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Retainage Debate Likely to Restart Soon

February 1, 2013

Overview

Few issues in recent years have raised so many questions and caused so much consternation in the world of construction contracting as the issue of progress payment retainage. Retainage is money that is owed by an upstream contracting party to a downstream party, but "retained" until the final payment on a construction project is delivered.

The reasons for retainage are many: ensuring satisfactory completion; protecting against the risk of potential default; protecting against the need to correct defective work; protecting against risks presented by third parties. Thus, for the upstream party, retainage provides a useful tool for hedging against risk.

For the downstream party, retainage is viewed in a much different light. For subcontractors, the retainage withheld by prime contractors often represents all of the subcontractor's profit on a given project. When multiplied over several projects – and particularly in light of the smaller margins caused by the recession – the amount of retainage withheld can be significant and have a substantially negative impact on operations.

The law on retainage is relatively straightforward. In circumstances where the contractor/subcontractor has provided a payment and performance bond, the maximum amount that the upstream party can withhold is 5 percent of the total amount of a given progress payment.

However, in circumstances where there is no bond in place, the amount that can be withheld as retainage is subject to negotiation between the parties. Because there is a law that mandates payment and performance bonds on public improvement projects in most circumstances, retainage withheld by public agencies is rarely more than 5 percent, and in the case of highway projects administered by ODOT, the amount is often less.

There is no real "standard" amount of retainage on un-bonded private projects. Many lenders require 10 percent retainage be withheld from prime contractors, and many primes withhold the same amount from un-bonded subcontractors. However, many withhold a significantly higher amount of retainage, and some have called 10 percent retainage on un-bonded subcontractors the "standard" – though this is largely based on perception and anecdote.

In 2013, the issue of retainage is likely to be taken up by the Legislature. This is at the behest of trade organizations that assert that the amount of retainage that can be withheld on any progress payment, regardless of contractual role and regardless of whether a payment and performance bond is in place, should be capped at 5 percent.

This is not the first time the retainage issue has arisen recently. In 2011, a limitation on retainage was proposed as part of a larger bill addressing other aspects of public contracting. That bill did not pass.

Going farther back, to the mid-1970s, the policy debate about the merits of allowing retainage versus restricting it were very similar to the issues being discussed today. Advocates in favor of allowing retainage to be decided by the parties pointed to the risks that prime contractors and owners undertake when agreeing to pay large sums of money to lower-tier contractors. Those primes and owners assume the risks without guarantees that those parties will be in a position to complete their work, correct deficient work, or pay their own subcontractors and suppliers. Thus, they argued, retainage was necessary to protect the upstream parties against defaults in performance, to pay claims and to ensure that any deficiencies could be corrected.

Conversely, the opponents argued that retainage is a drain on cash flow, monies withheld for retainage were misused, final payments were often improperly delayed, and ultimately the idea of retainage was fundamentally unfair.

In the end, the two sides reached a compromise, leading to the existing law: Retainage on bonded work is capped at 5 percent, and retainage on non-bonded work is subject to negotiation between the parties.

That compromise is what will be front and center in the debate that will likely take place in 2013, and the echoes of 1975 will surface in the halls of the state capitol as the same arguments are made by both sides again. How the Legislature will respond, and where a compromise may result, is anyone's guess.

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