Are Retention Monies a Performance Bond or a Penalty? 1

Monday, May 25th, 2015
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Construction contracts, which include the Standards Australia suite of standard form contracts, all have some form of retention or performance bond clause in them.

The reasoning behind these deductions or bonds is supposedly linked to performance – that is, the subcontractor places an amount of its own hard earned cash back on the table as a guarantee that it will perform its obligations under the contract.

What is supposed to then follow is that once the subcontractor has fulfilled its obligations under the contract, the retention monies or bonds are returned to them, supposedly intact. This is usually where the dream ends and the harsh reality of a different nature prevails.

The most common deviation in contracts on this point is that only half of the retention monies are returned at time of practical completion. Half! The other half is conveniently kept as a future performance bond against defect liability during the defect liability period (which can and does extend far beyond any reasonable period specific to the subcontractor’s scope.)

To add insult to injury, most contracts clearly forbid applying interest to retention monies, so not only is your money held by another for a period which is truly of dubious relevance to your scope of work, but it will gain no interest for this privilege!

Do the maths. You’re on a $10 million contract which will take you all of 16 months to complete. The project has a construction period of 30 months. Before you can start, you have to pay the main contractor an amount of five per cent of this contract sum, or $500,000, as a performance bond. This money will be held by the main contractor in an undisclosed account, and shall not bear interest for the period that it is held. The contract states that on receipt of a certificate of practical completion, you will receive half of your money back, with the other half being paid to you 12 months after project completion, which is 14 months after you finished up your scope.

In more simple terms, the main contractor will have use of the full amount of your money for a period of 16 months, and continued use of half of your money for a further 14 months.

Assuming that the main contractor places your money in an interest bearing account for their own benefit and receives six per cent return per year on it, they will have earned $40,000 on this investment during the 16 months that it takes for you to achieve practical completion.

They then return half of your money to you, or $250,000, placing the other half back into the investment deposit, together with the interest from the first lot, and by the time you are due to collect the remaining half of your performance bond some 42 months after you initially began the work, they will have collected $71,900.

I’ve specifically kept these calculations simple for this article, however you might want to ask your accountant to get a bit creative with dollar figures over a 42-month period and see what you come up with. You would be quite amazed.

So the bottom line question to ask yourself is whether your retention monies are a performance bond to keep you honest, or a lurk by the main contractor which equates to a penalty? Are you being slugged twice?

Let’s have a quick look at the most dangerous of all scenarios that every contract is exposed to – the upstream holder of the retention money goes broke! It happens every week, with monotonous regularity, and inevitably it is the small subcontractor and ultimately the project itself that suffers the most.

There is only one simple method that prevents abuse of retention monies either by loss or subterfuge, and that is to have in your contract a clause that clearly states that all retention monies must be held in an independent trust account, which must be interest bearing, and that the only beneficiary of the monies held in trust is you!

Like every other mitigation strategy that adds balance and value to a contract, it has to be negotiated and fought for. Otherwise it simply will not happen.

As always, risk safely.

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  1. Bruce Christopher

    Mervyn, another problem is that contracts can sometimes require the sign off by a particular project manager who in this day and age is unlikely to be with the company some 12 or 24 months following completion and money is held longer while trying to sort that one out. It's a waste of resources and can be solved by insisting on an automatic expiry clause and return.

    However, I found the best and fair method for both parties is to put forward bank guarantees for completion and acceptance periods, also with automatic expiry and clarity regarding claims, rather than to forego often critical cash flow. There is no reason for the contractor not to accept that, unless there is an ulterior financial motive and it is not reasonable for what probably represents the entire profit being held for what can be years.