A common source of Payment Issues is Retention. Retention is the customary practice of withholding of monies to cover defects and incomplete work due from the payer to the payee in construction contracts that are deducted from stage payments during the construction phase and then released when the project is completed.
The value of the Retention is normally 3% to 5% of the gross value due, so depending on the size of project it can be insignificant or very significant. For example, £100,000 at 3% is £3000 and £1,000,000 at 5% is £50,000. From a claims point of view, chasing £3000 could be disproportionately costly and difficult; whereas £50,000 is worth a try. Standard contract forms and the custom in construction projects is to release half of the money at "Practical Completion", when the building is handed over and then the remainder at the end of the Defects Liability Period, which can be any agreed period and often 12 months from Practical Completion.
The current JCT forms at the Intermediate level do not recognise retention by name but refer to the value of the works as being subject to "the applicable percentage", which is applied at certain stages, 95% through the construction phase, 97.5% at Practical Completion and 100% on the Final Certificate. This approach reflects the non-fiduciary status of Retention under this contract form, whereas if you look at the full Standard JCT Contract, Retention is recognised under a heading and an option for fiduciary status is set out.
It is normal for terms relating to retention and defects management to be included in the contract, if they are not in the contract the rules do not apply and all money is due for payment, unless it can be proved that the payee accepted the custom of deducting retention and submitting to oral terms. In other words, retention is taken and there has been no objection.
The main difficulty with Retention money is the failure to release and repay the money at the end of the project. The problem is then often amplified by the high risk and disproportionate cost of recovering the Retention. It is not unusual to see Retention going unclaimed for these reasons. Typical problems that arise and end in dispute are:
Prohibitive Legal Costs for small sums - Court and adjudication might commercially outweigh a claim.
Deliberate payment obstruction by the Payer - It is not unusual for such sharp practice to be an unwritten policy for the Payer to boost their own profits. In practice, controversially many Main Contractors see Retention as a 5% profit margin, it is not unusual for contra charges to be levied for defects, delay damages and disruption costs with other trades and site operations
Ignorance in respect of the Law - It is not uncommon for a Contractor to dictate to its Subcontractors that retention is not to be released until Practical Completion of the Main Contract and/or Main Contract Defects Certificate is issued. Clauses and actions to this effect are voided by the New Construction Act which states in Section 142(1A) (a) and (b) that performance of obligations or decisions by others under another contract will render any payment clause with these conditions void as they will fail to be "adequate payment mechanisms". All contracts must comply with the Construction Acts. The clever way around this in part for the main Contractor is to set an actual duration of the subcontract defects period, which the parties are free to agree, to the same date as the Main Contract end of defects date or beyond it.
Bad Management of Defects and Timetable for Payment - If instructions, meetings and snagging is not done during and at the end of the defects period, the contemporaneous record may be lost and any subsequent damage or defects might cause issue. It is recommended to the Payee that a clear contractual procedure is agreed and that the timetable is dealt with diligently, making a claim with clear evidence is the goal in every aspect of procedure.
Defects and Work Quality issues - The normal reasons for not releasing Retention after the work is complete. Again, if excuses and allegations are to be avoided defects must be managed with the contract procedure, instructions, meetings and snag lists. Defects are put right by the Payee contractor without extra charge. It should be noted that many contracts will include a provision where the Payer can employ others if the Payee does not act promptly or as a right in any event. That will mean set off charges against the Payee's account.
Variation not Defect - After Practical Completion, instructions may be issued to deal with defective work, which in fact may include in whole or part additional work that is not part of the contract. Arguments can flare over the status, is it a variation and attract further payment or the making good of defects for free? Let us look at an example of how a dispute can arise, in the finishes trades, a simple one might be a white emulsion painting contract, where after Practical Completion the recipient considers the colour tone to be the incorrect tone of white to that asked for. The contractor is instructed to repaint in a different tone. The contractor insists that he has used the tone asked for and he says it is the lights the Client has picked that make it look different and nothing to do with him. Is the painting a defect or extra work? Is the paint work wrong or is it a Client perception/preference change now it is built? Who pays? If the area is 5,000m2 at £8/m2 you see how a dispute of £40,000 arises when the work is claimed as a varied extra or if there is refusal to do the work (as entitled to refuse after Practical Completion) can the Client deduct from retention or sums due for engaging others that cost him £60,000?
Insolvency of the Payer - Whose money is it? Is Retention Ringfenced by Default? - Retention is thought by many to be ringfenced hard earned money that belongs to the Payee that must be handed over when everything has been completed or is it? The answer is by default no it is not the Payee's money unless the contract has very clear strict terms that have been adhered to. The contract will define the Retention as fiduciary and there will be a bank account set up in the Payee's name into which goes the retention money as work proceeds that is all essential to ringfence any money. In practice this never happens, there are Retention Bonds that can be set up too, again not something done in practice. The Retention is the Payer's money by default in the absence of terms and if the Payer goes bust the money is lost to the Payer's Creditors.
