What is Retainage in Construction: 10 Tips for Contractors or Subcontractors

In construction industry, it’s common for contractors to receive partial payment during a project, with the rest held back until the job is nearly or fully complete.

This practice, known as retainage, ensures work is finished to the required standards before full payment is made.

For contractors, it’s essential to understand how retainage works, why it's used, and how it impacts everyone involved in the project, from owners to suppliers.

Managing retainage effectively is critical to avoiding financial strain and ensuring smooth project completion.

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What is Retainage in Construction?

In construction, retainage is a practice in which a portion of a contractor's payment is retained by the project owner or general contractor until the work is fully completed.

This practice acts as a financial guarantee, ensuring that the contractor finishes the project to the agreed-upon standards. 

Retainage is common in public and private projects, with the retained amount usually ranging from 5% to 10% of the total payment.

Although it can create cash flow challenges for contractors, understanding retainage and the terms in your contract can help you manage it better and avoid payment delays.

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What’s the Purpose of retainage?

Key points to understand about retainage include:

• Work quality: By holding back a portion of payment, retainage ensures contractors and subcontractors meet the required quality standards before receiving full payment.
• Fixing defects: The withheld funds allow owners to promptly address deficiencies or incomplete work before the project is finalized.
• Project completion: Retainage motivates contractors to stick to deadlines and complete the projects as agreed, reducing the risk of delays or abandonment.

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Why Retainage is Important?

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Tips Of Retainage For Contractors or Subcontractor

1. Retainage Terms

Retainage terms are crucial for contractors. Clear definitions can prevent misunderstandings later.

Terms and conditions:

• Percentage of Retainage: The standard is often between 5% to 10%. Clarifying the exact percentage is essential.
• Release Conditions: Contractors should specify conditions for the release of retainage. This can include completion milestones or project acceptance.
• Timeline for Release: Setting a clear timeline can help manage expectations. Specify the duration after project completion when retainage will be released.
• State-specific regulations: Each state has rules on how retainage is applied, including maximum percentages, how funds are stored, and the duration they can be retained.
• Maximum retainage amounts: Some states cap the retainage at specific percentages. For example, in Illinois, private projects start with a 10% retainage, dropping to 5% once half the project is completed.
• Exceptions for residential projects: Regulations may differ for residential construction and heavy construction projects. In Illinois, the retainage rule doesn't apply to projects with 12 or fewer units.
• Mechanic’s lien deadlines: Be aware of your state’s deadlines for filing mechanic's liens, as they may expire before retainage payments are due. In New York, lien filing laws were extended to 90 days after retainage is due.

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2. Negotiation

Effective negotiation of retainage terms can lead to better financial management and successful project management. Here are some points to keep in mind when you are negotiation.

1. Agree on retainage amount: The owner and contractor should decide how much retainage will be retained or if any will be held.
2. Flexible retainage terms: Retainage terms can be flexible. For example, they might agree to retain 10% of payments until halfway through the project, then reduce it to 5%.
3. Decide where to hold retainage: After agreeing on retainage, the parties must decide where the withheld funds will be held until project completion.
4. Document Everything: Clearly outline retainage terms in the contract. This ensures both parties are aligned and reduces future disputes.

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‍Potential Clauses to Include

• Escrow Arrangement: Consider an escrow account for added security.
• Dispute Resolution: Outline procedures for addressing disputes over retainage. This establishes a clear path for resolution.

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3. State’s Retainage Laws

Each state has different rules governing retainage, including limits on the percentage that can be retained and the deadlines for releasing funds. For instance, in California, public projects retainage at 5%, and final retainage payments must be made within 60 days of project completion.

Here are some points that we need to look at;

• State-specific regulations: Each state has different rules governing how retainage is applied, including limits on the percentage that can be retained and deadlines for releasing funds.
• Impact on claims: These laws can also impact when and how to file a claim for unpaid retainage. For instance, if retainage payments are delayed beyond the legal deadline, you may need to take legal action to enforce your rights.
• Research and comply: It’s essential to research your state’s laws to ensure you remain compliant and understand how retainage laws affect your project contracts and payment schedules.

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4. Substantial Completion

• Tied to project completion: Retainage is usually released when a project reaches “substantial completion.” This term refers to when the project is nearly finished and can be used for its intended purpose, even if minor work remains.
• Delays for early subcontractors: Subcontractors who finish their work early, like those laying the foundation, may have to wait months or years before they receive their retained funds, causing potential cash flow problems.
• Clarify in the contract: To avoid confusion, contractors and subcontractors should ensure that the definition of "substantial completion" is spelt out. This will help manage expectations and ensure timely payments.

5.  Mechanics Lien Deadlines

• Lien deadlines and retainage: In most states, mechanics lien deadlines are based on the last date of work performed, not when retainage is due. Subcontractors may need to file a lien before their retainage is released to protect their payment rights.
• Lien protection: Filing a lien is often the most effective way to secure payment for outstanding amounts, including retainage. However, missing the lien filing deadline could mean losing the right to claim payment. For example, in Texas, subcontractors can file a Notice of Contractual Retainage within 30 days of completing their work to preserve their lien rights on retained funds. This ensures they can still file a lien if retainage isn't paid on time.

