Define Construction Retainage
Construction retainage--a portion of money retained by financiers, owners, contractors and subcontractors--encourages the various parties to meet their contractual obligations. Funds withheld through retainage help assure completion of the construction according to plans and specifications. Construction retainage also tends to level the playing field between those holding the money and those providing the labor and materials.
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Purpose
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The differing interests between people contracting for a work of construction and those that physically perform the work and/or supply the materials can lead to monetary conflicts. On one side, contractors, subcontractors and suppliers need reimbursement for the money spent to pay for labor or materials. On the other side, financiers, owners or prime contractors withhold payment until after work completion and the issuance of lien releases against the property.
Function
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In a simplified construction scenario, an owner hires a contractor to build something. Both parties sign a contract that stipulates that the contractor gets paid for the work periodically. The periodic payments equal the percentage of work completed, but the owner pays the amount billed and withholds a certain percentage as retainage. For example, if the contractor has completed 50 percent of a $100,000 job, the owner pays $50,000, minus the amount of retainage. If the retainage were 10 percent, the contractor would receive $45,000, or $50,000 minus $5,000.
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Time Frame
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The source of funding for the construction, such as a bank, holds the retained amount until job completion and a certain amount of time passes. A chain-reaction takes place when a financial institution withholds retainage from an owner, who withholds payment to a prime contractor, who then withholds money from several subcontractors until the job reaches 100 percent completion, and another month passes. The time delay allows for any corrective or unforeseen work before the final payment. According to The Contractors Group, the bank typically releases the retainage about five weeks after project completion.
Gamesmanship
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The gamesmanship of delaying the final payment of retained funds for a long time causes financial damages for some subcontractors. In an article in "The Business Review," Terence Burke observes that subcontractors "cannot withhold a similar amount of [retainage] payments due to their creditors." The holder of the funds, on the other hand, gains from the situation, Burke adds, with "investment returns on retainage becom[ing] a windfall as an interest-free loan."
Solution
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As innocent as retaining a small percentage of construction costs sounds, subcontractors can, and do, become insolvent when outstanding payments tied up in retainage keep them from paying their bills. For this reason, many states have laws that control the amount of retainage and when distribution must occur. Nationwide, retainage amounts of 5 to 10 percent and waiting periods of 30 to 35 days are typical.
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