Retention in a construction project refers to a portion of the contract payment withheld by the client or employer from the contractor or subcontractor until the project has been completed to the required standards and all defects have been rectified. This amount acts as a security for the client, ensuring that the contractor completes the work satisfactorily and addresses any issues or defects that may arise during the Defect Liability Period (DLP). The retention is typically released in stages, with part of it paid upon practical completion and the remainder at the end of the DLP.
Retention is a common practice in the construction industry and plays a vital role in ensuring quality and compliance with the contract terms.
Key Features of Retention in Construction:
- Purpose:
- The main purpose of retention is to provide the client with a safeguard against incomplete or defective work. It ensures the contractor has an incentive to complete the work to the agreed-upon standards and to return and fix any defects that arise during the DLP.
- Percentage of Retention:
- The amount of retention is usually expressed as a percentage of each progress payment or interim payment made to the contractor. It typically ranges from 5% to 10% of the contract value, though the exact percentage can vary depending on the contract terms and the nature of the project.
- Release of Retention:
- Retention is typically released in two phases:
- Upon Practical Completion: Once the contractor completes the project and the client deems it ready for handover, a portion (usually 50%) of the retention is released.
- End of the Defect Liability Period (DLP): The remaining portion is released once the DLP has expired and all defects have been rectified to the satisfaction of the client.
Types of Retention in Construction Projects:
Retention can be classified based on the party involved and the stages of the project. Here’s a detailed breakdown:
1. Client/Employer Retention:
Client retention refers to the amount the client withholds from the contractor during the construction period. It provides the client with security that the work will be completed in accordance with the contract terms and that any defects will be rectified.
- When it’s Applied: The client typically withholds a percentage from each progress payment or interim payment made to the contractor.
- Release Mechanism:
- The first portion of the retention (often 50%) is released upon practical completion, when the project has reached a stage where it can be used or occupied, though some minor works or defects may still need to be rectified.
- The remaining retention is released at the end of the DLP, after any defects that emerged have been addressed.
- Example: A client withholds 5% retention on a contract worth $1 million. Over the course of the project, $50,000 is withheld. Upon practical completion, $25,000 is released, and the remaining $25,000 is held until the end of the DLP (typically 6-12 months).
2. Main Contractor Retention:
In larger projects, the main contractor may also withhold retention from payments made to subcontractors. This mirrors the client’s retention and ensures that subcontractors complete their work to the required standard.
- When it’s Applied: Main contractors withhold retention from subcontractors to cover the risks associated with defects or incomplete work by the subcontractors. This is often done on the same terms as the client’s retention.
- Release Mechanism:
- A portion of the retention is released when the subcontractor’s work is practically completed.
- The final portion is released after the main contractor’s DLP has expired, ensuring that any defects in the subcontractor’s work have been rectified.
- Example: A main contractor withholds 5% retention on payments to a subcontractor responsible for electrical work. The subcontractor’s total contract value is $200,000, meaning $10,000 is withheld. Half of this amount ($5,000) is released when the electrical works are completed, with the remaining amount released after the DLP expires.
3. Retention Guarantees or Bonds:
Instead of withholding actual cash, some contracts allow for the use of retention bonds or guarantees. These are financial instruments provided by a third-party institution (such as a bank or insurance company), ensuring that the contractor will rectify any defects without the client needing to retain cash.
- Purpose: Retention bonds or guarantees can be used to improve the contractor’s cash flow since retention can significantly impact the contractor’s available working capital. The bond guarantees the client that funds will be available to fix defects if the contractor fails to meet their obligations.
- Release Mechanism: Bonds typically expire or are returned at the end of the DLP, provided that all defects have been addressed.
- Example: Instead of withholding 5% of each payment, the contractor provides a retention bond from a bank for the value of the retention amount, guaranteeing the client that they will rectify any defects.
4. Practical Completion Retention:
Retention at the point of practical completion refers to the portion released once the project is deemed practically complete. This means the building or infrastructure is ready for its intended use, even though there may still be minor defects or incomplete tasks (often referred to as snagging or punch list items).
- Purpose: Practical completion retention provides the contractor with an incentive to complete any outstanding works or rectify minor defects before the project is fully signed off.
- Release Mechanism: A portion of the total retention (typically 50%) is released upon practical completion, with the remainder held until all defects are addressed.
- Example: A $5 million project has $250,000 in retention. Once practical completion is achieved, $125,000 is released, while the remaining $125,000 is held until all snagging items are fixed and the DLP is over.
5. Defects Liability Period (DLP) Retention:
This type of retention is the amount held by the client until the end of the Defects Liability Period (DLP), also known as the maintenance period. The DLP ensures that the contractor will return to the project to fix any defects that arise after completion.
- Purpose: It acts as a final safeguard for the client to ensure the quality of the construction. The contractor is required to fix any issues during the DLP at no additional cost to the client.
- Release Mechanism: The final portion of the retention is released at the end of the DLP once all identified defects have been corrected.
- Example: If a project has a 12-month DLP, and there are no defects at the end of this period, the remaining 50% of retention (which was held after practical completion) is released to the contractor.
Key Considerations and Impacts of Retention:
- Cash Flow:
- Retention can significantly impact a contractor’s or subcontractor’s cash flow, especially in large projects. Since a percentage of payments is withheld, it reduces the immediate funds available for operational expenses, labor, and materials.
- Negotiation of Retention Terms:
- Contractors may negotiate to reduce retention percentages or secure early release of retention amounts upon reaching specific milestones, especially if they have a good track record or if the project is low risk.
- Late or Delayed Release of Retention:
- In some cases, there may be delays in releasing retention even after the DLP, leading to disputes between the contractor and the client. These disputes can arise due to disagreements about whether defects have been properly rectified or the overall quality of the completed works.
- Effect on Subcontractors:
- Retention impacts subcontractors in the same way it impacts main contractors. Some subcontractors, particularly smaller firms, may face financial strain if they are subjected to retention on each project, and delayed release can cause financial difficulty.
- Retention vs. Performance Bonds:
- Retention serves as a form of protection for the client, but in some cases, a performance bond or retention bond may be preferred because it allows contractors to maintain better cash flow while still providing the client with financial security.
Conclusion:
Retention in construction projects serves as a financial safeguard for clients, ensuring that contractors fulfill their contractual obligations and maintain the quality of their work even after practical completion. Retention gives clients leverage to compel contractors to fix any defects that emerge during the Defect Liability Period. Understanding the types of retention—whether client, contractor, or through bonds—and their release mechanisms is essential for managing cash flow, project risks, and ensuring successful project completion.
