The events resulted in state legislatures aided by lobbying groups wading into the area of regulating retainage, which is normally the subject of contract negotiations among sophisticated commercial construction industry players.
Most of these laws have been passed for the protection of subcontractors. Some have required that a project retainage escrow account be set up and funded with actual dollars. Any contract provision to the contrary is void and against public policy. Some states, such as Tennessee, have criminalized retainage violations and provided a hefty civil penalty e. Tennessee statutory law even regulates when retainage must be paid by an owner to a prime contractor, regardless of any contrary contract provision.
Because of these considerations, even on private projects, more discussions about retainage are occurring on the front end of a project. The bottom line: An independent evaluation should take place on the front end by the major players i. Gone should be the days when, as a matter of course, in any form loan agreement or construction contact, retainage is always withheld.
Federal laws and state laws differ when it comes to retainage limitations. Retainage laws also vary based on the type of project you are contracted for.
Factors that influence the likelihood of retention There are a variety of factors that can increase the likelihood of retention on a construction project, including: Larger project scope Longer project timeline Newer client relationship Reputation of the contractor Additionally, private projects often have higher retainage rates than federal and state projects. How much retainage is normally withheld? The amount of money withheld can be determined as: A retainage percentage of the total estimated project cost or contract value A specific dollar amount, without factoring in the actual cost of the project However, a total percentage is usually the preferred method for determining the amount withheld.
How long is retainage withheld? Can clients withhold retainage after a project is completed? Can retainage be released early? Challenges of retainage: How retention impacts contractors and subcontractors As mentioned, retainage can cause hardship on contractors and subcontractors. Understanding retainage laws: Legal limitations on retainage As mentioned, retainage can present a lot of financial risk that applies to all parties involved.
Private projects Private projects—those performed for private entities like individual homeowners—are held to different standards than public projects. Public works projects Public works projects are for the government. Here are some important federal laws that apply to public works projects that you should know: According to the Federal Acquisition Regulation FAR , funds should not be withheld without cause. FAR also stipulates that a prime contractor can set retainage with a contractor but cannot bill the government for retainage.
Certain projects may prohibit subcontractor retainage because of how long it would take them to get paid for their work. State, county, and municipal projects In general, the laws regarding retainage for state, county, and municipal projects tend to be less strict.
Consider factoring retainage into your initial contract price. Carefully manage your cash flow. Use a reliable accounting software. Establish a substantial business savings account. Final takeaways Retainage is an additional layer of complexity that contractors must learn to navigate. This content is for information purposes only and should not be considered legal, accounting or tax advice, or a substitute for obtaining such advice specific to your business. Additional information and exceptions may apply.
Applicable laws may vary by state or locality. Intuit Inc. Accordingly, the information provided should not be relied upon as a substitute for independent research.
When the retainage terms are met, the money is released and paid to the contractor, who then must pay withheld money to subcontractors. Sometimes, retainage may be determined based on the stage of the project, where the percentages vary depending on construction benchmarks.
The details and percentage of retainage can vary from job to job and from state to state for public projects. State regulations governing holding time of retainage vary for both public and private jobs. Retainage is meant to encourage productivity and efficiency. It provides financial incentive for a contractor to finish the job and do it well.
Many consider it the most effective insurance policy an owner has over contractors, and contractors over subcontractors and suppliers. Retainage may be most important in the last stages of a project. For the owner, retainage provides funds should a contractor or subcontractor default on the job. But for contractors, retainage can lead to cash flow concerns. As they wait to receive their full fees for one project, they still must pay their employees their full wages, make insurance payments, buy supplies and equipment and finance new projects.
Overcoming cash flow concerns can be a major hurdle, especially for small businesses. And tight cash flow can lead to tensions in business relationships and dealings.
This elevated the demand for contractors in the midth century labor market. Many of the people who filled the void lacked necessary experience, qualifications and skill sets to complete their jobs properly.
If they leave without warning, having to unexpectedly replace contractors and other workers was time-consuming and expensive. Retainage helped guard against those costs. It also provides a financial incentive for the contractor to see the project through to its successful finish. Withheld funds act as a safeguard for everyone involved in the project, from the owner on down through subcontractors and suppliers.
The agreed-on terms of a construction contract dictate the specifics of retainage, such as percentage withheld, how much is withheld with each payment and when the funds can be released. Keep in mind, most states have set some legal limitations. Those limits may differ if it is a federal project, a state or county project or a private project. In practice, though, it often scales lower and includes gradual reduction as construction benchmarks are reached.
A contractor also may use retainage with subcontractors, even if the government is not doing so with them. This, in effect, creates an unofficial retainage by the government. When it comes to state, county and municipal projects, some states actually require retainage while others set limitations. In some states, withheld funds are defined as a percentage of the total contract price, not of each payment.
So, depending on how the payment plan is structured, a project could reach the maximum retainage amount early and then not have any other funds held back in the final payments. Retainage limitations on private projects would vary by state. Many in the construction industry may not want to use retainage, yet it remains one of the best way to secure substantial completion of a project and protect the owner in case a contractor defaults on the job.
Contractors who have money withheld by the project owner should also use retainage with their subcontractors to mirror the protection that the owner has established.
Passing retainage down the line helps contractors better manage cash flow and incentivizes subcontractors to complete their portions of the job. Other best practices for construction accounting can help contractors and subcontractors reduce the burden of held back funds. Retainage affects the entire construction chain. And while the notion of withholding money may seem unfair, the process of retainage does offer benefits, even for contractors and others involved in the project.
That makes an impact on how companies manage their finances and working relationships. While retainage has its pros, it also has its share of controversy and negative feelings. After all, when you complete a job, you want to be properly and fully compensated in a timely fashion.
Retainage can get in the way of that payment. And depending on when your work was done on the project, you may disproportionately feel those effects. Retainage may be fixed or variable, depending on the terms of the contract. With variable retainage, the percentage can change based on the stage of project completion.
The construction industry has an unusual payment process. These go beyond a simple invoice. They typically include progress reports of the completed work and materials delivered, subcontractor invoices, schedules of work still to be done, photos and payroll receipts, among other documents.
This means that the lien deadline may pass well before a retention payment is due. Contractors often have to decide whether to file a lien or hope that their hiring party follows through on their agreement.
In some cases, states do make specific exceptions for retainage liens. In Texas, contractors can send a Notice of Contractual Retainage to the property owner within 30 days of completing their contract in order to reserve the right to file a lien on the retained funds. Some surety companies offer retention bonds, which is essentially an insurance policy that takes the place of retainage as a guarantee of workmanship.
A subcontractor may be able to negotiate an agreement in which they purchase a retention bond instead of having funds withheld from their payments. If an issue later arises for which the hiring party would have used retainage to cover the cost, the surety company steps in to pay. At the end of the day, construction businesses have a legal right to collect payment for work or materials they provide.
Retainage is no different. Contractors need to understand all of their rights, responsibilities, and options when it comes to negotiating retention, and collecting it after the job is done. If you found this blog post helpful and want to learn more about construction payments, check out the following content from Levelset:.
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