What Is Construction Retainage?
To receive payment for a project, the contractor must complete the project in its entirety. If a large company with a power lawyer team often take a long time to fully pay their contractors, an average Joe like you and me will have it harder to collect than a Fortune 500 company. That is where construction retainage comes into the picture. Put plainly, "retainage" means not paying for the entire work, or a portion of a completed work that is being done. A sufficient amount of retainage ensures that no contractor will have a reason to neglect a work condition, or disappear without paying subcontractors, making it a useful tool for project management. On a practical level, the owner will not pay for the entire project (or a work of a project) . Instead, the owner will pay 10 percent up front. The remaining 90 percent will be paid out in regular (say, 10 to 15 percent of the total due) increments every three to six months, until the project is completed. The untouchable 10 percent can be referred to as an insurance policy. If the work is fully and properly done, the owner will have to pay the retained amount. But because the owner is not going to pay the full amount at once, the owner will have the opportunity to comb through the work done and be satisfied that no issue will surface down the road. Properly drafted retention clauses can provide virtually no incentive to clients who do not pay.
Reason Retainage Laws Differ from State-to-State
The principal reason for this diversity is the fact that retainage and withholding regulations are typically promulgated at the state level. The state legislatures, and in some cases state agencies, make the decision to permit private owners to withhold retainage. The states that allow retainage generally have some minimum and maximum threshold for the amount that may be withheld. Other factors that go into the legislative process include whether or not particular types of projects, such as federally funded or public construction projects, are excluded from the regulations, or whether or not those disclosures are mandatory. Additionally, some states limit the amount that can be withheld during the duration of performance. For example, some states allow the owner to withhold 10 percent during construction but permits an unconditional release of a portion of the retainage upon completion of the project. Legislative history shows that certain factors, such as prompt payment laws and economic conditions, have factored into state decisions concerning retainage regulations.
Retainage Commonalities
In addition to the variations in retainage laws from state to state, there are also time periods and percentages that are more or less universally found in retainage statutes. The variation is most often in the percentage allowed to be withheld and the time period in which the retainage is to be released. As a general rule, a substantial percentage of retainage will be released by the owner upon substantial completion of the project. A typical provision might contain the language that 90% of retainage will be released within 10 days after substantial completion. The retainage not released upon substantial completion will then be disbursed 50% upon final completion and the remainder within 60 days of final completion. That said, the release and retention of retainage is certainly not universal and can be varied widely.
Early release of retainage is becoming the norm in the public sector. Twelve states have amended their retainage statutes in the last few years to allow a contractor to gain an automatic release of retainage 30 days after a project reaches date of substantial completion. So far, only Arkansas has such a rule for private projects. These statutes are all very new, however, and it remains to be seen whether they are effective in actually accelerating the payment process.
One common exception to these requirements is that retainage need not be released in the event that a lien, stop payment, or performance bond claim is made against a project. Especially where that claim is a legitimate claim, there are no requirements for owners or prime contractors to turn loose the holdback.
As the economy tightens and more public entities are forced to let their projects to the lowest bidder, this kind of express right may well become an issue of increasing importance. In those instances where the owner is not able to pay all of the contractors on a project, there are often cries for the cruelty of the contract and statutes which obligate the owner to release all retainage. Scrutiny of those statutes will show that they generally have very limited teeth.
Another common element in retainage statutes is that where there is a project bond, retainage need not be held. Here again, the purpose of the retainage law is to enhance the value of the bond that stands behind it. In the instances where there is a performance bond in place, the purpose of retainage is served by the bond. There seems to be no reason to require the same money to be held in two different forms.
Key Highlights for State Construction Retainage Laws
The following is a non-exhaustive list of typical state requirements for retainage. Please note that this does not cover every state and every variation in retainage laws. Please be advised that you should always consult an attorney in your state on any retainage issues to be sure you are following the law correctly.
California – No statutory retainage on any projects. However, if retainage is withheld on residential projects, the surety will be liable for interest (bank rate) on the withheld retainages after 45 days of receipt. However, the Bank of America prime rate is currently .25%. Invoice payment must occur within 10 calendar days of the owner’s receipt of the invoice (or, 7 days after the work is performed). Owner shall then make payment within 10 days of receipt from the lender. The lender must be given a copy of any notices by lender who has furnished the owner with a notice of commencement of labor and material. If retainage is withheld, contractor may request a 50% reduction in such retainage once work is 50% complete. If retainage is withheld, contractor shall receive interest at prime on the retainage if not paid when due. Subcontractors must be paid within 10 days of subcontractor submitting invoices (or, 7 days after work is performed).
