Retainage
Retainage is a portion of the agreed upon contract price deliberately withheld until the work is complete to assure that the contractor or subcontractor will satisfy its obligations and complete a construction project. A retention is money withheld by one party in a contract to act as security against incomplete or defective works. They have their origin in the Railway Mania of the 1840s but are now common across the industry, featuring in the majority of construction contracts. A typical retention rate is 5% of which half is released at completion and half at the end of the defects liability period. There has been criticism of the practice for leading to uncertainty on payment dates, increasing tensions between parties and putting monies at risk in cases of insolvency. There have been several proposals to replace the practice with alternative systems.
History and purpose
The practice of retainage dates back to the construction of the United Kingdom railway system in the 1840s. The size of the railway project increased demand for contractors, which led to the entrance of new contractors into the labor market. These new contractors were inexperienced, unqualified and unable to successfully complete the project. Consequently, the railway companies began to withhold as much as 20% of contractors' payments to ensure performance and offset completion costs should the contractor default. The point was to withhold the contractor's profit only, not to make the contractor and its subcontractors finance the project.Given the often large-scale, complexity, cost and length of construction projects, the risk of something not going according to plan is almost certain. Accordingly, a common approach that contracting parties take in order to mitigate this risk is to include retainage provisions within their agreements. The concept of retainage is unique to the construction industry and attempts to do two things: provide an incentive to the contractor or subcontractor to complete the project and protect the owner against any liens, claims or defaults, which may surface as the project nears completion. Incidentally, owners and contractors use retainage as a source of financing for the project, contractors in turn withhold retainage from subcontractors, frequently at a greater percentage than is being withheld from them.
United Kingdom
Retentions are widely used in the British construction industry: in the majority of all contracts awarded, a sum of money is withheld as a security against poor quality products or works left incomplete. Clients withhold retention against main contractors and main contractors withhold payment against sub-contractors. Retentions typically take the form of a percentage on the contract value. The rate can vary wildly but is typically around 5%. The general state of the economy can affect the rates set: in a buoyant economy with plentiful work sub-contractors are able to pick which work they accept and therefore have potential to negotiate more favourable rates.The chain of retention starts with the client who withholds money on the main contractor. The main contractor withholds money on sub-contractors who may also then withhold on sub-sub contractors. The retention money is typically released in two portions ; the first being payable at completion of a project and the second at the end of the defects liability period. This period is the time during which the client is able to identify works that are defective to the contractor who must then remedy them; it is often twelve months. The use of retentions is not common to all sectors of the industry; for example lift installers have developed their own guarantee system instead.
A mobilization payment is an advance payment to a contractor at the start of a project to assist in the beginning of operations.
Impact
The use of retentions is intended to encourage efficiency and productivity. The contractor has a financial incentive to achieve completion as early as possible and to minimise defects in the works. Retentions held against sub-contractors are also a key source of cash for main contractors, who may use them to finance new projects.However sub-contractors often complain about the system. They sometimes lack a firm date on which retention monies will be paid and a 2017 British government report noted that more than half of contractors had experienced late or non-payment of retention monies. Delays are reportedly longer for sub-contractors and sub-sub contractors than for the main contractor. This restricts cash flow available for the company as a going concern and for capital investment. The chasing up of payments is also resource intensive, as such smaller businesses are hit more severely than larger ones. Some smaller companies simply write off the retention money, increasing their prices to compensate. The practice has also been described as increasing tensions between the parties in contract.
There is no current requirement for retention monies to be ring-fenced and they are usually held in a client's or contractor's main bank account. This can cause problems in cases of insolvency, where the money can be lost and payments owed to the supply chain put at risk. The use of retentions can also render construction companies unsuitable for factoring.
Development in the UK
Railway construction in the 1840's saw a rapid increase in the number of contractors, often with little experience of the industry. There was a rise in the number of insolvencies and a drop in workmanship standards. Railway companies therefore began withholding a minimum of 20% of payments to contractors as a security against incomplete and defective works. This practice had spread across the industry by the mid-19th century.The 1994 Latham Report recommended that legislation be introduced to protect retention monies held by a party, which would prevent it being lost during a liquidation. Despite all of Latham's other payment recommendations being incorporated into the Construction Act 1998 this one was omitted. The practice was reformed somewhat by the Construction Act 2011. This made it illegal for the release of retention under one contract to be linked to that of a second. This ended the practice whereby contractors would refuse to release retention to sub-contractors until they had been paid it themselves by the client, over which the sub-contractor had no influence.
The 2018 collapse of contractor Carillion had a dramatic effect on the industry. Many of its sub-contractors lost large sums of money as £250 million in unpaid retention was lost when the business went into liquidation.
Proposed replacement
There is limited use of alternatives to retention in the British construction industry. However, there have been recent movements to try to effect change. The Department for Business, Energy and Industrial Strategy commissioned research into the matter to determine the extent of the use of the practice and its effects on the industry and economy. This was published in 2017 and also identified a number of alternatives to the practice. A DBEIS public consultation was subsequently launched; this closed on 19 January 2018 but no recommendations were subsequently made for government action. A private members bill was introduced to the House of Commons by Peter Aldous on 9 January 2018 seeking to introduce protection to retention money but did not proceed through parliament.The Build UK industry group aimed to secure abolition of retentions by 2025, following an ambition outlined by the Construction Leadership Council in 2014. Build UK put forward proposals that retentions by the main contractor on sub-contractors should be no more onerous than those imposed by the client on the main contractor. They also proposed that retentions should only apply to permanent works, as temporary works are unlikely to lead to defects. The organisation also wants small value contracts to become retention-free by 2021, as the risk to the main works is lower for these contracts.
The Construction supply chain payment charter, adopted in 2014, had a target for "ZERO retentions" by 2025 in construction contracts dated 1 January 2015 or later, along with the adoption of 30 days' standard payment terms across the construction sector. However, the charter was withdrawn on 18 January 2022 in favour of reporting regulations applicable to large businesses. The reporting regulations lapsed on 6 April 2024.
Some organisations have proposed retention deposit schemes, whereby money is deposited with a third party, although these lead to increased fees and bureaucracy and do not solve disputes between parties over when retention should be released. A mandatory retention deposit system was proposed for inclusion in the Enterprise Act 2016, but the proposed scheme was not subsequently included within the Act. Following the collapse of Carillion there have been increased calls for retention reform. The Scottish Government began a consultation on retentions in 2019. It stated that the UK was behind other countries by continuing the practice, despite the matter having been looked into several times by the UK Government. Alternatives include project bank accounts, retention bonds, performance bonds, escrow stakeholder accounts, parent company guarantees or trust funds to hold retention monies.