James Bessey - Retention is a time-honoured method of keeping contractors and subcontractors on their toes by withholding a fixed sum of money. The problem is: it doesn't work
A number of commentators and industry groups have started to question retention. As we are moving away from pay-when-paid, developing the partner ethos and operating our supply chains with more transparent mechanisms, this is a good time to consider whether retention really does anything to encourage performance. What's more, the ringfencing of construction contracts by the Construction Act and the review of that legislation give us an opportunity to reconsider the acceptability of retention.

Retention has long been a feature of contracts. The concept is simple – an agreed proportion of money due under the contract is withheld to encourage the contractor or subcontractor to complete the works, to remedy defects and remain committed. However, whether it achieves these aims is questionable.

For serious defects, the amount withheld (usually 5%, often in two instalments) is unlikely to cover the cost of putting right any substantial defect.

It might be suggested that retention is only intended to deal with snagging problems. If this is the case, then it is not clear why, given the Construction Act's requirements for payment and withholding of payment notices, an arbitrary percentage should be withheld.

There is, for instance, no reason why at practical completion, the value of the snagging works to be completed cannot be totted up and settled by a payment notice for that amount, or by a notice of withholding.

Indeed, in terms of providing encouragement, such an approach would be better than keeping back a percentage of the sum due. The reason is that withholding an arbitrary percentage does little to encourage the party providing the service from reducing snagging. The good subcontractor is, in effect, penalised.

Of course, if the extent of the snagging works exceeds the amount being retained, the mechanism is unlikely to persuade the contractor or subcontractor to put them right, and there may be a question over whether practical completion should have been certified.

The criticism of retention as a concept is that it is an arbitrary discount that hits cash flow and is used, on occasion, as a bargaining counter. The cash flow issue arises because, conventionally, retention is taken in instalments as the project progresses. In contrast, a proper valuation process of defective or snagging work items could be implemented late in a project, thereby minimising cash flow problems.

Of course, supporters of retention will argue that until the industry cleans up its reputation retention should remain. I would suggest that if the real purpose of retention is to indemnify against defects, then there are more attractive alternatives, such as performance bonds, guarantees or insurance. Latent defects cover is, for instance, available.

The Construction Act ringfences what is and what is not a construction contract, so we do now have a statutory framework that would allow legislation to outlaw contracts that provide for the arbitrary withholding of money.

Of course, such legislation would need to be carefully framed and might be difficult to implement.

That said, the industry does respond to legislation that guides conduct and practices. Doing away with retention would appear to be consistent with the spirit of the act, which requires proper particulars of what has, and has not been, paid, along with the reasons. Current retention percentages do not do that; they are arbitrary.

A number of lawyers practising in the construction field also carry out work in areas such as computer software agreements. These generally do not contain retention provisions but, as do construction contracts, make provisions for staged payments.

It might, therefore, appear that other industries are unwilling to accept an arbitrary sum being held over.

As the construction industry readdresses its procurement methods and supply chains, perhaps it is time to look again at the issue of retention.