Key Takeaways:

  • Contract retention is commonly used in construction to ensure project completion and quality.
  • Retainage is typically 5–10% of payment, held back until certain milestones or final approval.
  • Contract retention applies at both general contractor and subcontractor levels.
  • There are federal, state, and contractual rules regulating how long retention money can be withheld.
  • Alternatives to retention include performance bonds and milestone payments.
  • Non-construction retention agreements can also be used in employment contexts to retain key personnel.
  • Best practices include clear retention clauses, defined release conditions, and compliance with applicable state laws.

A contract retention is commonly used during construction for the following reasons:

  • To protect an employer or a private individual from receiving incomplete services
  • To provide the hired contractor with incentive to get the job done right

Contract Retention and Construction

A contract retention provides assurance to an individual that a job will be completed. For example, if someone hires a contractor to remodel his home, he will want to ensure that the contractor will complete the job before leaving. This can be done through a contract retention.

A retention works by holding onto or retaining a portion of the contract until the job is complete. Once the job is done and the individual that hired the contractor is satisfied, the contractor will receive the retained portion.

A standard definition of retention money is a percentage of money that an employer or an individual holds as protection from incomplete or inaccurate work done by the hired contractor.

A retention includes two levels:

  1. The hiring individual holds the money until the contract is fulfilled, and he or she is satisfied.
  2. The contractor holds the money from his or her subcontractors.

For the first level, the individual and the contractor will decide upon a retention plan prior to signing the contract. Upon issuance of the completion certificate, the first half of the retention money should be verified and released. Any incomplete or rejected work should be listed in the completion certificate. If the hired contractor refuses to complete the job, the applicable amount of money will be taken from the remaining retention money so that the individual can hire a third party to complete the job.

The purpose of the second level is to protect the main contractor. The main contractor is liable for the work done by any subcontractors (s)he or she hires; therefore, he or she can retain the subcontractors' payments until the job is properly completed.

The last half of the retention money will be verified and issued when the defects liability period ends. The standard for this period is 12 months. This means that the contractor is liable for any issues that occur during those 12 months due to poor construction. After this period is complete, a maintenance certificate is issued, and the last half of the retention money is released.

Contract Retention Amount and Purpose

By having a contract retention in place, the hiring individual can take comfort in knowing that the contractor is obligated to complete the project or lose money. Most private-construction retention contracts require retainment of anywhere from 5 to 10 percent of the payment. Therefore, if the contractor doesn't hold up his or her end of the bargain, a fair amount of money will be lost.

Depending on the state, a limit may be placed on the percentage of payment that can be withheld. For instance, the State of Nevada does not allow an individual to retain more than 5 percent of the total contract payment. When the project is complete to its exact specifications, the retention will be paid. This prevents the hiring individual from getting stuck with cheap or low-quality work.

For example, say an individual is building a four-bedroom house, and he or she hires an electrician to service all of the bedrooms for $16,000 total, or $4,000 per room. Further assume that the retention contract withholds 15 percent of the electrician's payment until the job is fully complete. If the electrician completes only three bedrooms, then he will only receive 85 percent of the payment, or $13,600. This retention plan provides the electrician with an incentive to do the job from start to finish to avoid losing any money.

It is important to understand that while a retention contract is a key tool in a construction contract, it is not always applicable. For example, if a contractor must use stored materials, he is usually not held subject to a retention contract. In this type of situation, the contractor must pay for the materials at the start of the project; if a retention is in place, he or she will be stuck paying for them out of pocket.

Best Practices for Managing Retention

Whether drafting a contract retention clause or navigating its implementation, consider these best practices:

  1. Clearly define the retention amount (typically 5–10%).
  2. State the conditions for partial and full release, including timelines.
  3. Identify triggering events like completion certificates or inspections.
  4. Include dispute resolution procedures in case of non-compliance.
  5. Stay compliant with local laws and construction standards.

Proper documentation and transparency protect both parties and reduce the likelihood of legal challenges over withheld payments.

Contract Retention in Employment Agreements

While most commonly associated with construction, contract retention also plays a role in employment settings, particularly through retention agreements. These agreements are designed to encourage valuable employees to remain with a company during periods of transition, such as mergers or leadership changes.

Key elements of an employment-related retention agreement:

  • Retention bonus offered upon completion of a set employment period.
  • Terms of service defining required duties and end dates.
  • Forfeiture clauses for early resignation or misconduct.
  • Confidentiality and non-compete clauses may also be included.

These contracts are strategic tools to prevent turnover and ensure business continuity, especially during uncertain times.

Retention vs. Other Security Measures

While contract retention is one way to ensure performance, it's not the only method used in construction and service contracts. Alternatives include:

  • Performance bonds: Third-party surety guarantees the contractor’s completion of the project.
  • Payment milestones: Payments released upon the completion of predefined tasks or project stages.
  • Warranty holdbacks: Money retained to cover potential defects during the warranty period.

Each method has pros and cons. Contract retention is simple and direct but may strain cash flow for smaller contractors. Performance bonds shift risk but involve added costs. Contracts should clearly state which method is used and under what terms.

Legal Rules and Retention Timelines

Retention payments are subject to specific timelines and legal requirements, which can vary by state or by the terms of the contract. For example:

  • Federal and state regulations may limit how long retention can be withheld. In some states, payment must be released within 30–60 days after project completion or certification.
  • Prompt payment laws often require that retention be released promptly once the contractor has met agreed-upon milestones or passed final inspections.
  • Defects liability periods—commonly 12 months—also affect when the final half of retained funds is released.

To avoid disputes, it's critical to define in the contract:

  • The percentage retained
  • Conditions for partial and full release
  • Timeframe for inspections and approvals
  • Final release timeline after the defect liability period

Frequently Asked Questions

  1. What is contract retention in construction?
    Contract retention is a practice where a percentage of payment is withheld from contractors until the project is completed satisfactorily, ensuring quality and compliance.
  2. How much money is typically held in retention?
    Generally, 5–10% of the total contract amount is retained, but the exact amount may vary depending on the contract and state laws.
  3. When is retention money released?
    Retention is often released in two stages: half upon substantial completion and the remainder after a defects liability period (usually 12 months).
  4. Is contract retention legal in all states?
    Yes, but each state may regulate the maximum retention percentage and timing of release under prompt payment laws.
  5. Can retention be used in non-construction contracts?
    Yes. Retention agreements are also used in employment settings to incentivize key employees to stay through critical periods.

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