Retention Bonds Explained in 5 minutes
The current situation.
Most construction professionals will agree that a key issue within the construction industry at the moment is the retention situation. If for example a typical contractor that works on a 2.5% profit margin agrees to take on a 12-month project of £10,000,000. With a 5% retention they are effectively sustaining a cash loss of £500,000 on the job until Practical Completion (“PC”), at which point they will break even provided that half the retention is released on time but even then they will still not receive their profit (£250,000 in this case) for a further 12 months. Obtaining the profit on the contract is still only possible provided that there are no issues with the work, the employer remains solvent, the project went to plan and was executed to budget and on time with no LADs or costly mistakes. Not to mention employers that see the retention as a bargaining chip or quasi discount.
How does a retention bond improve the situation?
With a retention bond in place the situation can be improved for all parties. A bond is put in place at the start of the project, as the contract is delivered, the employer continues to deduct retentions in the normal way on paper but then releases the full valuation to the contractor noting that they have a bond in place. As the project continues, the amount claimable under the bond increases automatically in accordance with the contract valuations. Whilst the contractor receives their profits in cash at each valuation, the contractor is able to operate in a more efficient manner given the improved cash flow thus making them much less likely to become insolvent (a plus for all parties). At Practical Completion or a fixed date, the bond with fall in value by 50% and then finally expire at Making Good of Defects or a date 12 months from PC. At the time or a similar time as to when you would expect the cash retention to be released under the contract if a bond wasn't in place.
Why would an employer accept a retention bond?
As previously mentioned, with a retention bond in place under a contract in lieu of a cash retention, the employer will have to pay out the retention monies at each valuation gradually throughout the contract. The employer shouldn't see this as damaging their own cash flow position as these funds should be ring fenced anyway so there shouldn't be a negative impact to the employers cash or funding arrangements by agreeing to a retention bond. Once in place, the employer will receive a guarantee from an A rated (or better) entity. This guarantee can be turned into cash should the contractor disappear before completing their contractual obligations or breach the contract. A contractor having sufficient cash flow is extremely beneficial to the employer and we could write an entire blog on these benefits. Broadly speaking however, projects which are profitable from the outset tend to run smoothly and the construction program will be set up to focus on completing the project in the most efficient way rather than in a way that front loads cash release.
What does a retention bond look like?
The PS Surety standard retention bond is universally accepted in the construction industry and can be found by clicking here or we will happily email you a copy on request if you want to get in touch. Having a standard industry wording can be very advantageous, as it can save the contractor and the employer legal fees relating to the drafting and approval of an acceptable bond wording.
How much does a retention bond cost?
Charges for retention bonds vary from between 0.4% of the bond value to 10% of the bond value and some Surety providers will ask for additional security from the contractor if they deem that the risk demands it. If you already have a Surety bond facility then you can expect to be charged the same rate for retention bonds that you currently pay for performance bonds. Some Surety providers charge a 50% uplift on facility terms for retention bonds so it could be worth speaking with a specialist broker.
Who pays for a retention bond?
Given that the level of security held by the employer remains unchanged, the contractor tends to pay for retention bonds as they are receiving a cash benefit. The retention bond premium is usually cheap compared to the cost of capital elsewhere however. and the opportunity cost of not having cash in the bank.
Can PS Surety help?
PS Surety is a dedicated surety bond brokerage and we would be delighted to assist any contractor with placing retention bonds. We are fully regulated by the FCA and we guarantee that we provide our clients with:
The best possible terms available in the market
An honest, open and joint approach to our client's Surety needs
Detailed client dashboard providing information on every bond ever placed by the client with PSS
Communication when bonds become overdue in order to help our clients to avoid or reduce additional premium charges
A single touch point within our organisation for wording reviews, quotes and queries
That sounds expensive.
Our service is completely free to contractors. We are paid a commission by the surety providers on each bond that we place with them on a contractors behalf, the details of which are fully disclosed in our client dashboard. The surety providers are happy to pay our commission because we specialise in bringing them business which fits their ever changing underwriting criteria. We also deal with frequent queries, wording issues, bond drafting and general administration. The price that you pay PS Surety for a bond is the same price that you would pay any Surety if going direct.