Effective Retention Management in Construction Contracts

Retention management has long been a contentious issue in the construction industry, with disputes arising between parties over issues such as late payment, underpayment, and non-payment. However, effective retention management is essential for ensuring that construction projects are completed to the required standard and that all parties are treated fairly. In this article, we will explore the topic of retentions in construction contracts and provide comprehensive guidance on how to effectively manage them.

What are Retentions in Construction Contracts?

Retentions are a common practice in construction contracts where a percentage of the contract value is withheld by the employer as a form of security against defects and other issues. The retention amount is typically released once the contractor has completed the work to the required standard. Retentions can be a valuable tool for ensuring that contractors complete their work to the required standard and providing security to the employer. However, the use of retentions has also been criticized by many, with concerns raised about the negative impact on cash flow and the potential for abuse by unscrupulous employers.

New CLC and NEC Guidance Encourages Alternative Approaches to Retentions

The industry acknowledges the need for reform in this area, and there have been considerable efforts by both the government and the sector to identify alternatives to limit the issues retentions present. As part of these efforts, the Construction Leadership Council (CLC) and NEC have developed guidance that challenges the default use of retentions and provides alternative options.

The joint guidance, published in November, explains how NEC deals with defective work and retentions, explores available alternatives, and highlights why a retention fund may not be necessary. The guidance is designed 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 principles of partnering, good management, and collaboration between the contractor and client.

The guidance sets out that retentions are unlikely to be needed on a carefully prepared and well-managed contract. It explores these principles, including the correction of defects under NEC and payment for work after notifying a defect. The NEC approach means that minimal defects should arise on completion. If any defects arise later, they must be corrected within a defined period. The approach to payment for work found to be defective varies according to the contract option chosen. The guidance suggests that all these approaches can be adopted without the need for retentions.

The NEC provides an option to use a retention fund as security for the client, to protect it from the contractor’s failure to correct defects after completion. However, unlike many standard-form contracts, retention under the NEC is an optional rather than core clause. The guidance emphasizes that the need for a retention fund, and the amount to be retained, depends on a number of factors, including the likelihood of defects arising, the stage in the contracts at which they arise, the belief in the willingness and capability of the contractor to make good the defects, and the robustness of the contractor’s financial position more generally.

In addition to a retention bond, there may be more appropriate optional clauses for providing protection against insolvency, such as the use of a performance bond or an ultimate holding company guarantee. The guidance stresses that these options should not duplicate each other.

Selecting a contractor with a reputation for high-quality work or with whom the client has a wider commercial relationship is crucial. This should be combined with careful drafting of the requirements for achieving completion and effective quality management during the contract.

Principles of Effective Retention Management

Effective retention management requires careful planning and communication between parties. The guidance developed by the NEC and CLC provides a set of principles that should be followed to ensure that retentions are managed effectively.

Principle 1 – Proportionality of Retention
Amounts One of the key principles of effective retention management is ensuring that retention amounts are proportionate to the risk. This means that the amount of retention held should be commensurate with the level of risk associated with the work being carried out. For example, if the work involves a high degree of risk, such as work on a critical part of a building, a higher retention amount may be appropriate than for lower-risk work. The proportionality of retention amounts should be discussed and agreed upon by all parties at the outset of the contract.

Principle 2 – Prompt Release of Retentions
Another important principle is the prompt release of retentions. Retentions should be released as soon as possible once the contractor has completed the work to the required standard. This helps to ensure that cash flow is not unnecessarily constrained and that the contractor can move on to other projects. It is important that a clear process for the release of retentions is set out in the contract to avoid any misunderstandings or delays.

Principle 3 – Mechanism for Resolving Disputes
Effective retention management also requires a mechanism for resolving disputes. This should be included in the contract and should provide for a fair and impartial process for resolving any disputes that may arise. This could involve the use of an independent adjudicator or other dispute resolution mechanism. It is important that all parties are aware of the dispute resolution mechanism and that it is agreed upon at the outset of the contract.

In conclusion, the CLC and NEC guidance provides an alternative approach to the use of retentions, which can often pose problems for contractors and their supply chains. The guidance seeks to encourage collaboration between contractors and clients, with the aim of delivering consistently high-quality work without the need for retentions. By adopting these principles, the industry can work towards fairer payment practices and a procurement and delivery model that incentivizes and rewards high-quality work.

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