Under the Construction Contracts Act head contractors must hold all retentions on trust. This can impose a heavy administrative and financial burden on companies, and creates substantial personal liability for directors.
Insurance or surety backed bonds can be a convenient, low risk and cost effective alternative for many construction firms.
RETENTIONS MUST BE HELD “ON TRUST”
Since 31st March 2017 the Construction Contracts Act has required main contractors to hold retentions “on trust”. This means they have to account for it separately and theoretically can’t use it to fund their own cashflow. And if the business fails retentions should be repaid to subcontractors as a priority over other creditors.
However, retention money does not need to be held in a separate account and it can be mixed in with other money. This leaves it vulnerable to appropriation by a liquidator, with no guarantee that it will be returned to subcontractors ahead of any other creditors. Ultimately, there is still no guarantee that retention funds will physically be available, because if there is no money left in the business any money owed simply cannot be repaid.
In addition, if a main contractor is holding retention money on trust, its directors may be exposed to personal liability for breach of their trustee duties under the Trustee Act 1956.
HEAD CONTRACTOR RETENTION BOND
This form of bond provides main contractors with a cost effective, simple alternative to holding retentions on trust, as they are otherwise obliged to do under the Construction Contracts Act. A bond is taken out for each project and covers the total amount of retentions held on that project. It means that in the event of a default by the main contractor subcontractors can make a claim directly to the insurer for the retentions owed to them.
BENEFITS OF A HEAD CONTRACTOR RETENTION BOND
- Comply with your obligations under the Construction Contracts Act but without needing to hold retentions on trust
- Maintain cashflow flexibility as retention money does not need to be reserved as cash or other liquid assets
- Directors not exposed to personal liability for breach of their trustee obligations
Applicants for a head contractor retention bond must first be pre-approved by the bond surety. This is done by completing an application form requiring information such as: the maximum value of retentions typically held, the company structure, a list previous contracts, a work in progress report and by providing recent financial accounts. This pre-approval will generally be updated each year, or when the head contractor wishes to increase their total retentions limit, by providing up to date financial accounts.
Once approved, the contractor then applies for a bond per project to cover the sum of all subcontractor retentions withheld on that project. This includes information on the specific contract, the expiry date of the bond and a list of the subcontractors, their details and individual retention amounts. The premium is calculated based on the total amount of the bond.
SUBCONTRACTOR RETENTION BOND (BOND IN LIEU OF RETENTIONS)
Subcontractors are entitled to offer a bond instead of retentions. Offering a bond can result in substantial cost savings for the subcontractor because the money that would have been retained by the main contractor instead remains in the cash flow of the subcontractor, improving its financial position. There is also no risk of losing retentions held by a main contractor if they go bust.
In addition, a subcontractor retention bond contains a fixed expiry date, so there is no confusion about when the subcontractor has been released from their obligations. There is also no need to chase the head contractor for the release of cash retentions at the end of the works and no incentive for head contractors to manufacture problems in order to withhold retention money.
BENEFITS OF A SUBCONTRACTOR RETENTION BOND (BOND IN LIEU OF RETENTIONS)
- Subcontractor gets paid in full, no money is withheld from their payment claims
- Their cash is not at risk sitting in the principal’s bank account for months
- No need to chase the principal for their money when the defects period expires
There is a non-refundable cost for the bond. This is typically around 2-4% of the bond value (with a minimum premium), depending on the financial strength of the subcontractor. Applicants for a retention bond must first provide evidence of their financial position, such as recent financial and management accounts. This is usually a once only or annual requirement. Once approved each bond is applied for individually.
In the event that a subcontractor refuses to fix defects the main contractor can call upon the retention bond and the insurer will pay. They will then, after the fact, investigate the claim and if possible seek recovery of their costs from the relevant party.
A subcontractor retention bond is usually offered at the beginning of a project in place of cash retentions. However, it is also possible to introduce it during the course of a project to release retention monies which have previously been withheld.
- Subcontractor agrees with principal to provide a bond in lieu of retentions and this is noted in the contract special conditions
- Subcontractor applies for bond
- Bond is agreed, paid for and provided to the principal
- Bond expires at the end of the contractual defects liability/maintenance period
Although a subcontractor retention bond involves a non-refundable premium, the fact that the subcontractor gets their invoices paid in full and isn’t exposed to the risk of delayed return or total loss of the retained money makes this cost very worthwhile.
OTHER TYPES OF BONDS
There are four other main types of bonds for construction:
These make sure a contractor puts in a serious bid. If they win the tender but pull out later the bond can be called on to make up difference between their price and the next successful bidder.
These guarantee that the contractor will perform their contract. If they fail to do so the principal can use the bond to cover the costs of engaging a replacement contractor.
These guarantee that the principal will pay the contractor. If they fail to do so the contractor can call on the bond to get paid for their work.
Advance payment bonds
These ensure that if a contractor defaults on payment for components they have ordered the supplier or manufacturer won’t be out of pocket.