By John Hickey
Retainage is a common way to manage risk. It is the withholding of a percentage of a payment to a contractor or subcontractor until completion of the work. Subcontractors have complained for years about the unfairness of high retainage percentages. A subcontractor who finishes its work near the beginning of a project may have to wait for 10 percent or more of the amount it earned until the entire project is substantially complete, which could occur a year or more later. And if there are problems on the project (e.g., the prime contractor or the owner runs out of money), the subcontractor's retainage may never be paid. Owners and contractors, on the other hand, need protection from subcontractors who stop showing up or otherwise default. Although owners and contractors can get some protection by requiring performance bonds from subcontractors, sureties will not bond many subcontractors.
Competing interests and the recent economic downturn have led to changes in the retainage rules in every West Coast state (legislatures found that many subcontractors could not survive if traditional retainage percentages were allowed), which has led to confusion among contractors and subcontractors. Below are descriptions of the retainage percentages that may be withheld from subcontractors by contractors in Oregon, Washington, and California, and on federal projects.
The 2013 Oregon Legislature capped the retainage a contractor may withhold from a subcontractor at 5 percent for all contracts entered into on or after January 1, 2014. The cap applies whether a performance or payment bond is provided and whether work is being performed on a public or private contract.
For contracts (public and private) entered into before January 1, 2014, there is a five percent cap on retainage when the subcontractor provides a performance bond in a sum that is equal to the contract price and that covers the period during which liens or other encumbrances may be filed. There is no cap if the subcontractor does not provide a performance bond.
On public projects, contracting agencies may accept bonds or other forms of security (e.g., U.S. bonds, obligations of a government corporation, Oregon general obligation bonds, and irrevocable letters of credit) in lieu of retainage. If a contractor submits a bond or other form of security in lieu of retainage, it must permit its subcontractors and suppliers to do the same.
Washington caps the retainage that a contractor may withhold from a subcontractor at five percent on public projects. If a public body allows a contractor to submit a bond in lieu of retainage, the contractor must accept bonds from its subcontractors and suppliers, and if a subcontractor or supplier submits a bond, the contractor must not withhold retainage and release any retainage that it previously withheld from the subcontractor. Washington law does not specify a maximum retainage percentage for private projects.
For contracts entered into between January 1, 2012 and January 1, 2016, the percentage of retainage withheld from a payment to a subcontractor on a public works project may not exceed the retainage withheld by the owner unless prior to or at the time its bid was requested, the subcontractor was given notice that a bond was required and the subcontractor did not provide the bond. The notice to the subcontractor must say that the bond has to be in the full contract amount and that retainage will be withheld in a certain amount if the bond is not provided. There is no cap if the subcontractor is given the notice and does not provide the bond.
California law does not specify a maximum retainage percentage for private projects. On private projects, owners must pay any withheld retainage within 45 days of completion, and contractors must pay retainage to subcontractors within 10 days of receipt of any retainage payment from the owner.
There is no government-wide federal law or regulation capping the retainage that a contractor may withhold from a subcontractor. In fact, the federal prompt-payment regulations state that they are not to be construed to impair the right of a contractor or a subcontractor to withhold retainage without incurring any obligation to pay a late payment interest penalty, "in accordance with terms and conditions agreed to by the parties to the subcontract, giving such recognition as the parties deem appropriate to the ability of a subcontractor to furnish a performance bond and a payment bond."
The penalties for withholding too much retainage from a subcontractor can be severe (e.g., high interest rates and recovery of attorney fees). To avoid costly surprises, contractors should confirm that their subcontracts comply with the retainage rules in the states in which they work, and subcontractors should make sure that contractors are not withholding too much.