Retainage (commonly referred to as retention money) can be the source of great frustration among subcontractors when part of their payment is withheld from them. Understanding its workings could mean the difference between healthy cash flow and anxiety-inducing nights spent wondering when you will get paid.
Start by reviewing the terms of your construction contract, then keep detailed records of work completed and payment claims submitted in order to facilitate timely release of funds.
What is Retainage?
Retainage refers to money withheld from progress payments by project owners or primary contractors in order to pay out only once construction work has been completed. It has been an industry practice since 1840 when railway projects first began being built across England; today retainage payments serve to incentivize contractors to complete construction projects on schedule.
Retention acts as an insurance policy against disputes, delays, or changes that alter the original scope of a contract. Therefore it’s essential for both parties to discuss retainage in detail prior to signing their contracts, and maintain consistent communication throughout.
Since retainage can significantly diminish cash inflows from progress payments, general and subcontractors should plan for it by factoring it into their cash flow forecasts. Doing so can help them better prepare for periods with limited or no income and avoid potentially problematic situations with lenders.
How is Retainage Calculated?
Retainage amounts are determined through negotiations based on project complexity and industry standards, and withheld from each progress payment as work nears completion. Therefore, it’s essential that contractors communicate their expectations to project owners throughout their task to avoid issues with retainage payments.
Retainage serves to protect all parties by ensuring contractors uphold quality standards and attend to details. Furthermore, it acts as an incentive for contractors to complete projects as agreed.
To increase cash flow for contractors and subcontractors, some projects are adopting reduced retainage rates or eliminating it entirely. Others are moving toward performance-based models which tie release of retainage to meeting certain quality and progress benchmarks. Whatever their approach, using technology to track progress, payments and invoices can ease administrative burden associated with tracking retainage as well as facilitate communication amongst all parties involved and facilitate documentation for dispute resolution over completion/substantiality of projects.
How is Retainage Released?
Contractual negotiations between owners and contractors dictate how retainage funds are handled, but state laws and prompt payment statutes establish guidelines as to when and how retainage must be released – such as setting maximum percentage withheld for retainage, how they are stored (an interest-bearing escrow account may be appropriate), or for how long retainage may remain withheld before release is mandated.
Retainage provides a financial incentive for contractors to execute projects accurately, protecting owners in case any problems arise. Unfortunately, retainage can also become a cash flow burden for subcontractors who rely on it for working capital and profit margin coverage; any delays in recovering unearned retainage payments add an extra stressor to construction projects while sowing distrust between contractors. Furthermore, unscrupulous contractors or owners have used retainage payments as leverage by demanding extra work outside scope or holding onto them until later payments.
What Happens if Retainage is Delayed?
Large construction projects take months or years to finish, so contractors need a steady cash flow in order to remain operational. Profit margins among contractors are often thin; without sufficient funding they could find themselves out of business altogether if their operations cease running smoothly – that’s where payment retention comes into play.
Retainage fees are negotiable in every contract; for example, if a contractor has proven they can deliver projects to their owner’s satisfaction without incurring excessive retainage fees, they could make the case for reduced or waived retainage amounts.
As well as taking into account various statutory provisions such as prompt payment laws, mechanics lien laws and bond claim laws when negotiating contracts, it’s also essential that payment terms and milestones are clearly defined to avoid delays in payments – this includes automating all payment terms, retainage policies and change order procedures from day one in order to eliminate misunderstandings immediately.
