Guidance aims to reduce need for retentions

Although retention payments are a long-standing feature of construction contracts, their use continues to spark debate across the industry.

The purpose of withholding cash is to provide security against contractors' failure to correct defects. Some cite their use to ensure contractors' performance and encourage them to eliminate defects in an industry where ongoing or minor defects can arise and the quality of work is key.

However, the practice of using retentions remains controversial, because there is little protection for the retained money in the event of insolvency. Furthermore, claims for the release of retention money are frequently disputed, and the release of retentions can be subject to long delays, contributing to cash-flow difficulties further down the supply chain.

Many in the industry are in favour of reform. They argue that withholding retentions is outdated and counterintuitive, when intelligent procurement approaches should be based on collaboration with a strong supply chain that will honour contractual obligations.

The UK Government estimates that up to £6bn is held in construction retentions each year in England alone, putting unnecessary financial pressure on contractors and their supply chains. Considerable work has therefore been undertaken by both the government and the industry on possible alternatives, to limit the problems retentions present.

Many of the current initiatives are being led by the Construction Leadership Council and carried out as one of its four strategic priorities, 'Next Generation Delivery'. This priority includes fairer payment practices and a procurement and delivery model that recognises, incentivises and rewards consistent high-quality work.

As part of this work, the CLC retentions working group collaborated with Beale & Company Solicitors LLP, Fenwick Elliott LLP and the NEC to develop guidance on dealing with retention payments under NEC3 and NEC4 Engineering and Construction Contracts as well as subcontracts.

The essence of the guidance is to challenge the default use of retention payments and the use of multiple security options, because the NEC construction contract suite is based on the premises of partnering, good management and collaboration between the contractor and client.

Retentions, the guidance suggests, are unlikely to be needed on a carefully prepared and well-managed contract. The guidance explores these principles, including the correction of defects under NEC and payment for work after notifying a defect.

The NEC approach, if implemented properly, should mean that there are minimal defects on completion. Any arising later must be corrected within a defined period. The NEC approach to payment for work that is found to be defective varies according to the contract option chosen. Importantly, all the approaches can be adopted without the need for retentions.

The need for a retention fund, and the amount to be retained, depends on a number of factors, such as:

• likelihood of defects arising
• stage in the contracts at which they arise
• belief in the willingness and capability of the contractor to make good the defects, and
• robustness of the contractor's financial position more generally.

Key to this is the selection of a contractor that is in robust financial health, with a reputation for high-quality work, or with which the client has a wider commercial relationship. This should be coupled with careful drafting of the requirements for achieving completion, and effective quality management during the contract.

The NEC also provides for an alternative to retentions including, but not limited to, in the form of a retention bond. There may also be more appropriate and useful optional clauses for providing protection against insolvency, including the use of a performance bond under option X13, or ultimate holding company guarantee under option X4. These options should not duplicate each other.

There is also a wider potential commercial benefit for the client if it makes clear that retention or alternative security will not be required from the outset. It is common practice for the contractor to make an allowance for providing a retention fund or other security when tendering for works. In fostering a collaborative relationship from the start and not seeking a retention or alternative security, however, the works may be provided at a lower cost to the client than would otherwise be the case.

As part of the webinar several polls were taken, with the results shown in the below bar chart.

While these responses are just a snapshot of current sentiment, they do suggest there is a need for further debate about the use of retentions and whether they have a place in a modern construction industry in the UK.