What Is A Retention Bond?

Posted: February 11, 2019

A retention bond is a type of performance bond that is increasingly used in the construction industry to eliminate cash retention practices. Learn more below, and request a quote from Contractor Surety Group today.

Some Background Information

As we mentioned, the purpose of these bonds is to replace cash retention practices. The purpose of cash retention was to leave some money on the table to protect the client for a period of time after contract completion, even after the contractor had received full payment for the project. The retained cash was available to pay for any work needed to correct workmanship defects that were discovered only after the contractor had been paid the full contract amount.

A retention bond serves the same purpose, but has some advantages over cash retention:

  • The contractor benefits financially by paying only a small amount for the retention bond and not having to tie up cash in retention.
  • The client has the money to pay for correction of defects.
  • The bond has a known expiration date, so the contractor knows when the financial obligation to the client ends.
  • The contractor doesn’t have to chase after anyone to release cash retention after successful project completion.

Who Needs a Retention Bond?

Retention bonds, like all surety bonds, involve three parties. These include:

  • The obligee that requires the bond
  • The principal that purchases the bond
  • The surety that underwrites and issues the bond

In most situations, the project owner is the obligee and the contractor is the principal. In some cases, however, the general contractor is the obligee and the subcontractor is the principal. This protects the general contractor against having to pay to correct defects in the work done by the subcontractor. This may be instead of or in addition to a retention bond purchased by the general contractor with the project owner as obligee.

These bonds are needed whenever a project owner requires a contractor to purchase one in lieu of cash retention, or when a contractor requires one from a subcontractor.

How Does a Retention Bond Work?

Let’s assume that an obligee requires a retention bond with an expiration date that’s calculated to fall 12 months after the project completion date. Up until that expiration date, the obligee may file a claim against the bond for the cost of any work that must be done to correct the principal’s work defects. The surety will verify that the principal has failed to live up to its contractual obligations before paying the claim. Once the obligee’s claim has been paid, the surety will seek reimbursement of that amount from the principal.

In some cases, the terms of the bond permit the principal to correct any work defects within a specified period of time after being notified of a problem. The obligee’s claim will only be paid by the surety if the principal fails to correct the problem. Once a claim is paid, the principal is then obligated to reimburse the surety.

How Much Does It Cost?

The amount of the bond is established by the obligee and is usually a predetermined percentage of the total value of the contract. The principal pays only a small percentage of that bond amount, which is determined by the surety based on the principal’s credit history and financial performance.

Request A Quote

If you’ve been informed that you need a retention bond, you can rely on the experts at Contractor Surety Group. We have years of experience in the industry, and contactor surety is our specialty. Request a quote today!