Retainage can be a touchy subject. It’s a percentage of the contracted amount that’s withheld from contractors until the project reaches substantial completion. Project owners appreciate it for the upper hand and assurance it provides them, while contractors and subcontractors would prefer to get paid and move on.
But, if we look at construction retainage objectively, it’s an integral aspect of construction. It’s a safety net that ensures projects are delivered according to the contract. In this guide, we’ll break down how retainage works and why it’s important to construction projects.
What Is Retainage and Why Is It Used?
Construction retainage is a percentage of a contractor’s total payment that is withheld until the project reaches substantial completion. Essentially, the project owner holds some of each contractor's payment and then releases it when the project is completed.
Retainage is a built-in, completely legal way for the project owner to buy a bit of insurance. The percentage withheld from each progress payment is around 5% to 10% (though the amount can vary). This incentivizes the contractor to deliver the project to the contractual obligations to get paid.
But retainage must be a “reasonable amount.” To ensure this, legal frameworks such as Prompt Payment laws can dictate how much can be retained and when the payment must be made. This ensures fairness and prevents project owners from abusing retainage.
Impacts of Retainage on Project Stakeholders
Retainage benefits project owners the most. However, it does impact everyone to some extent, including the project owner.
Retainage Impact for Project Owners
Retainage provides peace of mind for project owners. They’re able to leverage the 5% to 10% as a carrot on a stick to ensure the contractor meets the contract requirements. However, if they mismanage it or abuse it, project owners can quickly find themselves dealing with a payment dispute or lien on the property.
Retainage for Contractors
When used correctly, retainage is typically accepted by contractors, but the general contractor has the largest amount withheld. Since construction is cash-hungry, having their entire profit margin withheld makes it difficult to take on projects without loan interest. This can sometimes cause disputes or liens.
Retainage for Subs
The payment flow starts with the project owner, flows to the general contractor (GC), and then to the subcontractors. Contractors will often pass the retainage down the chain, withholding retainage from subcontractors until their portion of the project is complete.
This can cause disputes. A sub’s contract is usually smaller and shorter, so when the GC doesn’t pay them until the larger project is completed, they may file liens against the property. This is the core reason why Prompt Payment Laws exist.
Challenges in Managing Retainage
If you’re noticing a theme, it’s that retainage is accepted when managed properly. However, when it’s misused or mismanaged, challenges arise. Common issues include:
- Payment disputes: Definitions of terms like “reasonable amount,” “substantial completion,” or even “defective work” can vary. If the contractor thinks the work is completed and isn’t paid, disputes and liens can arise.
- Delayed payments: Retainage is a large amount, and large payments are often slow and complicated, delaying the payment process.
- Accounting challenges: Tracking the retainage amounts across multiple projects and contracts is difficult for everyone, including project owners, contractors, and subcontractors.
- Strained relationships: Retainage can disrupt project timelines, sour professional relationships, and create cash flow issues for contractors and subcontractors.
Strategies for Effective Retainage Management
Knowing that retainage can be both a useful tool and a detriment to the project, it has to be managed properly. The following are some helpful tips for avoiding challenges and disputes with retainage.
- Communicate clearly: Set a clear retainage amount and explain important aspects, such as what substantial completion and defective work mean and when retainage will be released. Also, make sure to outline dispute resolution methods, and put it all in the contract.
- Keep detailed records: Keep accurate records of retainage amounts, payment schedules, and the contract requirements agreed upon. If there are change orders, make sure they’re accounted for.
- Leverage technology: Construction management software can track progress, payments, account for retainage, and submit accurate invoices or fast electronic payments to foster transparency.
- Explore alternatives: While retainage is the most common tool, there are other options like performance bonds, a letter of credit, escrow accounts, or even parent company guarantees.
Navigating Retainage-Related Disputes
While disputes over retainage aren’t exactly inevitable, they do happen. They don’t have to derail your project, though. Here’s how to handle them:
- Start with open communication: Clear, honest communication can avoid most disputes. Discuss the issue and work together to find a solution.
- Use mediation or arbitration: When communication doesn’t lead to an agreement, try mediation or arbitration. Both of these options can be less contentious than legal action.
- Keep detailed documentation: Being able to fall back on contract documents, emails, and progress reports can help. Make sure to take pictures of completed projects and create detailed reports throughout. Tech-powered document management can be a big help.
- Understand the power of liens: When all else fails, a contractor can file a lien against the property for unpaid retainage. This certainly swings the power back into the contractor’s side of the court, but it could also cause more delays and payment problems throughout the project.
Best Practices for Successful Retainage Management
Retainage can become a headache if you let it. Here are some best practices that project owners, contractors, and subcontractors should consider:
- Set clear terms: Make sure that all of the important terms and conditions around retainage are clearly defined and documented. Be clear about percentages, release conditions, and payment timelines.
- Monitor and document progress: Whether you’re a project owner or contractor, stay on top of the project’s status. Perform site inspections, complete daily reports, and take detailed pictures.
- Be proactive: Stay ahead of potential disputes or delays so you can resolve them before they become an issue. In this case, an ounce of prevention is worth a pound of cure.
- Adopt technology: Construction management software tools can simplify accounts payable and receivable, allowing contractors and project owners to better track their retainage amounts.
By following these practices, both owners and contractors can navigate retainage with minimal friction and maximum efficiency.
Being Smart with Your Retainage Practices Matters
Ultimately, retainage is a part of the construction industry, and only avoidable with a few less-popular alternatives. But, by understanding its impact across all stakeholder on a project and using best practices, contractors and project owners can avoid disputes and treat each other fairly. By being proactive, fostering clear communication, and leveraging powerful software tools, contracted parties can work as a team and push forward for more successful project outcomes.
