Retention money is described as the sum of money held by the employer as a safeguard for any defective or non-conforming work by the contractor. Retention money safeguards the employer by defects which can occur during the defects liability period if the contractor doesn't response according to the contract terms.
Purpose of retention money
The purpose of retention money is, in significant part, to provide security, in the form of a source of funds, against the contractor's failure to complete any work outstanding when the works are taken over and to remedy any defects or damage and in respect of any other liability of the contractor to the employer. In general, retention money provides protection to the employer. Retention money gives the idea of importance of completing the signed project as per it's terms and designs. With such retention held, the contractor takes the responsibility to complete the construction project as per the design and quality stated in the initial contract.
Example of retention money
An example of retention money in practice would be a construction project where a contractor is hired to build a new office building for a client. The client agrees to pay the contractor a total of $10 million for the work, but agrees to hold back 5% ($500,000) of the contract value as retention money.
The contractor begins work on the building and completes it on schedule. However, during the final inspection, the client discovers that there are some minor defects in the building, such as a few cracked tiles and a leaky faucet. The client informs the contractor of the issues and gives them a deadline to fix them.
Once the contractor has made the necessary repairs and the client is satisfied that the building meets the required standards, the client releases the retention money to the contractor. In this example, the retention money served as a financial incentive for the contractor to complete the work to the required standards, and as a form of security for the client in case the contractor failed to complete the work as required.
Amount and limit of retention money
Amount and limit of retention money:
- The percentage to be applied to the contract value of the works executed to calculate the amount to be retained is the percentage of retention stated in the relevant contract document. The FIDIC forms also provide for the possibility of a limit of the retention money to be specified in the relevant contract document.
- If no limit is specified, the amount that the employer will be entitled to retain will simply be the percentage of the total contract value of the works. The ESCL research referred to above revealed typical amounts of 5% certified amounts in France, Greece and the Netherlands and 5% to 10% of the contract sum in Germany and Switzerland.
Rules on treatment of retention
The intention is that the retention money should, in effect, be set aside as a separate fund to be used only for the purpose of providing the employer with security against the making good of defects, and the purpose of making the employer a trustee is to protect the retention money against his liquidation.
The rules and regulations regarding the treatment of retention money can vary depending on the country and the industry. In general, retention money must be held in a separate account, and the employer or client is responsible for ensuring that the funds are used appropriately.
In construction industry, some countries have laws that require employers or clients to pay interest on retention money held, to ensure that the contractor or supplier is not unduly penalized for the employer's or client's delay in releasing the funds.
In some countries, the retention money can only be released once the contractor or supplier has provided a bond, letter of credit, or other form of security to guarantee that they will complete the work as required.
The rules also specify the time frame for the release of retention money, for example, in the United Kingdom the retention money must be released by the employer or client no later than the final date for payment under the contract, unless there are legitimate grounds for withholding it.
It is important to note that the rules and regulations regarding the treatment of retention money may also be included in the contract between the employer or client and the contractor or supplier, so it's important to review the contract before starting a project.
Release of retention in construction contract
Release of retention is another important item or milestone in any construction contract which is also an indication of completion of the scope of the project up to the mentioned stages. Usually, retention monies are released in 2 stages of the project. The first half of the retention monies needs to be certified and released at the time of issuing the Completion Certificate. If there is any outstanding work for the project, those will be stated in the Completion Certificate. A reasonable cost will be deducted from the retention money to cover the costs of completing the remaining work by a 3rd party if the contractor doesn't accept to complete the rejected work or any outstanding work. The second half of retention monies will be certified and released upon the expiry of defects liability period. In most construction contracts, the defects liability period is 12 months which the contractor is liable to complete any defects arise due to the poor workmanship. Upon issuance of Maintenance Certificate, the 2nd half of retention money will be released.
- G. Hök, A. Jaeger 2009, p.166
- E. Baker, B. Mellors 2013, p.393
- E. Baker, B. Mellors 2013, p.393
- A. Speaignt, G. Stone 2014, p.84
- R. Pettigrew 2005, p.32
- Baker E., Mellors B., (2013). FIDIC Contracts: Law and Practice, CRC Press, London.
- Hök G., Jaeger A., (2009). FIDIC - A Guide for Practitioners, Springer Science & Business Media, Berlin.
- Pettigrew R., (2005). Payment Under Construction Contracts Legislation, Thomas Telford, London.
- Speaight A., Stone G., (2014). Architect's Legal Handbook: The Law for Architects, Butterworth-Heinemann, London.
Author: Paulina Czarnota