Construction Retentions Escrow

Securing payment of your retentions under a building contract

While retention in the construction industry is an increasingly taboo subject (owing to the failure of some very large construction companies who had retained significant sums before their insolvency, which meant that construction companies lower in the supply chain never got what they were owed as a result), if they are properly handled by a third party, their purpose of giving the client the right to retain sums against work properly completed remains a valid and powerful incentive to the Contractor to do so.

What is the purpose of retention in construction contracts?

Retentions in construction range in value. Under the JCT contracts in the UK, retention under an Intermediate with Contractor's Design 2016 (ICD 2016), the standard retention is 5% and under the Standard Building Contract 2016 (SBC 2016), the standard retention is 3%. Often, private client lawyers will try to increase these amounts in the contract amendments.

These amounts are withheld from each month's payments up until Practical Completion ('PC').

How does retention get released?

At the next interim valuation after PC, the client is only permitted to deduct half of the retention percentage (2.5% or 1.5%, depending on the contract). When calculating the amount of money to be transferred to the Contractor, the Interim Payment Certificate will only deduct this lower amount, increasing the net amount to be transferred to the Contractor to include the 'released' retention.

At the end of the Rectification Period, the retention percentage is 0%, and the final payment to the Contractor includes any outstanding retention in the same way.

What are the criticisms of retention in construction contracts?

Under an unamended JCT

Construction Retentions are widely regarded to be outdated. While the theory behind encouraging the Contractor to complete the Works holds true, the reality of construction retentions under an unamended JCT contract is often quite different:

• In the event that the Employer becomes insolvent, the Contractor will never get any remaining retention (when Carillion folded, it was estimated to be holding some £800m in retentions);
• Retentions are often released late (or not at all), or eroded significantly as part of the final account agreement process; and
• Sometimes, retentions are offset against (perhaps) spurious or unfounded 'claims' so as to absolve the Employer from having to pay them.

In short, from a Contractor's perspective, there is little comfort in the retentions ever being paid in full. This doesn't really suit anyone - if the Contractor doesn't believe it will ever get its retention, it will have to include provision for it in its OH&P or elsewhere in the Contract Sum - the net result is that the Employer ends up paying more.

Under an amended JCT

The situation under an amended JCT is often worse for the Contractor. Construction lawyers representing the Employers usually strip out all of the protections afforded to the Contractor to guard against the disappearance of the retention:

• The Employer's interest in the retention should as trustee for the Contractor - that way, if the Employer becomes insolvent, the money is available to the Contractor and not the Employer's creditors - this is frequently omitted;
• The Employer should place the retention each payment cycle in a separate bank account (so that it is clearly identifiable as belonging to the Contractor), but this is also usually deleted.

How is a construction retentions escrow different?

The Construction Retentions Escrow or "Retentions Account" exists to try and bridge some of these challenges.

Where one of these is used, the retention for the construction project is deducted each month from the Contractor in the usual way under the contract but, instead of the Employer retaining it, it is paid into the Retention Escrow managed by a trusted third-party escrow or payment service provider.

As the third party receives the money each month, it produces a statement for the Employer and the Contractor (or makes the information available via an online portal) so that everyone knows the retention has been paid in.

At Practical Completion, the Contractor presents the Practical Completion Certificate to the third party, and receives the release of the first half of the retention, and the second half is released against the Final Certificate.

In this way, the retention is released promptly, and in full, and we pay the Contractor without delay.

Is this a Retentions Deposit Scheme?

While there have been various attempts to set up 'official' Retentions Deposit Schemes, none of these have managed to make it through the legislative process.

Nevertheless, our scheme functions just as the Retentions Deposit Schemes were intended to.

How do I set up a retentions escrow?

Setting up a Retentions Escrow is very straightforward. There are just a few administrative steps that must be undertaken. It is helpful for the Contractor to raise the issue with the Employer as soon as possible (we recommend doing so with you tender return), so that everyone has the opportunity to get comfortable with what's required.

Amend the JCT Standard Form Contract

We recommend making a very minor, standard-form amendment to the JCT standard forms of contract (you can contact us for a free amendment for all the major JCT forms) which does the following:

• Nominates a Retention Escrow provider (eg, dospay);
• Requires transfer of the Retention money each month (plus the VAT on the retention; see below) by the Employer into the Retentions Escrow;
• Requires that to happen each cycle before the final date for payment of the associated interim payment;
• Permits the Contractor to suspend Works if the Employer doesn't transfer the Retention into the Retentions Escrow in time; and
• Permits first release of the Retention money to the Contractor against the issue by the Architect/Contract Administrator of the Practical Completion Certificate.

Request a retentions escrow

You can request a no-obligation quote from us and usually open a Retentions Escrow within 48 hours.

Provide compliance information

When you are ready to proceed, we will need to carry out our compliance checks on the Employer and the Contractor (though we have already done this for a good number of Contractors, which helps to speed things up), to verify the terms of the Construction Contract and to issue you with the Retentions Trust Account Agreement.

Receive your Retentions Escrow Account details

Once all of the compliance checks are complete and the Retentions Escrow Agreement is signed, we can provide you with the account details.

How does the Retentions Escrow work with the monthly valuation cycle process?

Each cycle, on the issue by the Architect/CA of the Interim Payment Certificate, the Contractor will send two invoices to the Employer:

1. An invoice for the amount stated as due for the percentage of the Works complete, plus the applicable VAT, which will bear the bank details of the Contractor, for transfer directly from the Employer to the Contractor; and
2. An invoice for the Retention relating to that Interim Payment Certificate, which will bear the bank details of the Retentions Escrow, for transfer directly from the Employer to that account.

A note on VAT

We recommend (as you will note from our explanation of the proposed amendment above) that provision be made to include the VAT chargeable on the Retention in each cycle's deposit. This ensures that in case of Employer insolvency, the Contractor will recover the Retention in full and the VAT that needs to be paid on it.

This can lead to a small cashflow headache, however - during a long construction project, in effect, the Contractor will have issued VAT invoices to the Employer for the VAT payable on the Retention and have had to account to HMRC for that VAT, but will not have actually received the cash (as it is being held in the Retentions Trust Account).

Contractors tell us, however, that the requirement to pay up to 20% of 3-5% of the monthly interim payment to HMRC is a small price to pay for the comfort that the Retention Trust Account otherwise provides.

How do I get paid my retentions?

Under our Retentions Trust Agreement, the Employer agrees that we can release the retention to the Contractor in line with the construction contract and transfer it out upon simple presentation of the Practical Completion Certificate or the Final Certificate.

Is interest payable on a Construction Retentions Escrow?

We don't pay interest on Retentions Trust Accounts. Instead, we roll the interest up to cover our overheads, compliance and ongoing FCA-regulation which allows us to offer incredibly reasonable rates on Retentions Trust Accounts instead.

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