contract with the client and that any subsequent defects are satisfactorily rectified.
Because the owners of the construction project, or those who’ll be paying for the project, are the main beneficiaries of the arrangement, they usually take the lead in drawing up the terms of the retention and are also the main enforcers of the retention plan.
There’re generally 2 levels of retention in the construction industry. The first level involves the owner or funder of the construction project and the main or head contractor. Because head contractors usually subcontract works to specialist subcontractors, they create a second retention level.
The second retention level involves the main contractor of a project and the subcontractors who will be working for them. The secondary retention is meant to protect the main contractor from defects or unsatisfactory work by their subcontractors.
Payment of the retention
Once the contractor has completed all the works related to the project, the percentage of retention is halved, and a sum referred to as the first moiety is paid back to the main contractor by the client. The stage at which the first half of retention is paid back is commonly referred to as “practical completion” in most contracts.
The practical completion stage is then followed by a period commonly referred to as the “defects liability period”. The length of this period will range anywhere between 6 – 12 months depending on the terms of the contract. During this period, the contractor, and subsequently their subcontractors, are supposed to fix any defects that might have occurred.
The client will then inspect the works once the defect liability period is over (sometimes sooner if the remedial work is urgent) and create a defects schedule. The main contractor, viatheir subcontractors, then remedies the highlighted defects before the work is inspected again. If everything is in accordance with the contract, a “certificate of making good defects” is issued to the main contractor and the other half of retention (or the second moiety) is paid out.
The main contractor is supposed to extend the retention payments as they receive them from the client to their subcontractors with little to no delays.
The limitations of retentions
Ideally, retention payments should flow smoothly from the client to the subcontractors with minimum delays. This is often not the case. While the client usually makes good and pays the main contractor their moieties after the agreed upon conditions are met, some unscrupulous general contractorspurposefully delay the payment of the moieties they owe their subcontractors.
If the money is withheld long enough by the main contractor, the subcontractor (who’s focus has now shifted to current works) eventually stops trying to recover the money and opts to mark it as a loss and move on. This practice is quite common such that some contractors have made it operating procedure to count retention money meant for subcontractors as part of their profit; without any intention of disbursing the money whatsoever.
Another limitation is that when the main contractor fails, subcontractor retention monies usually end up being used to pay creditors even though the subcontractors had nothing to do with the failure.
Problems caused by retention non payment
While the main contractors usually get paid the retention money after fulfilling their part of the contract, sometimes they could face difficulties recovering themoney from the client. This is often as a result of a misunderstanding whereby the client misinterprets works information or misidentifies something as a defect.
Although both the main contractor and the subcontractor will suffer if the retention is not paid, it will be the subcontractors who suffer the most.
Non-payment or delayed payment of retention monies to subcontractors will have the following effects:
- It will debilitate their cash flow. With as much as 5% of turnover from a contract being held by the main contractor, subcontractors can face cash flow problems making the day-to-day running of the business nearly impossible.
- It causes administrative issues. Keeping record of the unpaid retentions from different contractors and following up payments takes up a lot of time and resources.
- The risk of non-payment becomes high due to contractor insolvency