Rethinking Retention Money in Construction Contracts

"Rethinking retention money in construction: Explore how transparency and new models offer better security for clients."

Rethinking Retention Money in Construction Contracts: Why Owners Should Consider Building by Administration

Retention money has long been a staple of construction contracts, designed to protect the owner from potential defects or incomplete work. While this practice provides a sense of security, it also introduces complexities and financial strain for contractors, often leading to disputes and delays. For owners seeking a smoother, more transparent project process, the building by administration model offers a compelling alternative to the traditional building by contract approach, reducing the need for retention money while maintaining quality and control.

The Concept of Retention Money

Retention money is typically a percentage of a contractor's progress payments—usually 5-10%—held back by the owner to ensure the work is completed to satisfaction. This sum is generally released in two stages: half at project completion and the rest after a defect liability period.

While it serves as leverage for owners, this practice can create financial strain for contractors, especially smaller ones that rely on consistent cash flow. As noted by the Construction Financial Management Association (CFMA), retention payment schemes disrupt cash flow, which can affect a contractor’s ability to fund ongoing work. This can lead to project delays, disputes, and cost overruns—all of which negatively impact the owner.

The Case for Building by Administration

Building by administration is a model that offers greater transparency and a better financial structure for both parties. Unlike the traditional building by contract model, where the contractor controls both the construction and financials, building by administration separates the two. The owner manages the project budget directly, paying for materials, labor, and other direct costs, while a project administrator manages the work for a fixed fee.

Here’s why this benefits owners:

Increased Transparency: In the building by administration model, owners have direct control over costs and a clear view of how their money is being spent. There are no hidden contractor markups on materials or labor, which can often inflate the overall budget.

Reduced Need for Retention Money: Since the owner manages the budget and payments directly, there is less risk of financial disputes. The administrator is paid a fixed fee and has no incentive to cut corners or delay work to improve their cash flow. As a result, retention money becomes less necessary as a safeguard.

Enhanced Trust and Collaboration: The building by administration model fosters a more collaborative relationship between the owner and the administrator. With fewer financial pressures, both parties can focus on delivering a high-quality project rather than navigating cash flow issues or retention disputes.

The Problems with Traditional Retention

Under a building by contract system, the owner often retains a percentage of the contractor’s payments to ensure any issues are rectified before the final payment. While this seems like a safe practice, it can often lead to unintended consequences.

Financial Strain on Contractors: Many contractors, especially smaller firms, rely on consistent payments to maintain operations. When retention money is held back, it disrupts their cash flow, forcing them to secure credit or reduce spending on labor and materials, which can delay the project. These delays ultimately affect the owner.

Increased Risk of Disputes: Delayed payments can escalate into disputes between owners and contractors, which may lead to further delays or legal action. The CMS Law Now article describes retention money as a “pernicious device,” often causing more harm than good by leading to unnecessary conflict.

Why Building by Administration Offers a Better Approach

By choosing building by administration, owners can mitigate many of these risks while still ensuring that quality work is delivered. Here's how this model benefits owners directly:

No Hidden Costs: In traditional contracts, contractors often mark up direct costs like materials and labor, which can make it difficult for owners to understand the true cost of the project. In contrast, building by administration offers full cost transparency, as the owner directly pays for all project-related expenses without contractor markups.

More Control Over the Project: Since owners are responsible for direct payments, they have greater control over the project's financial management. This leads to better cost tracking and more accurate budgeting throughout the project lifecycle.

Less Financial Strain on the Administrator: Unlike traditional contractors, administrators in the building by administration model aren’t dependent on retention money or progress payments for cash flow. Their fee is fixed, which aligns their incentives with the owner’s goals: completing the project efficiently and to the highest standard.

Conclusion: A Better Way Forward for Owners

For owners looking to reduce disputes, increase transparency, and improve project outcomes, moving away from traditional building by contract toward a building by administration model offers clear advantages. By eliminating the need for retention money, improving cost transparency, and fostering a more collaborative relationship with the project team, owners can ensure a smoother, more efficient construction process.

In today's complex construction landscape, it's time to rethink retention practices and embrace new methods that align the interests of all parties, ensuring projects are completed on time, within budget, and to the highest quality standards.

References:

1. CFMA. "How a Construction Retention Payment Affects Ongoing Projects." CFMA.

2. Baker Love. "Understand Risks Around Cash Retention: Take Steps Protect Position.

3. CMS Law Now. "Retention Money: A Necessary Evil or a Pernicious Device?"