Retention Bonds: An Alternative to Retainage Amidst COVID-19

Retainage is the amount of money that is held back by the owner or GC during the term of a project. A certain percentage of the contract price is withheld from the contractor until the completion of the entire project as a security in case things go sideways. However, retainage causes cash flow issues in an already cash-poor industry.

In the construction industry, where profit margins are already thinner, the retainage amount puts a strain on cash-flows and profits. An alternative approach is to issue a retention bond for a chance to get the retainage payment early to keep the business going during the global economic downturn due to coronavirus pandemic.

How to Avoid Waiting for Retainage through Retention Bonds

One of the most pressing issues in the construction industry is the delay in payments and small profit margins. And this issue has been heightened due to the current pandemic. Anirban Basu, an economist, says, “Risk of recession over the next three to six months is arguably more elevated than any period since 2007.”

How Can Retention Bond Help Getting Full Payment?

As yourself this question: can you take a risk by waiting for retainage? With the credit crunch, your construction business needs all the cash flow it can get its hands on, including the retainage payment.

As you already know, retainage is for security, in case the project goes sideways. A retention bond works the same way, without withholding the payment. A retention bond states that the construction company will pay the premium is a surety bond in exchange for not withholding cash as retainage. The party that submits the bond is the beneficiary of the retention bond. You can always consult a delay expert regarding nitty-gritty of the bond and secure full payment on the project.

In case an issue arises in the construction work on a project of the group that paid the bond premium, the customer can claim payment against the bond. As a result of the retention bonds, the final payment is made in full. Retention bonds are advantageous for projects whose bond premiums cost less than the retainage amount (i.e., the bond premium amount is less than 5-10% of the contract price or retainage price).

Types of Retention Bonds

Retention bonds come in two types: conditional and unconditional bonds.

Conditional (Default) Bonds:

A conditional retention bond is when the contractor (subcontractor) agrees to pay for damages only in case of a breach of contract or a certain default in the construction work of the project. This bond puts diligent responsibility on the performance of the contractor or a subcontractor regarding the construction of the project. However, this type of retention bond requires a high level of proof to recover against a claim made by the other party on the bond.

Unconditional (On-Demand) Bonds:

As the word “on-demand” suggests, an unconditional bond is payable on demand, without having to prove a specific contractual default. The burden of proof is lower in unconditional bonds as compared to the conditional one because the bond simply states that payment should be made due to the contractor’s actions or inactions that have affected the project.

Advantages of Retention Bonds During Coronavirus

One of the most obvious advantages of using retention bond to secure payment is the steady cash flow. With retention bond, you will receive payment in full instead of partial payment (90-95%), which enhances the ability to maintain steady cash flow and stay afloat during the crisis.

When your construction business is financially stable, there is minimal chance to default. Therefore, consult a Delay expert as soon as possible and issue retention bonds to secure payments. Otherwise, your business should be prepared for the downturn. Keep in mind that just like retainage, retention bonds also have an expiration date and lose liability after some time. So, don’t waste time and get advice from a construction expert to issue the bond today.

If we are talking about the advantages, it is only fair to discuss the complete picture. There is one disadvantage of a retention bond: high bond premium costs. If bond premium cost is significantly higher than the retainage amount, then issuing a bond does not make any sense. This way, you would only be paying more amount of money to secure a small percentage of the paycheck.

For example, if your retention bond premium is greater than the retainage price (5-10%) of the total project payment, then it is a bad idea to use the bond to secure retainage.

Protect your Cash Flow During COVID-19 Crisis

Retainage is a way by which top management maintains the leverage on contractors and subcontractors throughout the life of the construction project. Retainage is an outdated practice and is, at times, exploited by the top chain management. Therefore, retention bonds might be worthwhile to ensure full payment and steady cash flow for your business.