The purpose of retainage is to assure completion. The retained amount gives the owner security in the event the contractor or subcontractor refuses to fully complete its work. At the same time, receipt of that retained amount provides the contractor or subcontractor some incentive to get the last punchlist items finished.
The problem comes when an owner (or contractor) insists on excessive retainage or tries to hold it too long. Contractors and subcontractors are not bankers and should not be required to finance construction. That's the result when excessive retainage is withheld indefinitely because retainage represents payment for work already completed. In the long run, excessive retainage drives up the price of construction to reflect increased financing costs incurred by contractors. In the short term it impedes the cash flow of contractors and subcontractors struggling to remain competitive. In some instances it can spell ruin.
On public projects in Massachusetts the problem is addressed by statutes governing payments. Retainage is limited to 5% on the general contract and on filed and owner approved subcontracts. And the public owner must release retainage held on that subcontract work within 65 days of each subcontractor reaching substantial completion, and must release the general contractor's retainage within 65 days of substantial completion by the general contractor. The general contractor is statutorily required to pay subcontractors' retainage immediately after receipt from the owner. The only amount that may be withheld following substantial completion of subcontract and general contract work are amounts equal to the value of any claims or remaining punch list items. This statutory procedure requires release of retainage piecemeal as the work gets completed, rather than in one lump sum long after most of the major components of the project are fully complete.
On private work there are no statutes governing retainage. It is all a matter of negotiation. But the objective should be similar to that achieved on public work which is to limit retainage to its proper purpose of securing completion, and to insure prompt payment to contractors and subcontractors following completion of their work.
Because retainage functions as a form of completion security, the retained percentage should reflect other available security. Where the contractor or subcontractor provides a performance bond guaranteeing completion, the need for retainage is substantially reduced and the retained percentage should be lower than where no bond is provided. In that circumstance, it should never exceed 5% and should perhaps be lower.
On private work, subcontractors are not able to influence the percent retained by the owner under the general contract, but should limit retainage under their subcontract to an amount no greater than that withheld by the owner from the contractor. Except where a subcontractor is unbondable, it is unfair for a general contractor to hold retainage on a subcontractor in excess of that being withheld by the owner on account of the subcontractor's work. This could happen if the general contract requires only 5% retainage while the subcontract provides for retainage of 10%; or if the general contract provides for reduction of retainage when completion reaches a certain point, while the subcontract contains no provision for reduction. In both circumstances the contractor gets free use of money earned by subcontractors.
Both contractors and subcontractors should insist on contract provisions requiring release of retainage as the work of major trades is completed. To allow the owner to withhold all retainage on all work performed under the general contract until all work is 100% complete serves no legitimate purpose. It simply allows the owner to hold funds far in excess of those needed to insure completion; and it bestows an unearned economic benefit on the owner at the expense of those who spent their money to get the work done. In effect, such withholding unfairly transfers the cost of financing from the owner to the contractors.
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