By Lee Brumitt, Esq., Dysart Taylor McMonigle Brumitt & Wilcox, P.C.

In the 1840’s, the United Kingdom was constructing a massive railway system. The huge work demand brought unqualified and insolvent contractors to the fray. Defective and incomplete work was commonplace. To combat the losses and assure that work was completed, the government withheld 20% of the contract amount. Thus, the practice of retainage was born.

Advocates of the practice, such as the surety industry, argue that retaining funds offsets the risks of overpayment for quantity or quality of work actually installed, defective work, or insolvency. The practice was considered a sacred cow until the early 1980’s when the federal government led what has become a very slow erosion of the tradition. In 1983, the federal government proclaimed a new policy providing for the elimination of retainage on all federal construction projects. “Retainage should not be used as a substitute for good contract management, and contracting officers should not withhold funds without cause,” said the Office of Federal Procurement Policy. This “cause” standard was fully implemented in the Federal Acquisition Regulations in 1986 and the Department of Defense, the G.S.A., and the Department of Transportation all adopted a policy of “zero” retainage. Using federal funds as a carrot, some state departments of transportation now have “zero” retainage policies.

As a result of the economic downturn of 2008, retainage reform accelerated. The downturn caused some state legislatures to understand that retainage causes cash flow problems, provides gratuitous financing for owners, and allows owners and generals less incentive to properly inspect and manage a project’s progress. Where retainage at 10% was the prior norm, a number of states have stripped retainage to 5% or less, particularly on public projects. New Mexico banned retainage on most public and private projects in 2007; however, scheduling payments such that there is a line item for a “closeout payment” equal to 5 or 10% after work is substantially performed is allowed in New Mexico. Some states require owners to place retained funds in interest-bearing accounts. Additionally, states such as Missouri require retainage to be held in trust supposedly restricting the owner’s ability to use and consume those funds for other purposes. Many states such as Colorado, North Carolina, Missouri, and Kansas have procedures for the release of retainage to early-completing subs or upon a percentage of completion.

In states and on projects where retainage is still withheld, subcontractors need to take steps to lessen or eliminate the financial impact of retainage or to, at a minimum, insure that contract language complies with applicable laws and regulations.

Educate yourself on the retainage regulations governing your work. Owners, generals, or subs often do not know the current status of retainage statutes or regulations governing the work. As a result, contract language frequently defaults to the 10% standard and violates other applicable legal standards. Before you enter into any contract, educate yourself on the retainage laws and regulations applicable in the location of the work.

Subcontractors should never accept retainage terms or practices which are less favorable than the relevant law. It is hardly unusual for the subcontract form provided by the general to contain more onerous retainage terms and conditions than allowed by the jurisdiction governing the project. While the ConsensusDocs standard contract form states that the retainage percentage “shall not exceed statutory requirements,” the AIA standard form does not contain such language. If the contract does not comply with the law in every instance, educate the general and make sure the contract you sign is in strict compliance. If the GC has already bound itself to an unlawful rate of retainage with its owner, strongly suggest that the GC take steps to modify the retainage withheld by the owner to comply with the law.

Subcontractors should never accept retainage terms which are less favorable than the general construction contract. “Flow down” clauses make the general construction contract’s terms and conditions part of the subcontract. It is a good practice for the sub to obtain a copy of the general construction contract and review the retainage provisions before signing. A subcontract should never have more onerous retainage provisions than the owner requires from the general. The standard ConsensusDocs form provides some protection in that it requires any percentage withheld by the general from the sub to be “equal to the amount retained from the Constructor’s payment by the Owner for the Subcontract Work.” Additionally, the ConsensusDocs form requires that “the Subcontractor’s retainage shall also be reduced when the Constructor’s retainage of the Subcontract Work has been so reduced by the Owner.” Many state statutes protect a sub from a GC withholding a rate of retainage that exceeds the owner’s withholding.

More favorable contract terms supersede statutory requirements.  Many generals are willing to negotiate retainage terms, especially with a subcontractor that they trust and with whom they have had positive experience. One of the best arguments for reduction or elimination of retainage is that all contract forms allow the owner, design professional, and/or general to withhold funds based for any number of reasons including defective work, insolvency, or evidence that the work will not be completed on time or at all. In other words, owners and generals which manage a project appropriately already have the contractual means to protect themselves from those very things that retainage was meant to address.  The following are some of the items that should be the subjects of negotiation:

• Reduction or elimination of retainage once a project has reached a certain percentage of completion, such as 50%;
• Release of a portion of retainage already withheld once the work gets to a certain percentage of completion, such as release of half of the retained funds once the project is at 50% completion percentage;
• Deposit of withheld retainage funds in a segregated interest-accruing trust account;
• Payment of all interest on retained funds;
• Elimination of retainage where the subcontractor is required or willing to purchase performance and payment bonds for the project.

Early-completing subcontractors should always request a release of retainage upon completion of work. If you are an early-completing trade, always request a release of retainage upon completion of work whether those terms are in your contract or not or whether state law provides for such a remedy. Additionally, if the retainage withheld is significant, explore the possibility of putting up a “retainage bond” in exchange for a release of retainage.

Take caution not to waive lien or bond rights. Lien and bond rights can easily be waived through partial or final lien waivers. Subcontractors should exercise extreme caution and never sign contracts containing broad waivers of lien or bond rights, lien waivers which are not conditioned on actual receipt of payment, and lien waivers which expressly waive all liens/bonds as of a specific date. The ASA recommends that each time a sub signs a lien waiver, the following language should be affixed to the lien waiver above the signature line:

This waiver shall apply only to work for which payment has not been received in full; shall not apply to retention; shall not apply to unbilled changes, claims which have been asserted in writing or which have not yet become known; and shall be conditional upon receipt of funds.

Protect and perfect your lien and/or bond rights. If your request for release of retainage on completed scopes of work is rejected, you can always protect your lien and/or bond rights and immediately file a mechanic’s lien or payment bond claim if the time for doing so will or is likely to expire before your retainage is expected to be paid. Early- completing subcontractors are frequently required to wait several months, if not years, before retained funds are to be paid. It is not uncommon for retained funds to simply go unpaid or become “unavailable” at the completion of the project because of other problems having nothing to do with the early-completing subcontractor’s work such as poor project management, defective work by others, or the insolvency of the owner or general. Filing a lien or bond claim will not only assure that your claims do not become stale, it may also have the desired effect of compelling the owner, general, or surety to pay retainage in a more timely manner.

About the Author:

Lee Brumitt is a shareholder with the Kansas City law firm of Dysart Taylor McMonigle Brumitt & Wilcox, P.C. He has more than forty years of experience in construction law and litigation. He primarily represents subcontractor trades and specialty contractors on public, commercial and residential projects and  currently serves as the attorney for the Kansas City Chapter of American Subcontractors Association. Lee can be reached at (816) 714-3027 or lbrumitt@dysarttaylor.com