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Regarding Retainage in Construction Projects: Our Guide

By Roy Rasmussen Reviewed By Mike Lucas
By Roy Rasmussen
By Roy Rasmussen Reviewed By Mike Lucas

What is retainage in construction? Understanding this concept is crucial for financial planning on construction projects. 

Learn about what retainage is, why it’s important and what rules govern retention payments.

What Is Retainage in Construction?

Retainage or retention is a portion of money owed for a construction project. This money is withheld until substantial completion of the project. A retention payment serves as an incentive for contractors and subcontractors to finish a project.

Why Is Retainage Important?

Retention money in construction contracts serves several purposes for those withholding retainage. Retainage primarily benefits property owners and contractors who are hiring other parties for labor or materials.

How?

  • By including a retention guarantee in construction contracts, property owners and contractors provide an incentive for other parties involved in the project to complete work on time
  • Retainage provides property owners and contractors with leverage in the event a project gets held up by lien claims from another party
  • Property owners and contractors may use money withheld for retainage to finance projects, supplementing cash flow

These benefits can make retainage agreements advantageous to property owners and general contractors.

How Retainage Affects Contractors

On the other side of the coin, those having retainage withheld from them may find that their cash flow suffers as a result. Subcontractors especially may find financing difficult. This is because contractors often withhold a greater amount of retainage from them to compensate for payments they’re waiting on themselves.

In light of this, many contractors and subcontractors charge higher rates or take other measures to offset retainage. This makes factoring in retainage a critical part of planning construction financing to avoid cash shortages.

A construction contractor wearing a hard hat is handed a stack of cash.

How Does Retainage Work?

Depending on the contractual arrangement, a retainage payment may be withheld by:

  • The property owner from a general contractor
  • A general contractor from subcontractors

Contractors who are having retainage withheld from them by property owners may in turn withhold retainage from subcontractors, delaying retainage payments to subcontractors until payments are received from property owners.

The amount of retainage withheld may be based on a percentage of a total contract fee or on a percentage of partial payments known as progress payments. It may be withheld from each payment as a partial or variable percentage until project completion or it may be withheld differently for different line items. 

For example, a contract may stipulate certain subcontractors who complete their work early in a project, such as subcontractors laying foundations, may receive their retainage payment when their contribution to the project achieves a designated benchmark without having to wait until retainage is released for the entire project.

Typically, retainage is released when a project is considered substantially complete, meaning that the property owner can take possession of the project or assume its use and occupation. Alternately, it may be released when the project achieves another designated milestone stipulated in the construction contract. 

Laws governing retention in construction vary by state. In some states, retainage is mandatory, but not in others. Some states allow contractors and subcontractors to use securities instead of retainage. A number of states allow retainage funds to be held in escrow and repaid with interest. In some states, property owners and contractors must reduce retainage rates or eliminate retainage after a certain amount of a project has been completed.

Retainage Receivable vs. Retainage Payable

When recording retainage for bookkeeping, it’s important to distinguish between retainage receivable and retainage payable. 

For a contractor, retention receivable construction funds consist of money that the contractor is owed by the property owner upon completion of a project. Retention payable funds consist of money that the contractor is obligated to pay subcontractors for retainage. These different categories of retainage should be recorded distinctly on your financial statements to keep your books accurate.

What Are the Rules of Retainage?

In general, retainage rules are governed by whatever the parties involved in a building project agree to in their construction contract. However, individual states may set varying restrictions on what types of retainage agreements are allowed. States also may issue penalties for violations of retainage regulations. 

For example, state regulations may set maximum retainage rate caps, prescribe conditions when retainage must be released and establish interest penalties when retainage caps are exceeded.

For federal contractors, retainage rules are governed by the Federal Acquisition Regulation (FAR), the set of regulations governing the procurement of U.S. government contracts. Under the FAR, the Code of Federal Regulations Title 48 Section 52.232-5 stipulates that progress payments normally should be made in full, with retainage reserved for cases where satisfactory progress has not been achieved and capped at 10%.