Florida – 10% retainage can be withheld on commercial projects if the contract price is greater than $250K and the project is not considered residential. If the project is residential, the retainage restriction in the Florida Construction Lien Act applies (2% or less). Owner may withhold retainage until the architect submits to the Owner a Certificate of Substantial Completion. Interest on contract balances must be paid to the contractor 10 days after the owner receives payment.
New York – On non-residential projects, 10% retainage may be withheld. On residential projects (less than 4 units), retainage must not be more than 5% of contract price. Retainage must not be withheld on a public project if there is a surety bond. Subcontractors and suppliers must be paid retainage within 30 days of request for payment (or, 10 days after work is completed).
Texas – May not withhold retainage on "residential project" (a project involving four or fewer residential units). On projects not subject to a bond or where the contractor fails to obtain a bond or insurance, the owner may withhold retainage or 10% of the contract price from the contractor and 10% from any subcontractor or sub-subcontractor. The 10% limit is per pay application, not total project value. Retainage must be paid to the contractor within 10 days of substantial completion. Subcontractor must be paid retainage within 15 days of project completion.
Impacts of Retainage on Contractors and Subcontractors
The retention of a small portion of the contract price is generally one of those conditions found in construction contracts that most people involved in the project pay little attention to. But the concept of retainage has a significant impact on a contractor’s cash flow. As noted above, the client retains 5 to 10 percent of the contract price, reducing the funds available to the contractor appropriately. Then the contractor retains an additional 5 to 10 percent from all the subcontractors and suppliers it hires. In theory, this is supposed to give the client and prime contractor leverage to require that subcontractors finish their work and pay their subcontractors. The problem is that the reasons for the policy of retainage may not always apply to a particular situation. Often simple mistakes in calculations eliminate the need for retainage.
Consider a contractor bidding on a project with a contract price of $1,000,000. Assuming the standard 10 percent retainage, the client will pay the contractor only $900,000. If the contractor hires a subcontractor to do the roofing for $800,000, the contractor will retain $80,000 from the subcontractor, leaving the subcontractor with a payment of $720,000 to buy materials , pay employees, and pay its own subcontractors. If the roof takes longer to construct than the client expected, though, the contractor may end up holding back even more retainage from the project. For instance, if the roof takes an extra 30 days to complete, the contractor does not have to pay the subcontractor for any of the work it completes until the subcontractor finishes the roof and provides a final certificate.
With respect to retainage, there are two types of laws. So-called "silent" laws provide that retainage provisions automatically apply to all construction contracts unless the parties agree otherwise. The other type of law, found in many "prompt payment" acts, expressly forbid retention or limit the amount retainage that a client may deduct.
Enforcement of retainage laws has been inconsistent, so contractors need to carefully monitor the retainages withheld on all projects. State courts do not always enforce retainage laws in the manner they were intended. For example, a recent decision from the Colorado Supreme Court, Midland Contractors, Inc. v. Town of Parker, found that a client could retain retainage in excess of the statutory maximum, regardless of whether it promptly paid amounts due.
Updates and Trends in Construction Retainage
Over the past few years, states have continued to refine their rules regarding retainage. As the nation recovers from a crippling recession, purpose and terms of retainage rules are being re-evaluated to ensure they achieve what they are purported to, while balancing the needs of all stakeholders in the construction industry.
States across the country have addressed retainage rule changes in recent legislative sessions. In 2013, Michigan and North Carolina enacted new legislation, and in 2011 Ohio, Tennessee and Massachusetts enacted retainage rule changes. These changes have broadly responded to the difficult economic conditions over the past several years and have involved development industry stakeholders including contractors, subcontractors, general contractors, suppliers and others.
