Benefits and Level of Using Retention Bond for Construction Projects in Nigeria

Transcription

1 International Journal of Architecture, Engineering and Construction Vol 2, No 2, June 2013, Benefits and Level of Using Retention Bond for Construction Projects in Nigeria Ayodeji E. Oke Department of Quantity Surveying, Federal University of Technology, Akure, Nigeria Abstract: This research work assesses the extent of usage of retention bond in construction projects in Nigeria using project characteristics such as procurement methods, contractual methods, as well as project risks and problems as basis. Collected data were analyzed using statistical tools such as frequency distribution, mean item score, mean gap, Mann-Whitney U test and T-test so as to determine the mean values, differences in mean and significance of the difference. The findings from the study indicated that retention bond reduces the level of risks and problems associated with construction project performance. More so, the usage of retention bond in construction projects is significantly affected by selected procurement method as well as identified problems and risks of such project. Professional bodies are therefore encouraged to lay down relevant laws to encourage the use of retention bond in order to improve the quality of projects in the construction industry. Keywords: Construction project, contractual bond, Nigeria, performance, retention bond DOI: /IJAEC INTRODUCTION Tar and Carr (1999) stated that the construction industry, perhaps more than most, is plagued by risk. Too often, this risk is not dealt with satisfactorily and the industry has suffered poor performance as a result. Also, because of the complex nature of construction business activity, process, environment, and organization as noted by Zayed et al. (2012), the participants are widely exposed to a high degree of risk. One of the various means of managing these risks is through the use of bonds or guarantee. Supeman (2009) stated that retention bond is a type of performance bond that protects the customer after a job or project is finished. It guarantees that the contractor will carry out all necessary work to correct structural and/or other defects discovered immediately after completion of the contract, even if full payment has been made to the contractor. Wedlake (2007) also asserted that a retention bond is an agreement between a contractor, work/specialist contractor and a third party known as a surety or guarantor. In simple terms, the agreement states that, in return for the contractor agreeing not to hold cash retention, the surety will pay the contractor up to the amount that he would have had by way of retention should the specialist contractor fail to carry out the works or remedy defects. Contractors can offer Retention Bonds to Employers to get them to reduce the amount of retention required under the contract and it has been discovered that retentions are the bone of contention for contractors by employers holding back payments. Retention bond could eliminate this problem and increase cash flow (Nationwide Sureties Limited 1999). Treasury (1994) stated that the conditions of a retention should relieve the client from failure by the contractor to rectify defects in accordance with the contract up to the value of the bond. This research is aimed at identifying the various benefits and extent of usage of retention bond, risks associated with its usage as well as its effect on construction project performance. 2 LITERATURE REVIEW A retention bond represents a commitment by a third party (typically an insurance company or a bank), to guarantee the obligations of the contractor under a contract, up to an agreed limit, which would typically be the same as the maximum cash retention amount (Hosie 2010). As work is completed on site, the contractor is then paid in full for the works carried out in accordance with the contract and with the client being protected against default by the bond. The system thus provides better value to the contractor during the * emayok@gmail.com 98

