Retainage, also called retention, is common in the construction industry. Retainage is the percentage of payment that can be withheld from progress payments to contractors until construction has been satisfactorily completed. Retainage is intended to reduce the risk that contractors fail to timely and fully perform their contractual obligations (i.e., default).
The use of retainage can, and often does, have significant financial effects on contractors, particularly subcontractors performing work early in the construction process. These contractors may be unable to recover their complete contract price until many months later when the overall project reaches the designated contractual milestone (e.g., substantial completion). This waiting period is often criticized because, in essence, contractors are required to partially finance the underlying construction through interest-free retainage on labor, equipment, and material until construction has been satisfactorily completed.
Many jurisdictions, including Oregon, have attempted to strike a compromise between the interests of owners in protecting against contractor default and the interests of contractors in avoiding partially financing the underlying construction. Between 1969 and 1975, the Oregon Legislature passed laws that restricted the amount of retainage that could be withheld from progress payments and required payment of interest on retainage to contractors. ORS279.575 (1969), renumbered ORS 279.435 (1989); ORS 701.420 (1975). These laws created two separate legal frameworks for retainage, one for public projects and one for private projects, that lasted for nearly 30 years. During this time, the Oregon Legislature amended the framework for retainage on public projects ten different times, while leaving the framework for retainage on private projects unaltered.
In 2003, the Oregon Legislature merged the two frameworks, adopting the unaltered framework for retainage on private projects. ORS 279C.555 (2003). This merged framework remained substantively unchanged until 2019 when the Oregon Legislature considered whether to require retainage to be deposited into interest-bearing escrow accounts. The Oregon Legislature heard competing testimony from subcontractor associations and municipal and special district associations. The subcontractor associations supported the change, noting that retainage (and interest on retainage) was not being timely paid on projects. In contrast, the municipal and special district associations opposed the change, noting that an escrow requirement would create administrative issues by, among other things, adding complexity and cost. The Oregon Legislature sided with the subcontractor associations and passed House Bill 2415, under which retainage on private and public construction projects with contract prices exceeding $500,000 must now be placed in an “interest-bearing escrow account.” ORS 701.420(2)(b) (2020).
Unfortunately, the administrative concerns expressed by the municipal and special district associations quickly proved prescient. Many financial institutions proved unwilling to open escrow accounts for retainage without charging substantial fees—fees that often exceeded the amount of retainage interest. Claim disputes concerning retainage quickly expanded from whether (and how much) retainage was owing to whether retainage was being held in a statutorily compliant “escrow account” and whether the owner, contractor, or subcontractor should be responsible for paying associated “escrow account” fees. Notably, House Bill 2415 does not define “escrow account” or address responsibility for payment of fees attributable to such accounts.
Recognizing that House Bill 2415 created administrative issues, the Oregon Legislature introduced House Bill 2870 during the recent regular legislative session. As introduced, House Bill 2870 proposed amending the merged retainage framework by eliminating the “escrow account” requirement and otherwise entitling contractors and subcontractors to submit a retainage bond, also called a release of retainage bond, in lieu of retainage on all construction projects. Subsequent engrossed amendments proposed omitting smaller private construction projects from the retainage bond framework.
The retainage bond framework recently considered by the Oregon Legislature is similar to the long-standing framework in Washington State. RCW 39.08.010, 60.28.011. Under both frameworks, contractors and subcontractors are entitled to submit a retainage bond in lieu of retainage under most circumstances. This entitlement enables contractors and subcontractors to avoid waiting to recover their complete contract price until the project reaches the designated contractual milestone. If a contractor or subcontractor submits a retainage bond, the owner or contractor can assert retainage-related claims (e.g., incomplete or defective work) directly against the retainage bond itself.
Unlike House Bill 2415, House Bill 2870 received broad support from contractor and subcontractor associations and the Oregon State Bar Construction Law Section. The Oregon Legislature heard testimony from contractor and subcontractor associations, among others, that the “escrow account” requirement did not work and should be eliminated. The Oregon Legislature also heard testimony that financial institutions charged substantial fees to open and manage escrow accounts. Notwithstanding broad support and favorable testimony, the Oregon Legislature was unable to pass House Bill 2870, as amended, before the end of the recent regular legislative session.
Without legislative action, private and public construction projects in Oregon will continue to face claim disputes and other administrative issues attributable to House Bill 2415’s “escrow account” requirement. Fortunately, these types of disputes and issues are entirely avoidable if the Oregon Legislature reintroduces and passes legislation eliminating the “escrow account” requirement and establishing a retainage bond framework similar to the framework in Washington State. Such legislation is not controversial and has broad support amongst owners, contractors, and subcontractors.
This article summarizes aspects of the law and does not constitute legal advice. For legal advice for your situation, you should contact an attorney.
Column first appeared in the Oregon Daily Journal of Commerce on August 14, 2023.