Tennessee opens the door to looser retainage requirements

Retainage: Love it or hate it, it’s part of the construction industry. Most contracts provide for some sort of retainage to be withheld. Given the inherent risk of abuse with retainage practices, many states have enacted strict limits and requirements regarding its use – including Tennessee. Yet, a recent Court of Appeals case more or less exposed a loophole to avoid the Tennessee retainage requirements.

Tennessee retainage requirements & penalties

Retainage, under Tennessee law, is governed by the TN Prompt Payment Act. Specifically, under Tenn. Code §66-34-104; which states:

(a) Whenever, in any contract for improvement of real property, a certain amount or percentage of the contract price is retained, the retained amount shall be deposited in a separate, interest bearing, escrow account with a third party…

This provision means that if a GC or property owner holds retainage from a construction contract, they must put it in an interest-bearing account. It must be in escrow with a third party (they can’t hold it themselves) until the contract conditions are met.

Tennessee takes construction retainage very seriously. Violations come with both civil and criminal penalties. Failure to comply can result in civil penalties of $300 per day, for each day the retained funds aren’t deposited into such an escrow account. Furthermore, the party can also be criminally charged with a Class A misdemeanor. These types of crimes are punishable by up to over 11 months and in jail, or a fine of $25,000. Or both!

However, a recent Court of Appeals case appears to have validated a bypass of Tennessee retainage requirements.

A case of “hidden retainage”

The case in question is Vic Davis Construction, Inc. v. Lauren Engineers & Constructors, Inc. 

Project Snapshot

  • Owner: BAE Systems Ordnance Systems, Inc. (BAE)
  • General contractor: Lauren Engineers & Constructors, Inc. (Lauren)
  • Subcontractor: Vic Davis Construction, Inc. (Vic Davis)

BAE hired Lauren as a prime contractor to do work on an ammunition plant. Lauren then hired Vic Davis as a subcontractor to do underground piping and paving on the project. During negotiations over the subcontract, Lauren referred to “holdbacks” in the amount of 10% of the total contract price. Vic Davis objected, stating that under TN law retainage couldn’t exceed 5% of the contract amount. The final contract specifically stated that no retainage would be withheld from any invoices. However, there was a line item labeled “Turn-over, As-Builts, Final Clean Up, Demobilize.” Which, coincidentally, represented 5% of the total contract.

As the project progressed, numerous issues arose. Eventually, Vic Davis filed a lawsuit for breach of contract, breach of the implied duty of good faith and fair dealing, and (for the purposes of this article), violation of the Prompt Payment Act.

Vic Davis alleged that Lauren failed to deposit retainage in an interest-bearing, escrow account. As a result, they were seeking the statutory $300-per-day penalties. The trial court ruled that Vic Davis wasn’t entitled to those damages because the subcontract didn’t, in fact, provide for retainage.

Vic Davis appealed.

TN Court of Appeals: What retainage? We don’t see retainage!

On the issue of the Tennessee retainage requirements, the Court of Appeals agreed with the trial court. The term “retainage” refers to a percentage of the contract price withheld until the completion and acceptance of the work under the contract. Because they assigned the value to the line item “Turn-over, As-Builts, Final Clean Up, Demobilize,” the court said it didn’t count as retainage. Lauren was able to withhold payment at will, without being scrutinized under Tennessee’s strict retainage laws.

The appeals court seems to acknowledge that holding an entire payment doesn’t constitute retainage. Furthermore, the contract explicitly stated that no retainage would be withheld from invoices. And, in fact, retainage was not withheld from each progress payment. (Instead, Lauren withheld the value of a full line item amount…that was equivalent to the maximum amount of retainage allowed under TN law…)

In addition, the court went on to state that it’s not the role of the courts to rewrite contracts or include protections for those who didn’t speak up at the time of contracting. Lastly, since the contract included an integration clause, the parole evidence rule barred any discussions or negotiations from affecting the terms of the contract itself.

Tennessee contractors: Be careful

This result, frankly, is cause for concern. The freedom to contract is an important one; there’s no denying that. However, the prompt payment provisions, including the Tennessee retainage requirements, were enacted to protect contractors and subs. The outcome of this case essentially acknowledges the fact that, under the current retainage provisions, GC’s and owners can withhold retainage…as long as they don’t call it “retainage.” And if they don’t call it retainage, they apparently don’t have to abide by the state’s prompt payment retainage requirements.

Contractors and subs on Tennessee construction projects should read their contracts carefully. Even if the language states that no retainage will be withheld, clever contract drafting can still provide for it (indirectly).