2 Table 1. Sample Size No Respondents Population Questionnaires distributed Total retrieved and filled % filled 1 Quantity surveyors Architects Contractors TOTAL construction phase but at the same time without being detrimental to the client s concerns regarding substandard work at the end of the construction phase. For obvious reasons, Boswall (2010) noted that retention bonds need to be in the form of on demand bonds, which have the effect of giving the client the same degree of comfort and control over the rectification of possible defects as he would have if he simply withheld 5% cash from the contractor s interim payments. Retention bonds do not come free of course, and as with all forms of insurance, there is a premium to pay for the level of cover provided (Pipersville 2010). Albeit the cost of a retention bond would be assessed on its own merits, the cost is nevertheless influenced by factors such as the financial strength of the contractor, the volume of the bond business generally and the guarantors underwriting analysis of the concerned project. The purpose of the retention bond is to allow the contractor to recover from the surety. There are several benefits and usage of retention bond to both the contract owners and the contractors for construction projects. These benefits according to (Barnes and Davies 2008) include; 1. Sub-contract cost can be incurred by the contractor by reason of the failure of the sub-contractor to comply with the direction of the contractor. 2. Expenses or any direct loss and/or damage caused to the contractor as a result of the termination of contract can be sorted out legally. 3. Retention bonds can offer valuable legal protection to those planning to build or renovate a building. 4. Retention bond financially backs an individual or company, requiring its workers to fulfill all duties as outlined in the initial contract. 5. Greater pool of qualified contractors bidding for jobs, resulting in greater likelihood of timely project completion and less likelihood of contractor s failure. 6. Payment protection for subcontractors, suppliers, and laborers (Sub-contractors and suppliers may submit more competitive prices if they know they re protected by a payment bond). 7. Technical, management, and/or financial assistance for the contractor to keep project on schedule. 8. Retention bond guarantees correction of defects which result from faulty material or workmanship for at least one year. 9. Retention bonds are issued for large-scale projects with numerous provisional contracts for the efficiency of cost distribution at each stage of the project. 3 RESEARCH METHODOLOGY The research adopted a cross-sectional and correlation study carried out on a conveniently selected sample, cutting across some professionals in the construction industry. Primary data were collected with structured questionnaires comprising of open and closed-ended questions. Pre-qualified and registered Architectural firms, Quantity surveying firms and Contractors are the population of this field survey. In order to arrive at an accurate sample frame, the lists of these registered firms are as shown in Table 1. This was on the premise that most projects where bonds are administered are government-owned and only registered firms with the state government can submit bid for such projects. Frequency distribution, mean item score, mean gap, Mann-Whitney U test and T-test were employed in the analysis of the collected data. 4 FINDINGS AND DISCUSSION 4.1 Characteristics of Respondents Table 2 depicts the background information of respondents. The professionals surveyed were Quantity Surveyors, Architects, and Contractors with an average of Table 2. Characteristics of respondents Characteristics Frequency Percent Academic qualification of respondent B.SC/B.Tech M.Sc/M.Tech HND PhD 3 5 Category of organization Consulting Contracting Not stated Years of experience 0-4 years years years years above Average

3 Table 3. Benefits of retention bond Sub-contract cost can be incurred by the contractor by reason of the failure of the sub-contractor to comply with the direction of the contractor Expenses or any direct loss and/or damage caused to the contractor as a result of the termination of contract can be sorted out legally. Retention bonds can offer valuable legal protection to those planning to build or renovate a building. Retention bond financially backs an individual or company, requiring its workers to fulfill all duties as outlined in the initial contract Greater pool of qualified contractors bidding for jobs, resulting in greater likelihood of timely project completion and less likelihood of contractor s failure Payment protection for subcontractors, suppliers, and laborers (Sub-contractors and suppliers may submit more competitive prices if they know they re protected by a payment bond) Retention bonds are issued for large-scale projects with numerous provisional contracts for the efficiency of cost distribution at each stage of the project Rank of about 11 years of experience in the construction industry. Using the academic qualifications and years of experience of the respondents, it can be inferred that the data obtained for this research work can be relied upon. This is because all the respondents are highly educated, with recognizable professional qualification and substantial years of professional experience. 4.2 Benefits of Using Retention Bond Table 3 indicates the benefits of retention bond in the construction industry. It could be deduced that the major benefit of retention bond is its ability to financially backs an individual or company, requiring its workers to fulfill all duties as outlined in the initial contract. It also guarantee correction of defects which result from faulty material or workmanship for at least one year. However, all the identified benefits of retention bond are significant in the construction industry, with the least mean score of 3.30 out of a possible Table 4. Usage of retention bond on various types of project Types of Project Group Rank Building projects 3.73 Residential building Commercial building Office Building Civil engineering projects 3.68 Road Construction Railway Construction Highway Construction Heavy engineering projects 3.56 Telecommunication mast Dam construction Retention Bond and Project Type Table 4 indicates the level of usage of retention bond for various types of construction projects. For building projects, retention bond is mostly used for residential followed closely by commercial buildings. For civil engineering projects, road construction projects attract the use of retention bond most followed by railway and highway construction. On the general note, retention bond is mostly used for building projects in the construction industry. Trailing this are civil and heavy engineering projects. However, it could be observed that the lowest group mean score of 3.56 for heavy engineering works is well above average and it can thus be concluded that the level of usage of retention bond for construction projects is well above average. 4.4 Retention Bond and Project Procurement Method Traditional/Conventional System of procurement is the most significant method of procurement that encourage the use of retention bond as shown in Table 5. On the lower ebb are turnkey, Build Own Operate (BOO) and Build Operate Transfer (BOT). On procurement methods that does not encourage the use of retention bond, Table 5 further revealed that Traditional System of procurement is ranked highest followed by Turnkey. Using the mean gap values in Table 5 to examine the relationship between level of usage of retention bond and procurement method, a hypothesis was formulated: H 0 = Usage of retention bond has no significant effect on procurement method in the Nigerian construction project. H 1 = Usage of retention bond has significant effect 100