In Michigan, the State Legislature adopted Public Act 93 of 2013 to address concerns by stakeholders about the difficulty of collecting retainage from owners upon project completion. Consequently, owners are now required to release 50% of retainage to contractors at the time of final completion and the remaining 50% within 30 days thereafter. Contractors are also required to pay all subcontractor retainage at the time of final completion and provide a list of subcontractors and their contact information to the owner or general contractor. For 30 days following the owner’s receipt of the contractor’s retainage payment, the subcontractor may seek to recover its retainage payment from the contractor. Owners are prohibited from withholding retainage for any reason other than due cause, which is defined as failure by the contractor to meet contractual obligations or compliance with applicable law.
In North Carolina, Public Law 2013-405 (S.L. 2013-405) addresses concerns regarding retainage retention and continues to give bond claimants a lien on retained funds. The law mandates that retainage must be paid within 60 days after final acceptance of the work covered under the contract. Government contracts are permitted to retain up to 5% of retained funds until project completion, and retainage must be deposited into an escrow account with a financial institution approved by the owner. Employing the contractor’s payment bond to pay retainage to the general contractor is one way in which retainage must be released.
In Ohio there were concerns that once a project has been completed, it seeks to resolve any retainage disputes promptly and efficiently, and public agencies are given direction to release retainage promptly. R.C. 153.12(B)(3) has been amended to require public agencies to notify contractors once they obtain a copy of the architect’s or engineer’s certificate or evidence that work has been completed; the agency must use due diligence to release any retainage within ten days thereafter.
In Tennessee, Public Chapter 182 (HB 0375/SB 0486) revised the state’s retainage law by requiring payments for retainage to be due within 10 days from the date of physical completion and prohibits withholding retainage payments pending receipt of retained funds. The law also prohibits the owner and general contractor from holding more than 5% of the contract price as retainage and obliges prime contractors to pay retainage to its subcontractors within 10 days of receipt of retained funds.
Similarly, in Massachusetts S2284 consolidated the financial requirements between private and public entities and prevents withholding retainage for any reason other than circumstances expressly stated in E.G. M. G.L. c. 30, 39K, ยง39N, corrected by 2007, chapter 96.
The trend in state retainage law reformation suggests this will continue for the foreseeable future. It is likely that states will continue to evaluate their laws to ensure that stakeholders can strike a balance as it relates to retainage.
Best Practices for Handling Retainage
As contractors and subcontractors know all too well, the retaining of retainage can range from an absolute breeze to a virtual nightmare at any given point in a dispute. As with most things in life, however, there are a handful of best practices to adopt when it comes to retainage – making it easier to get your money in a timely manner in the event of a payment dispute.
Negotiating the Terms of Payment
One of the best ways to prevent a retainage problem is to negotiate the terms of payment before the contract is signed. What will be retained (if anything)? In what percentage amounts? Will the retainage be returned quickly upon completion of the work – or will it be held indefinitely? Answers to these questions should be ironed out before work begins.
Document, Document, Document
The most important aspect of maintain a successful relationship in the construction industry is to document everything – and the return of retainage is no different. Keep good records of what you’ve done, when you’ve done it, and what’s been paid to you. You can never have too many records – and in the event your retainage is held back, having good records will pay off in the long run.
Leverage Partially Paid Work
One of the most common reasons partial claims for retainage are made by owners or general contractors is dissatisfaction with the work product. Make sure you’re doing the best work possible: show up on time – and regularly. Take care of any legitimate complaints immediately. Be proactive about addressing issues that may cause a contract party to withhold payment.
Communicate
If there’s a problem, you must first know about it – which is why it’s so important to communicate regularly with the parties on either side of a construction contract. Keep lines of communication open with owners, architects, subcontractors, and everyone else involved in the process. This will both help you catch problems before they blossom into retainage disputes – saving you time and money both now and in the long run.
Summary: The State of Retainage
As with many aspects of construction contracting, retainage laws can vary significantly from state to state. For contractors and subcontractors, this patchwork of laws can make it exceedingly difficult to keep track of obligations and rights, especially because only some states have specific laws regulating the amount and duration of retainage. In some states, like California and Florida, there are no specific requirements on how long retainage must be held, or how much can be withheld , although the general principles regulating State and Federal Prompt Payment Acts will still apply.
For contractors, the most reliable way to protect yourself against retainage issues is to review your contract for any specific provisions related to retainage, amount of retainage, and duration of retainage. If there are no provisions, ensure that you local law does not address the issue specifically and confirm the generally accepted amounts and durations. If in doubt, a lawyer can advise you on best practices and potential pitfalls in your particular situation.
