User:ORourkeLaw/Retainage

Retainage is a portion of the agreed upon contract price, deliberately withheld until the work is substantially complete to assure that contractor or subcontractor will satisfy its obligations and complete a construction project.

History and Purpose
The practice of retainage dates back to the construction of the United Kingdom railway system in the 1840's. The size of the railway project increased demand for contractors, which led to the entrance of new contractors into the labor market. These new contractors were inexperienced, unqualified and unable to successfully complete the project. Consequently, the railway companies began to withold as much as twenty-percent of contractors' payments to ensure performance and offset completion costs should the contractor default.

Given the often large scale, complexity, cost and length of construction projects, the risk of something not going according to plan is almost certain. Accordingly, a common approach contracting parties take in order to mitigate this risk is to include retainage provisions within their agreements. The concept of retainage is unique to the construction industry and attempts to do two things: (1) provide an incentive to the contractor or subcontractor to complete the project; and, (2) protect the owner against and liens, claims or defaults, which may surface as the project nears completion. Incidentally, and more so now than ever, owners and contractors use retainage as a source of financing for the project.

Creation and Enforcement
If there is to be retainage on the construction project, it is set forth in the construction contract. Retainage provisions are applicable to subcontracts as well as prime contracts. The amount withheld from the contractor or subcontractor should be determined on a case-by-case basis by the parties negotiating the contract, usually based upon such factors as past performance and the likelihood that the contractor or subcontractor will perform well under the contract. Determining the amount of the retainage is a balancing act. If the retainage fee is too small, a contractor or subcontractor faces little incentive to close out the project. However, if the retainage fee is too big, the contractor or subcontractor will likely build the cost of the retainage in its project bid.

One can structure retainage arrangements in any number of ways. Subject to state statutory requirements, 10% is the retainage amount most often used by contracting parties. Another approach is to start off with a 10% retainage and reduce it to 5% once the project is 50% complete. A third approach is to carve out material costs from a withholding requirement on the theory that suppliers, unlike subcontractors, may not accept retainage provisions in their purchase orders.

Retainage clauses are usually found within the contract terms outlining the procedure for submitting payment applications. A typical retainage clause parallels the following language: “Owner shall pay the amount due on the Payment Application less a retainage of ten percent (10%).

"Substantially Complete"
Retainage is generally due to the contractor or subcontractor once his work is substantially complete. Determining just when substantial completion occurs is usually litigious. The standard analysis finds the event triggered when the owner occupies a structure and uses it for its intended purpose.

Retainage Abuse
Subcontractors tend to bear the brunt of retainage provisions, especially subcontractors performing work early on in the construction process. The main reason for this, is because many contractors pass down the owner's right to withold retainage to the subcontractor. For example, a subcontractor laying the foundation of a house may complete his or her work in the first few months of the construction project, but generally is not allowed to recover amount witheld from the owner and contractor until the project is "substantially complete," which could take a few years depending on the size of the house. Coupled with a contingent payment clause, the retainage can cause significant financial distress to a subcontractor.

Alternatives to Retainage
Several alternatives exist to standard retainage provisions that provide the same benefits and protections. For example, parties can agree to establish a trust account. A trust account provides the contractor with some control over its money, even if it is being held by the owner. In a trust account, retainage is withheld by the owner, placed in a trust account with a trustee that has a fiduciary relationship to the contractor. The trustee can invest the retainage at the contractor’s direction, thereby allowing the contractor to “use” the retained funds that normally would sit idle in an escrow account.

Other alternatives to retainage are to allow the contractor to supply substitute security to the owner in the form of a performance bond, bank letter of credit, or a security of, or guaranteed by, the United States, such as bills, certificates, notes or bonds.

=See also=

Punch List