4 Table 5. Procurement methods and retention bond Procurement With Retention Bond Without Retention Bond Method Rank Group Rank Group Gap Traditional/Conventional System Construction Management Procurement Option Construction Management Management Contracting Design and Build Design and Contract Turnkey Package Deal Variants of BOT Build Own Operate Transfer (BOOT) Build Own Operate (BOO) Build Operate Transfer (BOT) Build Transfer (BT) Build Lease Transfer (BLT) Rehabilitate Operate Transfer (ROT) Collaborative Procurement Options Partnering Joint Ventures Strategic Alliance Pubic Private Partnership Fast Track System on procurement method in the Nigerian construction project. It could be observed that all the calculated mean gap values are less than Hence, it could be concluded that usage of retention bond has significant effect on Procurement methods of construction projects in Nigeria. 4.5 Retention Bond and Contractual Method In determining the relevance of retention bond to identified types of contract, Table 6 revealed that lump sum or plan and specification contract is the most relevant with mean score of 3.30, this is followed by contract based on bill of quantity and contract based on schedule of rate. Cost plus percentage is ranked fifth while the lowest ranked is package deal or turnkey contract with mean score of Risks of Projects with/without Retention Bond For construction projects with retention bond, the study revealed that inflation of market price of materials required for construction risk is the most significant type of risk as shown in Table 7, followed by delay in approval risk. The third rated risk is use of alternative route available while the lowest ranked risk is war with mean score of Furthermore, the study revealed that the most paramount risk that may occur on projects without retention bonds is delay in approval Table 6. Relevance of retention bond on types of contract Types of Contractual Arrangement Position Cost reimbursement contract Cost plus percentage Cost Plus fixed fee Target cost Price given in advance contract Lump sum or plan and specification contract Contract based on schedule of rate Contract based on bill of quantity Package deal or turn-key contract risk while the least are hospitality and war. Using mean gap values in Table 7, the relationship between the level of usage of retention bond and project risks was examined using the stated hypothesis: H 0 = There is no significant relationship between retention bond and risk associated with construction project performance. H 1 = There is significant relationship between retention bond and risk associated with construction project performance. The analysis revealed that all the calculated mean gap values are less than It could thus be concluded that there is significant relationship between retention bond and risk associated with construction projects. 101

5 Table 7. Risk associated with/without retention bond Type of With Retention Bond Without Retention Bond Risks Rank Group Rank Group Gap Financial Risks Inflation of market price of materials required for construction Alterations made on site Political Risks Change in law risk Corruption Risk Delay in Approval Risk Expropriation Risk Physical Risks Natural disasters or accidents War Hospitality Embargo Import or Export Restriction Contractual Risks Delay in award of Contract Change of Contractor Logistics Risks Delay in supply of materials New innovation Legal Risks In appropriate documentation of Environmental impact Assessment (EIA) Environmental Risks Location of the site of construction Market Risks Traffic volume Growth of transport substitutes Availability of other revenue sources Network Risks Access to the existing government road network Feasibility of connecting to the existing infrastructure Use of alternative routes available Table 8. Problems associated with construction projects with/without retention bond Problem With Retention Bond Without Retention Bond Rank Rank Gap Project abandonment Building Collapse Cost Increment Quality of project Delay in the commencement of project Postponement of some sections of work Over duration of project Inadequate finance Incompetent professionals Poor organization of the industry Unfavorable weather condition

