Retainage

Retainage is a portion of the agreed upon contract price deliberately withheld until the work is substantially complete to assure that contractor or subcontractor will satisfy its obligations and complete a construction project.

The practice of retainage dates back to the construction of the United Kingdom railway system in the 1840s. The size of the railway project increased demand for contractors, which led to the entrance of new contractors into the labor market. These new contractors were inexperienced, unqualified and unable to successfully complete the project. Consequently, the railway companies began to withhold as much as 20% of contractors' payments to ensure performance and offset completion costs should the contractor default. The point was to withhold the contractor's profit only, not to make the contractor and its subcontractors finance the project.

Given the often large-scale, complexity, cost and length of construction projects, the risk of something not going according to plan is almost certain. Accordingly, a common approach that contracting parties take in order to mitigate this risk is to include retainage provisions within their agreements. The concept of retainage is unique to the construction industry and attempts to do two things: provide an incentive to the contractor or subcontractor to complete the project and protect the owner against any liens, claims or defaults, which may surface as the project nears completion. Incidentally, owners and contractors use retainage as a source of financing for the project, contractors in turn withhold retainage from subcontractors, frequently at a greater percentage than is being withheld from them.

If there is to be retainage on the construction project, it is set forth in the construction contract. Retainage provisions are applicable to subcontracts as well as prime contracts. The amount withheld from the contractor or subcontractor should be determined on a case-by-case basis by the parties negotiating the contract, usually based upon such factors as past performance and the likelihood that the contractor or subcontractor will perform well under the contract.

One can structure retainage arrangements in any number of ways. Subject to state statutory requirements, 10% is the retainage amount most often used by contracting parties. Another approach is to start off with a 10% retainage and to reduce it to 5% once the project is 50% complete. A third approach is to carve out material costs from a withholding requirement on the theory that suppliers, unlike subcontractors, may not accept retainage provisions in their purchase orders.

Retainage clauses are usually found within the contract terms outlining the procedure for submitting payment applications. A typical retainage clause parallels the following language: "Owner shall pay the amount due on the Payment Application less retainage of [a specific percentage]."

Retainage is generally due to the contractor or subcontractor once his work is substantially complete. Disputes often arise regarding just when substantial completion occurs. The standard analysis finds the event triggered when the owner can occupy a structure and use it for its intended purpose.

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Wikipedia