The CLC and NEC send retentions to Coventry…

Allan Owen and Francesca Gallagher discuss recently published joint guidance regarding retention payments and construction contracts.

New Engineering Contract (NEC) and the Construction Leadership Council (CLC) recently published joint guidance regarding retention payments under the NEC3 and NEC4 Engineering and Construction Contract (ECC) and Engineering and Construction Subcontract (ECS).

Retentions – the basics

The purpose of contractual retention payments within the construction industry is to provide security against defective work and supply chain insolvency. However, the government estimates that up to £6 billion is held in construction retentions each year in England alone. This ultimately leads to unnecessary cashflow pressure on contractors and their supply chains.

NEC currently provides an optional clause (Option X16) to use a retention fund as security for the Client to protect it from the Contractor’s failure to correct Defects. This contrasts with many other standard forms of contract which contain mandatory retention provisions.

The CLC aims at removing retentions from the construction industry by 2025 with a shift to procurement and delivery models which recognise, incentivise, and reward consistent high-quality work.

Steve Bratt, Chair of the CLC’s Business Models Workstream, states that “the long-term aim is to eliminate the need for retentions altogether. This guidance illustrates that often the need for retentions can be avoided through good contract management and selection of contractors with a good track record of quality work”.

This collaboration between the CLC and NEC aims to demonstrate that there are other ways, aside from retention provisions, to ensure good and reliable performance from contractors. We consider these alternatives below.

Alternate security

The guidance references certain other Optional clauses within the NEC contract which provide alternate forms of security against the risks of defective works and insolvency. Clients are able to require the provision of a performance bond (Option X13) or a parent company guarantee (Option X4) either of which may be called upon in the case of insolvency or failure by the Contractor to rectify defective works. The guidance suggests that retentions (using Option X16) should only be included if the client considers that there is a need for holding a retention fund and that other security is not sufficient or available.

Correcting defects

The guidance states NEC’s approach to the correction of defects reduces the necessity for retention provisions.

Under NEC contracts, the Contractor has an obligation to correct defects whether or not it is notified of them. The definition of ‘Completion’ is that all the work which the Scope requires to be done by the Completion Date has been completed and that any notified Defects which would prevent use of the works have been corrected.

This means that if the client carefully specifies the requirements for ‘Completion’ within the Scope, the Contractor will be encouraged to ensure that all defects are rectified prior to ‘Completion’ rendering any retention fund unnecessary.

Payment for defective work

Similarly, the guidance points out that NEC’s approach to payment for defective work removes the necessity for retention provisions. For a fixed price contract (Main Payment Options A or B), if the correction of a defect would delay later work, no payment is made in respect of the defective work until the defect is corrected.

Furthermore, in contracts where payment is made for the Defined Cost of work done (Main Payment Options C, D and E), the cost of correcting defective work is deducted from Defined Cost in the following circumstances:

1. where defects are corrected after Completion – thereby providing a strong motivation for the Contractor to ensure the works are free of defects at Completion; and
2. where defects result from the Contractor not complying with a constraint on how it is to provide the works stated in the Scope – this incentivises the Contractor to comply with the constrains in the Scope and emphasises the need for clients to pay careful attention to the preparation of Scope documents.

The risk of delayed payment for work, or losing the entitlement to payment altogether, is a material concern for the Contractor under any NEC3 or NEC4 contract. The NEC and CLC guidance suggests that this reduces the need for retentions as the consequences under the provisions dealing with payment for defective work act as a sufficiently powerful motivator for the Contractor.

Effective quality management

A common theme throughout the guidance is that if there is effective quality management of the contract, a retention fund becomes unnecessary.

Effective quality management consists of ensuring that there has been careful drafting of the requirements for achieving Completion and also ensuring the Contractor is in “robust financial health”. If the Contractor has a reputation for good quality work, this should provide a client with comfort that any defects that do arise will be corrected, rendering a retention fund unnecessary.

Closing thoughts

This guidance highlights that retention provisions are not always necessary in construction contracts and that through other contractual provisions, as well as effective quality management of a contract, clients are able to avoid the significant financial consequences which retention provisions cause.

Notwithstanding this, only time will tell whether clients deem the alternatives outlined by the guidance to provide sufficient protection in lieu of retentions. We expect that the CLC’s aim of removing all retentions by 2025 will become ever more challenging given the current trend of rising insolvencies in the construction sector.

Allan Owen is a Senior Associate and Francesca Gallagher is a Trainee Solicitor at Sharpe Pritchard LLP.

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