6 Table 9. Retention bond and projects problem, risk and procurement method Problems Risk Procurement Method Mann-Whitney U Wilcoxon W Z Asymptotic Significance (2-tailed) 9.26E Exact Significance [2 (1-tailed Significance)] 5.67E Problems associated with Construction Projects with/without Retention Bond Table 8 revealed that postponement of some sections of work is the most prominent problem associated with retention bond in the construction industry. This is followed by delay in commencement of project, quality of project and inadequate finance, while building collapse and incompetent professionals are the least problems. For projects without bonds, delay in the commencement of project is the most significant problem, while project abandonment and building collapse are at the lowest ebb. Using the mean gap values in Table 8 to examine the relationship between the level of usage of retention bond and problems associated with construction projects, a hypothesis was formulated: H 0 =There is no significant relationship between retention bond and problems associated with construction project H 1 = There is significant relationship between retention bond and problems associated with construction project The analysis revealed that all the calculated mean gap values are less than This showed that there is significant relationship between retention bond and problems associated with construction project. 4.8 Difference Between Projects with/ without Retention Bond Mann-Whitney U test and Levene s Test were used to determine the difference between projects with and without the use of retention bond, using such factor as procurement methods, project risk, as well as problems associated with the construction project. Retention Bond Usage and Projects Procurement Methods Mann-Whitney U comparison on Table 9 depicts procurement method involving retention bond in construction projects, having mean score of and sum of ranks of 480.5, is more than that of project without retention bond with mean score of 10.31, and sum of ranks of It is evident the Z-value of procurement method with or without retention bond by Mann- Whitney U test has comparison difference of Using T-test in Table 10, Levene s Test for equal variance revealed that the average mean of procurement method with retention bond is with standard error of 0.06, while procurement method without retention bond has average mean of 2.50 with standard error of This indicates that the test is not significant with the value given as However, considering the T-test for equality of means of the two variables, that is, difference in mean of projects with and without bond is 6, indicating that the test is significant. Retention Bond Usage and Project Risks It could be observed from Table 9 that risk in construction project without retention bond having mean score of is higher than that of construction project with retention bond. Therefore, degree of occurrence of risk in construction project without retention bond can be said to be more than that of construction project with retention bond. More so, the Z-value of risk associated with or without retention bond by Mann-Whitney U test has comparison difference of Using Levene s Test for equal variance, Table 10 revealed that the average mean of risk with retention bond is with standard error of 0.048, while risk without retention bond has average mean of with standard error of 0.181, indicating that the test is not significant. Considering the T-test for equality of means of the two variables, difference in mean for projects with and without bond is , indicating that the test is significant. Retention Bond Usage and Problems Associated with Construction Projects Mann-Whitney U test in Table 9 revealed that problems associated with retention bond on construction projects are far lower than that of project without retention bond. Problems associated with project with retention bond was ranked 67 with mean score of 6.09, while problems associated with projects without retention bond is ranked 186 with mean score of Using Levene s Test for equal variance in Table 10, it could be observed that the average mean of problems with retention bond is with standard error of 0.059, while problems without retention bond has average mean of with standard error of This indicates that the test is not significant with the value given as However, considering the T-test for equality of means of the two variables, difference in mean for with or without bond is , indicating that the test is significant. 103

