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What Are Retentions In Construction Contracts?
14 September, 2023 | Bret Gower
Retentions are a crucial aspect of the construction industry, and they are often used in building contracts to ensure that defects are rectified and all outstanding disputes are resolved before final payment. They can also serve as an incentive for contractors to deliver quality work. In essence, retentions are a portion of the payment that is held back by the client as a form of security until specific conditions are met, and they play a significant role in the payment process for builders and tradespeople.
Retentions can be complex, and it is important for builders and tradespeople to understand how they work and how to account for them. This article will discuss what retentions are in the construction industry, how they work in building contracts, and their legal framework in New Zealand, including the Construction Contracts Act and the NZS3910 standard.
Examples of Retentions in Practice
To illustrate how retentions are used in practice, let us consider two examples.
Firstly, imagine a client who engages a builder to construct a new commercial building. The contract specifies that the retention rate is 10%, and the retentions will be held until the work is completed, defects have been rectified, and any outstanding disputes have been resolved. The builder completes the work, and the client identifies several defects that need to be rectified. The builder rectifies the defects, and the client is satisfied with the work. The retentions are then released, and the contract is completed.
Secondly, consider a situation where a homeowner engages a contractor to renovate their house. The contract specifies that the retention rate is 5%, and the retentions will be held until the work is completed and defects have been rectified. The contractor completes the work, but the homeowner identifies several defects that need to be rectified. The contractor rectifies the defects, but the homeowner is not satisfied with the work. The parties enter into a dispute, and the retentions are held until the dispute is resolved. Once the dispute is resolved, the retentions are released (either to the contractor for having remedied the defects or to the homeowner to arrange for the defects to be remedied by somebody else), and the contract is completed.
How are retentions calculated?
Retentions are usually calculated as a percentage of the contract value, and they are deducted from each payment made to the contractor. For example, if the retention rate is 5%, and the contract value is $100,000, the client will withhold 5% from each payment made to the contractor – a total of $5,000.
When are retentions paid?
Retentions are usually released once the work is completed, defects have been rectified, and any outstanding disputes have been resolved. However, in some cases, retentions can be held for an extended period, depending on the terms of the contract.
How to account for retentions
Accounting for retentions can be complex, and it is essential to ensure that accurate records are kept. It is important to have a clear understanding of the terms of the contract, including the retention rate, the period for which the retentions will be held, and the conditions that must be met before the retentions are released.
Builders and tradespeople must ensure that they keep accurate records of the work completed, any defects that have been identified, and the rectification work that has been carried out. This information will be required to claim the retention payment once the work is completed.
It is also essential to ensure that any variations to the contract are properly documented and agreed upon by both parties. This will help to avoid disputes and ensure that the retentions are released in a timely manner.
The NZS3910 standard is a widely used standard form of construction contract in New Zealand. The standard includes provisions for retentions, including the retention rate, the period for which the retentions will be held, and the conditions that must be met before the retentions are released.
Under the NZS3910 standard, retentions are held by the client, and they are released once the work is completed, defects have been rectified, and any outstanding disputes have been resolved. The standard also includes provisions for the payment of interest on late payment of retentions and the potential for the contractor to provide a bond instead of retentions being held by the client.
Construction Contracts Act treatment of Retentions
In New Zealand the Construction Contracts Act 2002 (the Act) is the primary legislation governing the payment process in the construction industry. It includes provisions for the retention of funds, including the maximum retention rate, the period for which the retentions can be held, and the conditions that must be met before the retentions are released.
On 5 October, 2023 the Construction Contracts (Retention Money) Amendment Act 2023 came into force, and its provisions will be incorporated into the Act.
The amended Act includes provisions for the payment of interest on late payment of retentions.
The explanatory note to the Bill (that became the Amendment Act) provides:
“Subcontractors are at risk of not receiving retention money held for them by the contractor should the contractor become insolvent if retention money is mingled with working capital. The amendments to the Construction Contracts Act are intended to reduce the risk by better protecting retention money automatically by providing that it is held on trust from the earliest practicable point of time. As trust property, the retention money cannot be used by party A for any other person and is separate from the insolvency estate of the construction company.”
Obligation to hold retentions on trust
The money must be held on trust for the benefit of the contractor. This means that the retention money must be held separately from other funds and cannot be used for any other purpose. The purpose of this amendment is to provide greater protection for contractors by ensuring that their retention money is not at risk of being used for other purposes by the party holding it.
Requirement to keep retention money in a separate trust account
The amended Act will require parties holding retentions to keep the retention money in a separate trust account. This means that the retention money must be kept separate from other funds and cannot be co-mingled with other funds. The purpose of this amendment is to provide greater transparency and accountability for retention money, making it easier for contractors to track their retention money and ensuring that it is used only for the purpose for which it was intended.
Requirement to pay retentions to contractors within a specified timeframe
Unless the contract provides otherwise the parties holding retentions must pay them to the contractor within 20 working days of the date on which the payment is due. By requiring parties to pay retentions within a specified timeframe, contractors will receive their retention money more quickly, improving cash flow and reducing the risk of payment delays.
Requirement to provide information about retention money
Under the amended Act parties holding retentions must provide information to contractors about the amount of retention money held and the name of the bank or financial institution in which it is held. This information must be provided within 10 working days of the contractor’s request. This amendment aims to improve transparency and accountability in the retention process, making it easier for contractors to track their retention money and ensuring that it is used only for the purpose for which it was intended.
Provision for adjudication of disputes relating to retentions
The Act provides for adjudication of disputes relating to retentions. This is designed to allow a more effective and efficient dispute resolution process for disputes relating to retentions. By adjudicating disputes under the Act, parties will have access to a specialist dispute resolution process that is tailored to the construction industry.
Penalties for non-compliance
Under the amended Act penalties for non-compliance will include fines of up to $200,000 for individuals and company directors can be liable for fines of up to $50,000 per offence. These penalties aim to provide a strong incentive for parties to comply with the proposed amendments, ensuring that the new legal framework for retentions is effective and efficient in practice.
Don’t navigate the complex world of construction law alone. If you have questions or need guidance on retentions, building contracts, or any construction-related legal matters, Bret Gower, our trusted Construction Law Expert, is here to help. Ensure your projects and contracts are watertight and compliant. Reach out to Bret Gower today and secure your construction future.