Overpayment - If the Payer has over paid then the Retention will be reduced accordingly.
It depends who terminates the contract. The general rule is if you are terminated you will not get the benefit of the Retention.
If you are the Payee (e.g. the subcontractor) and you are terminated, no further payment is due including the Retention until the Final Account when the job has been completed by others. It is normal in such an instance for damages to be due to the Payer not a release of money or Retention.
If you are the Payer (e.g. the Employer or Main Contractor) and you are terminated, you will be required to pay the value of the work done at the termination date and release all Retention held. Payment typically to be made within the adequate payment mechanism that applies. The likely Payment Due Date, depending on the contract, being on the making of a claim by the Payee. However, if the termination of the Payer is due to the insolvency of the Payer, the Payee will be due payment but as a Creditor. Unfortunately, if the Retention is not ringfenced the Retention will form part of the debt due in the bankruptcy.
If there is a mutual parting of the parties, a clear settlement agreement including what happens to the Retention is needed otherwise a dispute will inevitably arise.
Retention has been a cause for complaint and quarrel for all time subcontractors often find it difficult and see it as a subbie bashing tool. It gives power to the Paying party to hold back on payment, whether there is good reason or not to do so. It is also a source of pain and concern when the party holding the Retention goes bankrupt, a recent big example of this was Carillion where millions in Retention owed to subcontractors has been lost.
A Bill was introduced to the House of Commons on 9th January 2018 by Mr Peter Aldous MP proposing that the current Construction Acts be amended (with the forthcoming review) to make any Retention clause under a construction contract ineffective unless the Retention money is paid into an approved Deposit Scheme, rather like Landlords now have to with their Tenants deposits. The Scheme would be backed up by a mediation or adjudication dispute resolution process says the Bill. The proposed deposit scheme would also importantly ringfence the money from bankruptcy, to avoid a "Carillion" happening again. Great idea, however the problem will be in the cost of the dispute resolution process if the adjudicator is asked to determine who gets the Retention fund, he will have to determine the Final Account including all the issues, extensive variations, contra charges, EOT delay analysis, loss and expense account, the whole Final Account to arrive at a decision on the Retention. It would require an advanced Construction Adjudicator to determine the disposal of the Retention and might cost more than the Retention. Some careful commercial thought is needed to make this proportionate cost wise and how the ADR process is adopted. It will in any event be interesting to see how the proposal develops. We would like to see for the purposes of commercial practicality, multiple retentions for multiple contracts held by the same Payer to be amalgamated as a right for the purposes of adjudication. For example, a subcontractor may have 20 projects with the same Main Contractor for small sums, which put together amount to one large sum, it would make sense for one adjudicator to deal with the whole sum due rather than appointing an adjudicator on each of the 20 contracts.
Notwithstanding the recommendations made above where problems occur, the claim must be managed. Obtaining, the half retention release when substantially complete also provides evidence that Practical Completion has been reached so it is a good idea to insist on that at that point in time in any event. Practical Completion prevents delay damages being incurred beyond that date and triggers the timetable to final sign off. It is often a mistake made by Contract Administrators to fail to issue a Practical Completion certificate, however an Adjudicator rule what this date is in the process of getting to the bottom of a dispute.
The contract will dictate how the retention will be repaid, if there are no terms in a written contract and thus no retention rights and there is an objection to the taking of it during the works, there will be no right to take the money as retention and this will be recoverable immediately.
Where retention rights do apply, the law on the matter is straightforward, in Hoenig v Issacs (1952), Denning LJ ruled that:
"entire performance is usually a condition precedent to payment of the retention money but not, of course, to the progress payments. The contractor is entitled to payment pro rata as the work proceeds, less a deduction for retention money. But he is not entitled to the retention money until the work is entirely finished, without defects or omissions."
The rule is you get the Retention back. Save the half release at Practical Completion if that right is in the contract, you do not get the retention back until you have "entirely finished" the work. That normally means the end of the contract defects period. If you are a subcontractor and it is the end of your defects period that you have agreed for your work, it is time to claim.
If the payment is not forthcoming despite the process being managed, it can easily turn into a long-winded pursuit for payment and where small sums are due, it is difficult to justify the chase given the high disproportionate cost of legal proceedings. Debt recovery and adjudication are the most effective way of tackling the problem of non-payment through Arbicon, we will also claim interest and if possible costs from the Paying Party depending on your contract rights and implied contract rights.
A change in the rules relating to Retention are welcome, particularly in instances where the payer goes bust. Arbicon's team understand the up-to-date law and rights of parties in respect of these matters and the best commercial way of tackling such issues. Arbicon are experts in resolving problem final accounts and collecting outstanding retentions.
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