7 Table 10. T-test determining differences in mean Variables Significance Number of Standard Significance Standard Variables Error Difference (2-tailed) Error Difference Problems With retention bond E Without retention bond E Risk With retention bond E Without retention bond E Procurement With retention bond E Without retention bond E Discussion of Findings Benefits of Retention Bond The successful delivery of a construction project depends on the level of application of retention bond for such project. Supeman (2009) stated that retention bond is a type of performance bond that protects the customer after a job or project is finished. From the study, it was discovered that all the benefits of retention bond observed in the course of this research are significant. More so, the findings of this research strongly agree with Central Unit on Procurement (1994) assertion that retention bonds give contractors better and more certain cash flow through full payment at all stages (without the deduction of retention money). Usage of Retention Bond Wedlake (2007) asserted that the use of retention bond was originated in the United Kingdom basically as a bond for liability defect in building project. It was observed from this study that retention bond is mostly used on building projects in Nigeria compared to other construction types. It was also discovered that procurement options and contractual methods do affect the choice and usage of retention bond in construction industry. Retention bond is most used on lump sum or plan and specification contract than any other contract. More so, of all the types of procurement method used in Nigerian construction industry, the traditional/conventional system is the one that mostly involves the usage of retention bond, while fast track method is the least. Risks and Problems Associated with Retention Bond The purpose of risk assessment is to determine the probability of risks occurring and their potential impact (Kanoglu and Gulen 2013). Scottish Government (2006) asserted that, it is well documented within the construction industry that poor cost estimating and scheduling are two of the root causes of project failure. The interrelationship between time and money is always of major importance to both the owner and contractor. The study however revealed that retention bond reduces the level of risk associated with construction project performance. 5 CONCLUSION AND RECOMMENDATION After a thorough literature review, data collection and in-depth analysis of issues surrounding retention bond in Nigerian construction industry, the study revealed that retention bond are mostly used for fixed-price construction projects as compared to other contractual methods. More so, the study showed that for any construction project, the selected procurement methods, as well as risks and problems associated with such construction project, has a significant effect on usage of retention bond. The study also deduced that introducing retention bond to construction project of any kind will enhance project performance in terms of cost and time. This will further help in subsequent reduction of construction risks to the barest minimum. Retention bond should therefore be encouraged in the construction industry in order to minimize risks and problems associated with construction projects. REFERENCES Barnes, P. and Davies, M. (2008). Subcontracting under the JCT 2005 Forms. Blackwell Publishing, Oxford, United Kingdom. Boswall, R. G. (2010). Construction Bonds Guide. Clark Wilson LLP. Available at (accessed 06/23/2011). Central Unit on Procurement (1994). Bonds and Guarantees - A Guidance Paper of the Central Unit on Procurement, HM treasury. London, United Kingdom. Hosie, J. (2010). Security for payment: bonds and guarantees - Five pitfalls and protection against them. Construction & Engineering London Legal Update, 60, Kanoglu, A. and Gulen, S. (2013). Model for managing the contractual risks of construction firms imposed 104

8 by the procurement system. International Journal of Architecture, Engineering and Construction, 2(1), Nationwide Sureties Limited (1999). Construction Bond Specialist. United Kingdom. Pipersville, P. A. (2010). What is a Construction Bond. Available at (accessed 11/12/2010). Scottish Government (2006). Scottish Public Procurement Toolkit - A Step by Step Guide to Producing a Strategic Sourcing Strategy. Scotland Publication, Scotland. Supeman, A. (2009). World Reference Language Forum. Superman, France. Tar, J. H. M. and Carr, V. (1999). A proposal for construction project risk assessment using fuzzy logic. Construction Management and Economics, 18(4), Treasury, H. M. (1994). Bonds and Guarantees, A Guidance Paper of the Central Unit on Procurement, HM treasury. No 48, HM treasury, London, United Kingdom, Chapter No 48 Bonds and guarantees. Wedlake, B. (2007). Retention: Striking out cash retentions. National Specialist Contractor Council Journal, 20(6), Zayed, T., Elwakil, E., and Ammar, M. (2012). A framework for performance assessment of organizations in the construction industry. International Journal of Architecture, Engineering and Construction, 1(4),