Introduction
Retention monies are a percentage of the money that is payable to a subcontractor that is withheld by the builder until a portion is released on practical completion and the balance on final completion.
Developers also withhold retentions from builders.
This article should also be read in conjunction with the Who really funds projects article
The myths
There is a popular myth that subcontractors simply add the value of retention monies to the tender price of if they lose the retentions they have not really lost anything.
That is untrue. Retentions come out of the actual amount payable to the subcontractor for goods, materials and labour and are not an add on.
If a subcontractor is not paid retentions that comes out of profit and costs.
The other myth is that retentions offset the builder’s liability when the subcontractor has been paid for defective work.
That is also incorrect as work that has not been performed properly has not been performed and there is no obligation on the builder to pay for it.
The final myth is the profit margins made by subcontractors in the building industry. Profit margins tend to be a closely guarded secret.
However, prior to COVID 19, profit margins were single digit numbers with a tendency to range between about 5% to 7%. While there are some circumstances where profit margins were 10% to 20%, they were rare.
The post COVID 19 crisis is going to have an adverse effect on profit margins.
Why retentions
Retentions were relevant a long time ago when a lot of construction work involved hand crafting on site and the use of materials that were not of a consistent nature.
There was also less ability to inspect and verify the quality of the work performed at the time.
There was also a high degree of itinerancy among subcontractors and rapid turnover of subcontracting businesses.
Problems arising from construction methods in use would arise during construction and during the 12 months after the work was practically complete (that is, the building is complete and fit for occupation). A portion of the retention monies is released on practical completion.
The 12 months after practical completion is called the defects liability period which ends on final completion when the balance of the retention monies are released.
Why no longer relevant
Retentions are no longer relevant to the modern construction environment for the following reasons:
- Modern manufacturing process produce uniform quality products that meet the required specifications;
- Hand finishing is minimal;
- Modern quality assurance means that work is checked as it proceeds; and
- Subcontractors also have to be licensed and meet the Minimum Financial Requirements with penalties for collapsing companies which means that they are there for the long term.
Deleterious effects
As anyone who has had anything to do with business knows, cashflow is king.
The system of retention monies does not exist in any other industry and if it did there would be outrage about its drag on business viability.
While there has been some improvement on the really bad old days when builders were holding up to 50% as retentions, the drag of retentions on cashflow has a significant effect on the survivability of a subcontracting business and is a significant bar to new entrants into the industry.
For trades that are subject to the QBCC licensing scheme, retentions are restricted to 10% of any progress claim until retentions reach 5% of the contract sum (that occurs at a point half way through the contract).
Half the retentions are released at practical completion and the balance at final completion.
If we consider the amount of retentions against pre COVID 19 profit margins using a margin of say 6%:
- As at the half way point, retentions being withheld from each progress payment exceed the profit margin on each progress payment;
- The subcontractor often does not start to see a profit margin on progress payment until about the last 2 or 3 progress claims;
- If the profit margin is less than 6%, there is no profit until retentions are released on practical completion (which would equate to half the profit);
- Even if the subcontractor has a 6% profit margin, the practical completion release amounts to 41% of the profit margin;
- That means the subcontractor has to wait 12 months for the release of the balance of retentions on final completion to receive the final 41% of its profit.
- The proposed roll out of project bank accounts will not be complete until 2022 at the earliest;
- The most vulnerable are being left to last;
- There will still be a significant number of projects that are exempt from project bank accounts; and
- They still do not ameliorate the deleterious effect of retentions on cashflow.
There cannot be any doubt as to why there is such a great deal of anger over the failure of a builder, especially when a 408C fraud has been committed.
Retentions as ransom
Retentions are also used as ransom.
There are many circumstances where subcontractors have the theoretical right to take action to protect their interests by terminating their contracts where the builder is in breach or insolvent.
However, that puts their retentions at risk which makes a subcontractor very loath to take action.
Project bank accounts
There is a perception that project bank accounts have solved the problem.
They have not for the following reasons:
Related articles
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