How Much Retainage Should Be Withheld?

The average amount of retainage withheld on private construction projects is 7.59%, according to a Clemson University study. For state projects the average is 5.56% and for federal projects the average is 3.26%. Applicable state and federal regulations should be considered when setting retainage rates.

A stack of money rests next to a hard hat.

How Long Should Retainage Be Withheld?

How long retainage should be withheld is determined by your construction contract retention provisions, subject to any applicable regulatory restrictions. With typical contracts, retainage is withheld to the substantial completion of the project.

For practical purposes, this means that retainage may be withheld for months. On average, it takes 99 days after project completion for general contractors to receive retainage payments, according to the Clemson study. In some cases, it took as much as 365 days. For subcontractors, the average time was 167 days, while some cases took as long as 529 days.

How Can You Negotiate Retainage in Construction Contacts?

To reduce the risk of late retainage payments, you can attempt to negotiate more favorable retainage clauses into your construction contract. 

Have your attorney review your contract and consider items such as:

  • Is your contract in conformity with applicable state regulations?
  • Will your retainage be held in escrow?
  • What percentage will be withheld?
  • Will withheld retainage earn interest, and if so, who’s entitled to it?
  • What are the conditions for the release of your retainage?
  • Can another project participant use retainage funds to compensate for unsatisfactory workmanship claims?
  • Can the property owner use retainage funds to offset collateral claims against the property for unpaid payments (known as discharging a lien claim)?

Identify items you’re concerned about and consider negotiating them with your client. You may be able to offer an alternative to retainage, such as a letter of credit, surety bond or retainage bond.

What Happens When Someone Won’t Release Retainage Payments?

Say a party on a construction project won’t release their retainage payment to you. If so, the first step is to verify that the work is complete. 

Providing documentation of task completion throughout the project can put you in a stronger position to:

  • Demonstrate project completion
  • Negotiate retainage release

Claiming a Mechanic’s Lien

If this fails to trigger retainage release, you may need to exercise your right to claim the property as collateral for unpaid payments. This process is known as claiming a mechanic’s lien.  A lien is a claim against a property title asserting the right to sell the property as collateral to pay for unpaid debts. Such a claim puts the title to the property in dispute, making it difficult to refinance or sell. 

This provides a strong incentive for property owners and others involved in the payment chain to get retainage disputes settled.

Before you can claim a lien, you may have to first follow some preliminary procedures. At the start of a project, a best practice is to send a notification called a preliminary notice that establishes your right to declare a lien in the event of nonpayment. In some states under specific conditions, this may be required in order for you to declare a lien later.

When nonpayment actually happens, a best practice is to send a notification called a notice of intent to lien, announcing that you will exercise your right to declare a lien if payment is not received by a deadline. In some states, this is required before you can declare a mechanic’s lien.

Factor Retainage Into Your Financial Planning

Retainage is a percentage of money held back on construction projects by property owners or contractors until substantial completion of the project. It provides a financial incentive for contractors and subcontractors to complete projects. It protects the interests of the party holding back the retainage. However, it can create cash-flow issues for parties waiting to receive funds.

To reduce retainage issues, work with your attorney to negotiate favorable contractual terms. If a client is slow to release retainage payments, seek to negotiate release by providing documentation of completed work. Should this fail, consult with your attorney about whether pursuing a mechanic’s lien is advisable.

Avoiding retainage problems also requires good financial planning to prevent cash-flow crunches. Construction financing strategies such as equipment financing can help you improve your financial planning. Take a few minutes to fill out our free, no-obligation prequalifying application and find out what types of financing may be available to you.

Roy Rasmussen Contributing Writer for Fast Capital 360
Roy is a respected, published author on topics including business coaching, small business management and business automation as well as an expert business plan writer and strategist.
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