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6.  Retention Bonds

• Retention bonds as a replacement: Retention bonds provide project owners with a financial guarantee while allowing contractors to receive total payments without withheld funds. The bond ensures that the contractor fulfills their obligations, and if any issues arise, the project owner can make a claim against the bond.
• Cash flow benefits: This option improves cash flow for contractors who would otherwise have to wait until the project’s completion to receive their retained funds. By negotiating for a retention bond, contractors can avoid the financial strain caused by retainage.
• Low-cost alternative: Retention bonds are often more affordable than having retainage retained and can be an attractive solution for contractors and owners.

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7. Retainage Variables

• Flexible retainage terms: Variable retainage allows the percentage retained to decrease as the project progresses or to apply different rates to labor and materials. This can help subcontractors who face higher up-front costs, such as purchasing materials. For example, a contract may initially withhold 10% retainage but reduce this to 5% once 50% of the project is completed, easing financial pressure as work progresses.
• Managing up-front costs: Negotiating variable retainage can help contractors manage their costs more effectively while giving the project owner some financial security. This arrangement helps balance the needs of both parties.

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8. Retainage Funds Negotiation

• Interest-bearing accounts: Instead of simply withholding retainage, contractors can request that the retained funds be placed in an interest-bearing escrow account. This allows the funds to generate interest while they are being held.
• Financial benefits: Retainage held in an escrow account provides contractors with a small but helpful financial return, which can offset some of the burden of waiting for final payment.
• Agree on terms in advance: Contractors should work with the project owner to agree on where the retainage will be held, specifying the details in the contract. This will prevent any disputes later on and ensure both parties benefit from the arrangement.

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9.  Retainage Release Timelines

Session Law 2007-365 also authorizes the owner to withhold additional retainage after a contract is fifty per cent (50%) complete with retaining two and one-half per cent (2.5%) of the total retainage through completion of the contract.

• Clear release conditions: Contractors should clearly define when retainage will be released. Many contracts tie the release of retainage to substantial completion, but negotiating for earlier, partial releases can improve cash flow.
• Partial releases during the project: Negotiating partial retainage releases at specific milestones can provide contractors with access to funds earlier in the project. For example, retainage might be reduced after 50% completion or once major project phases are finished.‍
• Avoid payment delays: Specifying the retainage release schedule in advance helps avoid unnecessary delays at the end of the project and ensures that all parties know when to expect final payment.

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10. Full Payment

• Legal right to full payment: Contractors are entitled to full payment for the work they’ve completed, including retainage. Understanding your legal rights is essential for ensuring you get paid in full.
• Lien rights and deadlines: To protect your right to retainage, familiarize yourself with your lien rights and deadlines in your state. In some cases, filing a mechanics lien may be necessary to secure payment for retained funds.
• Be proactive: By negotiating clear retainage terms and tracking deadlines, contractors can avoid disputes or delays in receiving their full payment, including the retainage amount.

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Financial Challenges of Retainage

• Cash flow issues Retainage can strain contractors' cash flow, especially for businesses operating on thin margins.
• Administrative burdens Managing retainage adds complexity to bookkeeping and financial management, especially when dealing with multiple stakeholders.‍
• Delayed payments Without clear contract terms and timelines, retainage can lead to payment delays, creating further financial strain.

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Alternatives to Retainage

• Surety or retention bonds: Contractors can offer retention bonds as an alternative to retainage. The contractor receives full payment while the owner still holds protection through the bond.
• Substitute security: Contractors may provide alternative forms of security, such as a letter of credit or U.S. securities, in place of retainage.
• Construction trust funds: In states with trust fund statutes, money received for subcontractor payments is held in an interest-bearing trust account until all parties are paid.
• Escrow accounts: Retainage can be placed in an escrow account, allowing contractors to earn interest and help manage cash flow while the project is ongoing.
• Build a strong reputation: Contractors with proven track records can sometimes negotiate lower retainage percentages or secure favorable retainage terms as the project progresses.

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Conclusion

Retainage is a critical aspect of construction contracts. Understanding its nuances can significantly impact a contractor's cash flow and project management. 

Key takeaways include the importance of clearly defined terms in contracts. Contractors should ensure that payment schedules specify retainage percentages and release conditions, which reduces confusion and strengthens relationships with clients.

Using construction management software can help contractors stay informed regarding retainage and ensure proper documentation. Keeping detailed records of work completed and retainage retained can prevent disputes and facilitate smoother payment processes.

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FAQs

How can contractors effectively manage retainage in construction projects?

Contractors can manage retainage by implementing thorough documentation and clear communication with clients. Regular follow-ups on payment schedules can also help ensure the timely release of retainage.

What strategies can contractors employ to reduce retainage-related cash flow issues?

Contractors can mitigate cash flow issues by negotiating lower retainage percentages upfront. Additionally, they can improve project management efficiency to minimize delays and expedite the release of retainage.

How do state laws vary regarding construction retainage?

State laws regarding retainage can differ significantly. Some states impose maximum retainage limits, while others have specific regulations governing the timelines for releasing retained funds.

How is retainage typically handled for stored materials in construction projects?

Retainage for stored materials often hinges on the terms outlined in the contract. Typically, contractors may receive a portion of the costs related to materials once they are stored on-site, subject to verification and inspection.