Understanding Retainage

September 11, 2024

What is retainage?

Retainage, or retention or holdback, is a common practice in the construction industry where a portion of payment, typically 5-10%, is withheld until a predefined milestone is achieved on a building project. Retainage has a long history in the industry and can apply to both general and subcontractors.

The Purpose of Retainage

Retainage, when properly utilized, is designed to address several issues inherent to construction and other critical projects:

Quality assurance: Retainage incentivizes a contractor and any applicable subcontractors to complete work to the owner's satisfaction. It also encourages contractors to meet or exceed quality and performance standards on a project.
Defect correction: Retention provides the owner or general contractor financial leverage by withholding a portion of payments. This leverage ensures the contractor addresses defects, deficiencies, or incomplete work.
Project completion: Retainage motivates contractors to complete their work within the agreed-upon schedule to avoid abandoning or leaving projects unfinished.

Retainage offers several benefits for both owners and contractors.

Risk mitigation: Retainage helps mitigate the financial risks associated with contractor and subcontractor defaults, delays, and incomplete or defective work.
Quality control: As a practice, retainage encourages contractors to maintain a high quality of work throughout a project, as the release of the retained pay can be contingent on meeting specific project standards.
Dispute resolution: Retainage provides a financial cushion for owners to address disputes, deficiencies, or disagreements that may arise during a project.

Challenges

While retainage has advantages, the practice may cause additional burdens on the contractor.

Cash Flow Impact: In an industry already often beset by thin margins and cash flow issues, retainage can create further financial strain on the bottom line of contractors and subcontractors.
Delayed Payment and Abuse: There are some complaints across the industry that retainage can result in unnecessarily delayed payment and — in extreme cases — abuse. For example, in the 2018 case United Riggers & Erectors v. Coast Iron & Steel, the California Supreme Court ruled that retainage payments could only be withheld if a dispute was in good faith. And, in that particular case, the general contractor at issue had not offered any justifiable reason for holding back retainage payments to its subcontractor.

Best Practices

As with so many things across the industry, it all comes back to the contract between the owner and general contractor.

Negotiate

The first and most important thing to make clear is that in most jurisdictions, retainage is negotiable. This implies that the owner and the general contractor must agree on the money retained before beginning a project. For example, an owner and contractor might decide to keep 10% of the payments until the job reaches 50% completion, after which they will reduce the retainage on progress payments to 5%.

Once parties agree on the use and amount of retainage, owners, general contractors, and subcontractors should next decide on where to hold the retained payments

Some jurisdictions limit the amount of money that may be retained on payments, how that money must be held, and which types of projects are allowed to use retention in the first place. For example, in Florida, the statute requires that retainage cannot exceed 5 (five) percent for the project's life.

To explore the laws around retainage in the United States, see Levelset's interactive map: Retainage Rules Across the United States.

However, the most essential thing governing the use of retainage on a project will always be the contract between the owner and the general contractor or that between the contractor and the subcontractor.

The most essential thing governing the use of retainage on a project will always be the contract between the owner and the general contractor or that between the contractor and the subcontractor.