This article was written for the ConsensusDocs newsletter and first appeared here.

Introduction

Most, if not all, construction contracts contain a provision for “retainage.”  The origin and concept of retainage dates back to the railroad boom that embraced Great Britain in the 1840s. In its simplest terms, retainage is a mechanism by which an owner or general contractor withholds disbursement of funds from the payment of a requisition in order to secure future performance of a contract and/or to pay for repair of defectively performed work. Retainage typically ranges from five to ten percent, with the amount being reduced as the project progresses to substantial and final completion. One of the reasons for withholding retainage is to incentivize a contractor to complete its work in accordance with the contract terms and conditions. While this may be well-intentioned in concept, it all too often leads to abuse that impacts project cash flow and raises tension between the parties. This typically happens on projects that have delay issues, deficient drawings, and/or claims of defective work. When a project has “gone bad,” the withholding of retainage is one of the first things that an owner will latch onto in order to leverage its position against a contractor. In order for a contractor to put itself in the best position possible, the following negotiation techniques and protective measures should be kept in mind.

Know Your Applicable Statute

Every state except West Virginia has statutes in place that govern the payment of retainage on public projects. On federal projects, the amount of retainage withheld shall not exceed ten percent as set forth in the Federal Acquisition Regulations (“FAR”). The common thread running through these statutes is the payment of interest as a remedy when the retainage is not timely paid. Historically, most retainage statutes were applicable only to publicly funded projects. This has recently changed with a substantial number of state legislatures recognizing that the payment of retainage on private projects was a serious enough problem to warrant regulation. These include Alabama, Arizona, California, Colorado, Connecticut, Idaho, Illinois, Kansas, Louisiana, Maine, Maryland, Massachusetts, Minnesota, Missouri, Montana, Nebraska, Nevada, New Mexico, New York, North Carolina, North Dakota, Ohio, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, and Vermont. New York’s retainage laws relating to private projects were enacted only this past November.

The AGC/ABA Construction State Law Matrix tracks state laws addressing the release of retainage and 60 total issues. More information can be found here.

Because the retainage statutes for public and private projects differ from state to state, a contractor performing work in a given state should be aware of the retainage provisions that are applicable. A contractor should be aware of the amount of retainage that can legally be withheld, when it should be released (i.e., upon substantial or final completion) or reduced, and whether the statute applies to public or private work. It is open to question, for the most part, whether a contractor can contract around retainage provisions set forth in state laws. Since there is little to no reported legal authority providing guidance, caution should be taken to not be overzealous in negotiating down the protections provided by a state’s retainage law. The potential consequences of such actions could lead to allegations of violation of the applicable retainage statute and potential claims of bad faith being asserted in a legal proceeding.

The Contract

Generally speaking, retainage provisions in public contracts are typically not negotiated, but this may not apply to private contracts. Negotiations of a favorable retainage provision should be considered of paramount importance with the goal of minimizing as much as possible the amount of retainage as work on the project progresses. For example, contractors should consider incorporating provisions reducing retainage by fifty percent when the project reaches fifty percent completion and releasing all retainage at the time of substantial completion, with only a small amount withheld for the value of any uncompleted or punch list work. The remainder would be paid at the time of final completion. It is also worth noting that at times on a private project a performance bond or the posting of a letter of credit can be provided in place of retainage. However, this does not seem to routinely occur because postings of these types of security come with their own share of risk that may make them an unattractive option. It remains true that public owners will always require the posting of a payment and performance bond (in addition to retainage) because they are required to obtain these bonds by state statute.

Also, in the context of a GMP contract, contractors should try to negotiate retainage only applying to pure material and labor costs and not to project general conditions, fees, insurance, deposits, or long lead items. From a general contractor’s perspective, retainage that is set forth in a prime contract should mirror the retainage provisions set forth in the project subcontract agreements. It is not sound business for a general contractor to enter into a subcontract agreement where the retainage provision in the subcontract is lower than the retainage provision set forth in the general contractor’s agreement with the project owner. Also, note that setting a higher retainage amount in the subcontract may be prohibited by some state statutes on retainage or prompt pay laws.

Creating a Clear Record of the Retainage Amount

In most instances, the amount of retainage is easily identified in monthly payment requisitions. Attention should be paid to ensure that the amount is clear and correctly calculated. In the event of a complicated construction dispute that may involve allegations of delay, defective work, and claims for equitable adjustment, contractors should not want to muddy the waters when it comes to seeking payment of base contract retainage that should be easily established by approved monthly requisitions. A good strategy to keep in mind, in the event you encounter a troubled project that may be headed toward litigation, is to try and negotiate payment of the retainage when the project is fully complete, separate and apart from what other sums that may be in dispute. Parties may agree to carve out the retainage piece of their dispute under a full reservation of rights, with both parties agreeing to still pursue their respective claims against each other. The incentive for this is the high interest rate (i.e., nine percent in New York) on a judgment entered against a party that loses in a litigation.

Timing of Payment

As previously alluded to, the time for the payment of retainage will, in large part, be dictated by the contract or applicable statutes. If retainage is not paid as required, there should be immediate follow-up correspondence confirming the time the retainage request was submitted and that it remains unpaid, contrary to the statute or contract provision, whichever is applicable. The goal is to create a clear paper trail in the event of a dispute and to set the stage for arguing at a later point in time, if necessary, that you are entitled to the relief provided for under the applicable retainage statute. Creating such a paper trial could also help establish a claim of bad faith.

Relation of Other Statutes Related to Construction

Retainage statutes should not be confused with prompt payment statutes, construction/mechanic lien statutes, bond claim statutes, or municipal mechanic lien-type statutes. While these statutes have similar public policy considerations and goals, they each provide their own type of protection separate and apart from the other.

Conclusion

In sum, in order for contractors to be in the best position possible to recover their retainage, they should be educated about the retainage statute that applies to their project; aggressively negotiate a favorable retainage provision; and create a clear paper trial in the event a dispute occurs over the payment of retainage.

For more information, please contact Gerard J. Onorata.