CLC and NEC publish guidance on how to limit the use of retentions in NEC contracts

The Construction Leadership Council (CLC) and NEC have today published joint guidance to the construction industry on how to minimise the use of retention funds in NEC works contracts (CLC and NEC, 2022).

The UK government estimates that up to £6 billion is held in construction retentions each year in England alone. This puts unnecessary cashflow pressure on contractors and their supply chains, particularly if retentions are paid late or not at all due to upstream insolvency.

The new, freely available guidance is part of CLC’s ambition of moving to zero retentions by 2025, by reducing or eliminating defective construction work and by having a procurement and delivery model that recognises, incentivises and rewards consistent high-quality work.

Eliminating retentions

According to Steve Bratt, chair of CLC’s business models workstream, ‘Our long-term aim is to eliminate the need for retentions altogether. This new guidance illustrates that often the need for retentions in NEC contracts can be avoided through good contract management and selection of contractors with a good track record of quality work. I thank NEC for their collaborative approach to working with CLC on this longstanding contractual issue.’

Peter Higgins, chairman of the NEC4 Contract Board said, ‘The construction industry has traditionally thought of retentions as a necessary and inevitable part of the cost of doing business. NEC contracts take a different approach, treating retentions as an option to be used only if necessary. NEC is pleased to have worked with CLC in preparing this guidance, which highlights when holding a retention fund creates an unnecessary expense for the contracting parties.’

Secondary option X16

The new guidance points out that secondary option X16 on retention in the NEC3 and NEC4 Engineering and Construction Contract (ECC) and Engineering and Construction Subcontract (ECS) enables clients to use a retention fund to protect them from a contractor’s failure to correct defects, possibly resulting from insolvency in the supply chain. 

‘This contrasts with other contract forms where the use of a retention is prescribed rather than optional. Other options can however be used as an alternative. These include the option for a performance bond (X13) or ultimate holding company guarantee (X4). These may well be more appropriate and useful in providing protection against a contractors’ insolvency if that is judged to be necessary.’ 

Furthermore, the guidance says that if agreed by the client or stated in the contract data, a retention bond can be provided by the contractor. ‘Option X16 should only be used if the client considers there is a need for holding such a fund.’

Requirements for completion

The guidance notes that the NEC 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 − or others doing their work − have been corrected. 

‘Carefully specifying the requirements for completion within the scope should help avoid there being defects in the work at completion and means there is little need for holding a retention fund.’ 

The guidance adds that if the scope does not specify the requirements for completion, the contract requires that all notified defects which prevent the use of the work must be corrected. ‘Again, provided the work is properly reviewed before completion, there should be no need for a retention even if the scope is silent on completion.’

Payment for defective work

The guidance points out that the NEC approach to payment for work which is found to be defective also removes the necessity of a retention. For a priced contract (Options A or B), it says payment for work which incorporates a defect is excluded if the correction of the defect would delay following work. ‘An example might be a defect in the foundation which prevents the wall construction being done until it is corrected. The price for the foundation would not become due until after the defect is corrected.’

Where payment is based on the defined cost of work done (Options C, D and E), no payment is made for the cost of correcting defects after completion. This, the guidance says, provides, ‘a strong motivation for the contractor to be free of defects at completion. In addition, under Options C and D, any additional costs incurred by the contractor in remedying defects will reduce the contractor’s share and potentially result in the contractor going into “pain”.’  

Focus on quality 

The guidance concludes that a retention fund should be unnecessary if there is effective quality management during the contract and the contractor is in robust financial health, has a reputation for the quality of its work and has a wider commercial relationship with the client. 

‘In the absence of any solvency concerns, retentions should only really be necessary in circumstances where the client does not believe it will be able to effectively operate quality management during the works, or does not have confidence that its selected contractor will be willing to correct those defects which do arise at, or following, completion.’

It adds that there is also a wider potential commercial benefit for clients if they make it clear a retention or alternative security will not be required from the outset. ‘Typically, contractors will make an allowance for providing retention fund or bond when tendering for the works. Accordingly, if this is not sought – and that is made clear from the outset - the works may be provided at a lower cost to the client than would otherwise be the case.’

Free webinar 

On 16 January, NEC is running a free webinar to support the new guidance and give NEC users an opportunity to learn more about how to minimise the use of retentions. Click here to find out more and to register.

CLC and NEC would like to thank all those who participated in the developing the new guidance, in particular, Peter Higgins of PD Consult on behalf of NEC, and Andrew Croft of Beale & Company Solicitors LLP and Claire King of Fenwick Elliott LLP on behalf of CLC. 

Download the guidance here.

Reference:
CLC and NEC (2022) NEC and CLC guidance for dealing with retention payments under NEC3 and NEC4 contracts. Click here to download.