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The Problem With Retention And How It Can Be Solved
Recovery of retention is a problematic area for all parties in the contractual chain, with non-payment of retention often being the cause of substantial cash flow problems. With insolvency rates currently at a record high, it is now more important than ever for contractors and sub-contractors to focus on recovering retention.
The Problems with Retention
Firstly, retention is often not released on time and in accordance with the contract. This is a problem for all parties in the contractual chain. In a typical construction contract, the level of retention can often be more than the level of profit margin; therefore, until retention is paid, it essentially means that the party having their retention withheld may be in loss.
Secondly, in the case of sub-contracts, the release of retention is often dependent on circumstances outside of the sub-contractor’s control, such as the remedying of defects under the main contract by other parties.
Recovery of Retention
Unfortunately, it is becoming more and more unusual for paying parties to release due retention when they are required to; therefore, a strategy needs to be formulated in relation to recovering retention. The contractual position regarding recovery of retention will vary; however, in all cases it is vital that parties who are owed retention ensure that they are organised and have maintained their records properly. To promote good record keeping and increase chances of obtaining retention payment, it is beneficial to produce an appropriate spread sheet for each contract which specifies notable information relating to the contract. For example, the project name, start date and practical completion. Against applicable milestones, it should be highlighted when and how much retention is due to be released.
Parties owed retention monies should be persistent in chasing payment, resorting to formal applications for payment (with interest) if necessary. If the above steps do not help, it might then be necessary to take formal legal steps to recover retention.
Whilst the majority of retention problems are faced by sub-contractors, some contractors still encounter problems with recovering retention from employers. Employers often seek to withhold retention based on an incorrect interpretation of the works information (and therefore incorrectly identify a defect). As such, it is vital for contractors to establish the precise nature of any alleged ‘defect(s)’ preventing release of retention, as they may be challengeable.
Problems Faced by Sub-Contractors
Retention is a particularly challenging area for sub-contractors. Many sub- contracts state that retention is released on practical completion and after the certificate of making good defects is issued under the main contract meaning that sub-contractors can be left waiting for retention money long after their works have completed.
In Pitchmastic v Birse , Pitchmastic, a roofing sub-contractor, was employed by Birse on a supermarket development project. Under the sub-contract, the balance of retention would be released when the certificate of making good defects had been issued under the main contract. Pitchmastic achieved practical completion of its sub-contract works in March 1998. Following the expiry of the defects liability period, no certificate of making good defects was issued. Since Pitchmastic’s own works were free from defects, it argued that it was entitled to receive its retention.
The court found that the only way Pitchmastic could overcome the terms of the sub-contract was if it could show that Birse had prevented the issue of the certificate of making good defects by failing to proceed with reasonable diligence to make good the defects.
Whilst Pitchmastic had failed to provide enough evidence to establish that the contractor was not remedying defects with reasonable diligence, the case provides useful advice to sub-contractors in similar situations. For example, identifying the reasons why the certificate of making good defects is being delaying is essential. Firstly, sub-contractors need to confirm that none of their own defects are outstanding. Secondly, sub-contractors need to try to establish what the defects under the main contract are and how they can be remedied. With this information, the sub-contractor will be in a better position to be able to assess whether the contractor is not proceeding with reasonable diligence. In such circumstances, an adjudicator may instruct the contractor to release the retention, even without a certificate of making good defects having been issued.
Furthermore, it is always worth checking whether the defects alleged to be in existence are actually defects. If all parties have complied with the works information, then the paying party cannot rely on the existence of a defect to withhold any due retention.
Changes to the Construction Act
Under the Housing Grants, Construction & Regeneration Act 1996, as amended by the Local Democracy, Economic Development and Construction Act 2009, payment under sub-contracts entered into after 1 October 2011 cannot be conditional upon the performance of obligations under a separate contract. This is beneficial to sub-contractors entering into new sub-contracts as it means the release of their retention can no longer be dependent on milestones under the main contract.
However, sub-contractors should be aware that contractors are beginning to stipulate retention release dates in sub-contracts which are far into the future (e.g. 18 months after practical completion of the sub-contract works). Whilst these clauses are compliant with the law, they clearly allow contractors the opportunity to have received their own retention under main contracts before they are obliged to pay retention to sub-contractors.
Nonetheless, many sub-contracts have not yet been amended; therefore, for any sub-contracts entered into after 1 October 2011 with non-compliant retention clauses, the Scheme for Construction Contracts will apply.
Avoiding the problems associated with retention recovery is often achieved by the use of retention bonds.
What is a retention bond?
A retention bond is a formal agreement between the contractor, sub-contractor and a third party surety. The surety acts as a guarantor between the contractor and the sub-contractor. The retention bond states that the surety agrees to pay the contractor the value of a cash retention if the sub-contractor fails to remedy any defects.
How does a retention bond work?
The retention bond only takes effect if the sub-contractor does not achieve practical completion and/or prevents a certificate of making good defects from being issued. In these circumstances, the contractor can ‘call’ on the retention bond.
Usually, a retention bond will stipulate that the sub-contractor is allowed the opportunity to rectify any defects within a fixed period of time from being notified of the defect. If the sub-contractor fails to remedy the defect, the contractor can call the retention bond and the surety will remedy (or pay for the remedy of) the defect. The surety will then pursue the sub- contractor for the cost of the defect.
Why use a retention bond?
If drafted correctly, the use of retention bonds is generally considered to be beneficial to a construction project.
Where an insurance company acts as the surety, sub-contractors will need to pay for the surety’s premiums. However, sub-contractors conversely benefit from not having any retention monies withheld. Many sub-contractors feel that the benefit of their cash flow being unaffected by retention is more valuable to them than the cost of a retention bond. In addition, retention bonds usually contain a fixed expiry date so all parties are clear when the sub-contractor is released from its obligations. Most importantly, the sub-contractor is free from having to chase retention monies at the end of a job.
For the contractor, a retention bond provides the same level of security as a cash retention would. However, the added benefit is that the retention bond is improving the cash flow and financial stability of the sub-contractor.
Want to know more?
As specialist construction lawyers, Hawkswell Kilvington have a wealth of experience in drafting various bonds and guarantees, including retention bonds and performance bonds.
Hawkswell Kilvington offers a specialist Retention Recovery Service which provides fixed cost solutions to parties who are struggling to recover retention.
If you would like to discuss any of the above, please contact Jonathan Hawkswell at firstname.lastname@example.org.This article contains information of general interest about current legal issues, but does not provide legal advice. It is prepared for the general information of our clients and other interested parties. This article should not be relied upon in any specific situation without appropriate legal advice. If you require legal advice on any of the issues raised in this article, please contact one of our specialist construction lawyers.