Retention in the context of contractors and construction projects refers to a portion of the payment that is withheld by the client or project owner from the contractor’s earnings until the completion of a project or a specific phase of it. The purpose of retention is to ensure that the contractor fulfills all contractual obligations, including completing the work to the required standard and remedying any defects or issues that may arise after the work is substantially complete.

Key Aspects of Retention:

1. Retention Amount:
   • The retention is typically a percentage of each payment due to the contractor. Common retention rates range from 5% to 10% of the contract value, although this can vary depending on the project and the terms agreed upon in the contract.
2. Purpose of Retention:
   • The primary purpose of withholding retention is to provide the client with security and leverage to ensure that the contractor completes the project as specified. It acts as an incentive for the contractor to address any defects or incomplete work promptly.
3. Release of Retention:
   • Retention is usually released in two stages:
     • Practical Completion: A portion of the retention (often 50%) is released when the project reaches practical completion, meaning the work is sufficiently complete for the project to be used for its intended purpose, even if some minor defects or finishing touches remain.
     • Final Completion (Defects Liability Period): The remaining retention is released after the defects liability period (also known as the warranty period) ends, typically six to twelve months after practical completion. During this time, the contractor is responsible for rectifying any defects that arise.
4. Retention in Subcontracting:
   • Retention is also commonly applied in subcontracting agreements. Main contractors may withhold retention from payments to their subcontractors under similar terms as those in the primary contract with the client.
5. Contractual Terms:
   • The terms governing retention, including the percentage withheld, the conditions for release, and any interest on retained funds, should be clearly specified in the contract. Contractors and subcontractors need to understand these terms to manage their cash flow effectively.
6. Impact on Cash Flow:
   • Retention can have a significant impact on a contractor’s cash flow, as a portion of their earnings is withheld until the project is completed. This makes it essential for contractors to factor retention into their financial planning and ensure they have sufficient working capital to cover ongoing costs.
7. Retention Bonds:
   • In some cases, instead of withholding cash, the client may accept a retention bond. A retention bond is a type of surety bond issued by a bank or insurance company that guarantees the contractor will fulfill their obligations. This allows the contractor to receive full payment without retention while still providing the client with security.
8. Legal Considerations:
   • The use and release of retention are often subject to specific legal and regulatory frameworks, which vary by jurisdiction. In some regions, legislation may limit the percentage of retention that can be withheld or set specific timelines for its release.
9. Disputes Over Retention:
   • Disputes can arise if the client withholds retention beyond the agreed period or refuses to release it due to alleged defects or incomplete work. Such disputes may require negotiation or legal intervention to resolve.

Example:

• Construction Project Scenario: A contractor is hired to build a commercial office building for $1 million. The contract specifies a 10% retention rate. As the project progresses, the contractor submits invoices for work completed, but the client withholds 10% of each payment. Upon practical completion, the client releases half of the retained amount ($50,000), and the remaining $50,000 is released after the defects liability period ends, provided any defects are corrected.

Advantages of Retention:

• Client Protection: Retention provides clients with a financial safeguard to ensure that contractors complete the project as specified and address any issues that arise after completion.
• Quality Assurance: The withholding of funds motivates contractors to maintain high standards and promptly address any defects, ensuring a higher quality of work.

Disadvantages of Retention:

• Cash Flow Strain on Contractors: Retention can strain a contractor’s cash flow, particularly on large projects or when multiple projects are being undertaken simultaneously.
• Potential for Disputes: Disagreements over the release of retention can lead to delays, legal disputes, and strained relationships between contractors and clients.

Alternatives to Retention:

• Retention Bonds: As mentioned earlier, retention bonds offer an alternative to withholding cash, allowing contractors to maintain better cash flow while still providing security to the client.
• Milestone Payments: Some contracts may use milestone payments linked to specific stages of completion instead of retention, providing a structured payment plan without withholding funds.

In summary, Retention is a common practice in construction contracts designed to ensure that contractors fulfill their obligations and complete projects to the required standards. While it provides security to clients, it also presents challenges for contractors in terms of cash flow management. Understanding the terms and implications of retention is crucial for both parties in a construction project.