This article discusses retainage “best practices” which can help your company with the negotiation process, describe key features of retainage laws across the country and explain how to use them.
Why Retainage Laws and Practices Are Necessary
Retainage practices have a long history dating back as far to the construction of the United Kingdom railway system in the 1840s. These laws are a responsive creation to the complexity of most construction projects, which involve multiple parties, delays, interfaces and more.
The retainage concept has two general purposes: (1) To provide an incentive to the contractor or subcontractor to complete the project; and (2) To give the owner some protection against problems like liens, contractual defaults, delays, and more.
Some may argue that retainage practices further complicate the already cumbersome construction accounting process. This may be true, but it’s hard to imagine the construction industry without the use of retainage as it is a fairly effective way to accomplish the two above-stated goals. A great discussion of the pros and cons of retainage laws was published by the Surety & Fidelity Association of America in “Retainage: It Gets The Job Done.”
Retainage practices have now been built into United States law to both promote its use (in government contracts) and prevent its abuse (in private projects).
Why Retainage Laws and Practices Are Evil
The first section discusses why retainage laws and practices are necessary, but because I believe they are a “necessary evil,” I must now report on why they are evil. Retainage practices are problematic because they cause practical issues and personality issues within the construction world’s already complicated accounting and payment system.
First, practical issues. It is clear that cash flow is an issue in the industry. Cash suffocates construction businesses faster and more often than any other industry, as highlighted in the industry’s failure rates. The industry also has low profit margins, and in fact, the margin percentages are often times lower than the percentage of retainage withheld from a contractor. Do the math – retainage is a brutal cash flow issue in a brutal industry.
Second, retainage causes personality problems and opportunities for abuse. A few weeks ago I wrote a brilliant (yay!) article that discussed the various problems to getting paid in the construction industry, and one specific problem was “tempers.” It’s no secret that personalities complicate the construction process from start to finish and that better funded and more sophisticated parties take advantage of those further down the food chain.
Retainage laws provide another opportunity for abuse as contractors and subcontractors need the money pretty bad (see cash flow discussion above) and can probably be driven to negotiate for what they can get if those holding the money hold it long enough.
Legal Variables To Understand About Retainage Laws
Since retainage laws are “necessary” and “evil,” state lawmakers have made a plethora of attempts to balance the good and bad and creative a productive tool for the industry. Every state’s laws are different, of course. Nevertheless, they do follow a general formula.
On government projects the retainage is usually pretty controlled. The statutes usually require the government to retain a certain percentage for retainage and dictate when that retainage must be released. In some states, after a project is 50% complete, the retainage amount must decrease.
Since the government is regulating the government it usually presumes that there won’t be any abuses, and accordingly, there is little in the laws governing public retainage to punish the agency if there are any abuses or capricious action.
On private projects the retainage is less controlled, meaning that the state laws never require a party on a private project to hold back retainage. To the contrary, most retainage statutes applicable to private construction will serve the sole purpose of preventing abuses by providing punishments if retainage is held without authorization or if an unreasonable amount of retainage is withheld.
The challenge with the private laws is that those who need the retainage money the most won’t have the cash to fight for the penalties.
How do you keep up with which retainage laws apply to your project if it’s different in every state. Of course, this is a particular challenge for companies who operate in multiple jurisdictions. The American Subcontractors Association just released a 50-state Retainage Law Guidebook, which promises to be a pretty good desk manual for this stuff. They are also having a Webinar on “Negotiating Retainage” on April 9th, in the event you’re interested.
How To Get Your Hands On The Retainage Money
So, you’re entitled to retainage money and it’s being withheld from you? There are several strategies that contractors can use to get retainage back faster. You can make legal demands. You can file a lawsuit. The most effective way to get paid, however, may be to file a mechanics lien.
As we’ve discussed in the past, filing a mechanics lien is one of the most effective ways to get paid on a construction project, and this is especially applicable when you’re trying to get retainage money owed to you.
Plan For The Cash Impact
Don’t be silly. Know your numbers. The Construction Financial Management Association’s 2007 Construction Industry Annual Financial Survey reported that the company’s net earnings (before income taxes) for a specialty contractor was 2.9%. That’s a lot less than the retainage percentage often held. Don’t fool yourself into thinking you can float a project with 5% – 10% retainage when you’re working on a 2.9% margin and don’t have a mound of cash in the bank.
If you agree to a retainage percentage make sure it makes sense for your company. Otherwise, taking the project can be a lot more fatal than just not doing the job.
Make Sure Retainage Is Fairly Passed To You And Pass Retainage Holdback Down The Contracting Chain – Fairly
Retainage is what it is. If the general contractor is dealing with 5% retainage with the property owner, than it’s highly unlikely you’re going to get a contract without at least 5% retainage withheld. However, you should fight to make sure the retainage percentage is “equitable,” meaning it is the same percentage withheld up the chain.
Similarly, make sure you protect yourself by holding back retainage from your subs. Don’t get clever – just be fair about it and push the same percentage down the chain as is being imposed on you.
Perhaps there is a way to offset the retainage requirement on the project. Owners, developers and general contractors may be willing to negotiate the retainage percentage if your company’s reputation is good enough, or if you can offer some other type of security such as letters of credit, performance bonds, etc. I’ll admit, however, this is really tough.
One possible area for negotiation, however, is interest. In some states it is required that retainage gain interest in favor of the party for whom the retainage is withheld.
Mechanics Liens & Lawsuits: Get Serious If You Don’t Get Paid On Time
Don’t get pushed around with retainage. If you’re entitled to payment and the contractor or developer is withholding retainage funds, the law is strongly on your side. Now, you simply need to harness its power.
You can do this in two ways.
First, we love mechanics liens here, and you should too. A mechanics lien filing is the most effective and inexpensive way to get your company paid on a construction project. Fight fire with fire on the construction project if confronted with a non-payment situation like this and get your mechanics lien claim filed. Deciding if you can file a mechanics lien for retainage can be a bit of a mind twister because of timing issues, which we’ve discussed in the past respecting retainage issues and pay-when-paid clause issues, but the bottom line is that you need to file your lien within the lien timeframe for the value of your work.
Second, know which retainage laws apply to your situation. If you’re on a private project you are likely entitled to penalties, interests and attorney fees in the event retainage is being unlawfully withheld from you. Do not, however, include these amounts in your mechanics lien claim. You can include the retainage amount, because this relates to the work you actually performed, but it is highly unlikely that you can also include the ancillary debts (interest, penalties, attorney fees) in the claim itself even though you can recover these amounts in suit.