Most contractors will encounter retainage within their construction contracts—the practice is common in the construction industry. However, many contractors and owners don’t fully understand retainage and how it applies to their construction projects, leaving them with cash flow issues or unsure of what to do to get final approval to release their full payment.
Further confusing the matter, retainage rules may change by geographical location, impacting the administration of the construction contract. All construction stakeholders should understand the concept of retainage and how it applies to their construction contracts so they can manage their cash flow effectively and know when to expect retainage to be released.
What is retainage in construction?
Retainage, also known as retention or holdback, is a percentage of a contractor payment that the owner or general contractor keeps until the project reaches a specific milestone. The amount of pay withheld for retainage varies, but it is generally between 5% and 10% of the progress payment it’s applied to.
Because retainage is money the owner or GC keeps until they’re satisfied with the work, it acts as a lever owners and general contractors can use to ensure a contractor has completed the job as agreed before releasing the final payment. If retainage is to be applied to a project, the exact rules for its use will appear in the original construction contract.
Why include retainage in construction contracts?
Retainage is a tool that owners can use to encourage contractors to complete a construction project as agreed. When used well, it offers a chance for the owner to give final approval of quality work, and gives contractors and subcontractors a financial incentive to finish a job before moving on.
How does location impact retainage laws?
Some states put limits on the amount of retainage owners and GCs can hold, and the rules depend on whether the owner is a private citizen or company or a public entity like a municipality.
While some states, like Texas, Illinois, and North Dakota, set specific limits that retainage cannot exceed, others stipulate that the retainage amount must be “reasonable.”
Construction contracts that stipulate retainage greater than what’s allowed by state limits, or that violate prompt payment laws will be superseded by state laws.
Common issues with retainage
While retainage is a common practice in construction, it has its drawbacks for construction companies and the industry as a whole.
Paperwork overload
There’s a lot that goes into each and every construction payment. Retainage adds another layer of complexity to construction accounting and bookkeeping, and additional administrative burden for everybody involved. In some states, retained funds are required to be held in an escrow account, where interest could accrue while the contractor waits for them.
Delayed payments
Cash flow and working capital are common worries for contractors as they navigate each project’s payment cycle. Retainage may further impact contractors’ finances as they await payment for work they’ve already done – in some cases, a contractor has to wait for payment until substantial completion of the entire project is completed, not just the section the contractor has worked on. Contractors who participate in the early part of the project could be waiting several months before being eligible for payment, which can make cash flow management difficult.
Retainage disputes
Construction contracts need to lay down exact rules for how retainage applies to each project. Still, the process leaves lots of room for disputes over an owner or GC who is withholding retainage and when the payment should be released.
A contractor filing a mechanics lien against a property may be able to include retainage receivables that aren’t due yet, which could cause further animosity between construction stakeholders.
Best practices for managing retention payments
Some of the problems stemming from retainage can be alleviated with effective business processes, which can ensure both parties to a contract fully understand what they’ve agreed to do and take complete records as the project progresses.
1. Proper documentation and record-keeping
Disputes over retainage payments may result from an unhappy or distrustful customer. Contractors must ensure they have completed the project as contracted before expecting retained funds to be released. Once a dispute begins, the contractor will rely on records of their work and costs incurred to push for holdback to be released, and the more complete and organized those records are, the better.
Integrated software systems can help ensure records are easily accessible and easy to find. Truss tracks payments as they’re made to vendors, and integrates with construction accounting software to make financial record-keeping automatic from invoice creation through reconciliation.
2. Negotiate a workable contract
The retainage rules that apply to each project will be outlined in contract documents. Contractors must read and understand all sections of the contract, and the contract should attempt to provide an answer to as many possible scenarios as possible.
Contractors then have to read the retainage policy and plan out each stage of the project to ensure that they can maintain a healthy cash flow if the retainage funds are delayed. Keep in mind that, as with anything in the contract documents, the retainage clause is negotiable. Consider asking for a lower retainage percentage or including stipulations for exactly when payment will come.
Also, note whether retainage funds will be held in escrow and whether they will earn interest until retainage release.
3. Streamline cash flow
Once the payment plan is set in the contract, contractors must carefully manage cash flow so that there’s enough coming in to keep funding project activities until project completion. Smoothing out the receivables process so that funds can be accessed soon after the receipt of payment can help improve cash flow for more seamless project activity.
Truss can help contractors process incoming payments faster by giving them the ability to accept ACH and card payments for free and access funds immediately after they’re sent.
4. Implement progress payments
Most construction projects use progress payments to break up the total cost of construction into more manageable chunks. Progress payments are issued at regular intervals of project progression or along a predetermined timeline and payment terms, and they help alleviate the financial burden of both the owner and the contractor. While project owners face reduced risk throughout a project, contractors can maintain financial stability throughout the project.
Truss simplifies progress payments by allowing users to pay partial invoices using different payment methods, tracking all progress payments associated with an invoice in one place. Both sender and receiver can view paid and outstanding amounts, reducing friction throughout the payment process.
5. Use lien rights to advocate for payment
Retainage provides the owner with some insurance that a contractor will complete the job as contracted, but the cards aren’t all stacked in the owner’s deck. Contractors may still have lien rights they can use to encourage the owner to release a retainage payment. If a contractor is prepared to file a lien against a property, the first step should be to send a preliminary notice signalling the intention to do so.
Note that while all owed money is covered by lien rights, the lien filing deadline won’t be extended just because some funds are being held back. Some construction contracts allow the GC a year after a project’s successful completion to release holdback, which can make it difficult to leverage lien rights.
It’s never a bad idea to consult a lawyer who specializes in construction law to check over a contract before signing it, or in case of any dispute. Laws regarding retainage change by state, so an expert can help navigate the nuances to avoid issues of nonpayment.
Always use due diligence and fast payment processes
Construction retainage is considered normal, but it can have an adversarial edge to it. Contractors and subcontractors should read their contracts thoroughly to understand their rights and responsibilities. Contractors can sell their stellar past histories, phenomenal credit scores, or relationship with the client to argue for more favorable contract terms, and seek legal advice for any uncertainties or for dispute resolution.
Whatever the retainage agreements are in place, contractors should streamline both sent and received payments to keep cash moving and construction projects operational. Truss makes receiving and sending payments simple – send clients digital invoices with payment links that can lead them to pay right through their own bank’s interface. Pay vendors quickly and easily with no more information than an email address, and they can access funds immediately.
