Withholding retainage in the construction industry is a relatively common practice, no matter what the project. Given the fact that profit margins on construction projects are pretty thin, ensuring that the retainage clause is fair and reasonable is crucial to making a profit. A recent case in California emphasizes this point by allowing a prime contractor to refuse to pay retainage to a subcontractor who didn’t finish the work under the contract.
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Retainage as a contract provision
If you work in the construction industry, you should be very familiar with this term. Retainage is the practice of withholding a certain percentage of money from each progress payment until the project is complete. This is meant to act as an incentive by the owner or general contractor to ensure proper performance of the contract. However, close attention should be paid to these provisions. The amount being withheld, and how long those payments can be withheld are of the utmost importance.
Regency Midland Construction Co. v. Legendary Structures, Inc.
The case in question is Regency Midland Construction Co. v. Legendary Structures, Inc. Regency Midland Construction, Inc. was prime contractor on an apartment building project. Regency hired Legendary Structures, Inc. as a subcontractor to provide concrete work to the project. The contract between the two parties included a retainage clause, as most construction contracts do. This clause is the root of the problem.
The retainage clause in dispute
The original retainage clause read as follows, “Ten percent (10%) of Subcontractor’s contract amount shall be withheld and will be released 30 days after final completion of the building.” However, the parties, at the time of contract, they struck out this language.
It was replaced by “35 days after completion of subcontractors work.” Clearly this is a poorly worded clause, as (a) subcontractors wasn’t capitalized as a “defined term,” and (b) there is no apostrophe.
The subcontractor was eventually replaced
As the project progressed, Regency had paid Legendary around $1M, which represented 90% of the value of the work they had completed. Withholding 10% of the value which came out to around $125,000. Eventually, tensions rose between the parties, and they mutually agreed to have Legendary cease work.
Regency was forced to hire a replacement subcontractor to finish the work. Legendary then sent a demand letter for retainage, stating that they were owed the 10% withheld from the work in place. Regency refused, citing the retention clause.
Legendary tried to argue that the term “subcontractors” also included the replacement subcontractor; and that once the work was completed the withheld retainage should be released. On the other side of this argument, Regency posits that “subcontractors work” means Legendary’s scope of work which included the entire concrete job.
This case went to both trial court and appeals, this is what the appeals court had to say.
Court: Retainage is meant to ensure proper performance
Since none of the facts are in dispute, this issue was solely resolved by the contract terms themselves. Specifically the modified sentence in the contract that was initialed by both parties. Although the new clause was poorly worded and typed, this was ignored by the court. As there apparently were multiple typos and inconsistent capitalization scattered about the 2-page contract. It was determined by the court that the typos or misspellings were inconsequential.
Instead, the dispute was resolved by focusing on the purpose of retainage practices themselves. The point of retainage is to provide incentive to the contractor to ensure proper performance. The opinion goes on to state that, “There are many dimensions to proper performance. Two are to finish the job and to finish it swiftly.”
Here, Legendary didn’t even complete performance, let alone do so swiftly. Therefore, under the terms of the retention clause, Legendary was not entitled to the retainage payments.
Takeaway: Be Careful When Altering A Contract
If not for the change in language, Legendary would have likely had a better chance to recover the portion of retainage withheld. Altering your contract terms before taking time to consider the consequences is a dangerous proposition.
Since the clause was changed from “completion of the building” to “completion of the subcontractors work” they are bound by the terms they agreed to. Since they never completed the work, they had no right to recover retainage payments. Legendary was required to suffer the contractual consequences of the modified retainage clause.