Retainage in Construction: The Comprehensive Guide
Retainage is a fee withheld from a contractor's or subcontractor's payment until the project is completed or until a time specified in the contract. Withholding retainage, often known as "retention," is a systematic method to guarantee that a contractor or subcontractor completes work entirely and appropriately. Retainage is usually between 5 and 10% of each progress payment.
The retainage on a construction project is determined by the parties' construction contract, which stipulates that a portion of each progress payment be withheld.
Retainage has mixed reviews in the construction industry and has also been regarded as a burden. Retainage is prevalent in various large and small construction projects, public and private. They hamper the contractor and subcontractors on the task. It may be a waste of finances for the owners to take advantage of the contractors by failing to pay them what they are owed with the project's final invoice. However, it has played a significant role in boosting productivity and efficiency for the contractors’ and also serves as a suitable insurance policy for project’s owner.
So, let's get into the why's and how's of it by understanding retainage's impact on various stakeholders and the concept as a whole.
In this article, we will go through the following to understand retainage:
- What exactly is Retainage?
- The Origins of Retainage and Why It Still Exists
- What's the difference between retainage and retention?
- How Do You Calculate Retainage?
- How Long Does Retainment Last?
- Retainage: Pros and Cons
- How does retainage in construction affect the contractor?
- Subcontractors and material suppliers are impacted by retainage
- Is retainage a necessary evil?
- Frequently Asked Questions
- Is it possible to release retainage early?
- What are the tips for managing retainage better?
- Can clients refuse to pay retainer once a job is finished?
- Key Takeaways
What exactly is Retainage?
Retainage in construction is a portion of the project expenditures held in reserve during the contractor's time on the job. This is used to ensure that a project is completed on schedule and to a high standard. The retainage is usually paid to the contractor, who subsequently distributes it to subcontractors after the project is fully completed.
Retainage is a problematic phrase in the world of construction finance. It is frequently portrayed as a burden imposed by the financing institution on the owners and contractors, even though retainage essentially helps further on to ensure that the construction project will be finished. But, before we go too far ahead of ourselves, let's clarify what we're talking about.
Retainage protects clients by ensuring that contractors adhere to agreed-upon agreements and complete the project to their satisfaction. While this is typically regarded as favoring customers, it also means that contractors do not have to wait until the completion of a project to receive payment.
The Origins of Retainage and Why It Still Exists
· Retainage was first used in the 1840s in the United Kingdom to ensure that construction projects were fully complete and mitigate the danger of bad craftsmanship, which was frequent (and, many would argue, still common). The proponents of the retention practice argue that withholding money from a contractor accomplishes two goals:
· it develops a financial incentive for the contractor to complete the project successfully, and
· -it protects other stakeholders in the event of problems, as the retained money can be used as a risk buffer.
The practice of withholding money from contractors during a construction project has been around for almost 200 years, and it still exists in substantially the same manner as it did in the 1840s.
The practice is now widespread and part of the industry's culture. The method is also codified in laws worldwide that govern the contractual stipulations that contractors can agree upon. The majority of these laws were enacted to control and limit the practice, primarily to promote its ethical usage and prevent its abuse.
However, many enterprises in the construction industry, particularly subcontractors and other project participants at the bottom end of the payment chain, are negatively impacted by the current state of this procedure. Furthermore, maintaining and tracking withheld funds is a major headache for everyone involved. Retention tactics in construction have been widely condemned around the world.
Various difficulties and issues arise when dealing with retained funds on construction projects. One question is whether or not any money should be withheld from the contractors! Nonetheless, when retention is refused, the following are the two main issues:
1. How much money should/will be held back?
2. How long should/will the funds be maintained in reserve?
As you might expect, the rules and solutions to this puzzle are not simple.
Let's look at some of the game's rules and how they may affect the project and bank balance now that we've looked at where this practice came from and why it exists.
What's the difference between retainage and retention?
The phrases retention and retainage are frequently interchanged in the building industry. However, there is a distinction in some cases: retention may relate to the money being held in construction, whereas retention refers to the act.
Both phrases, however, relate to the same item in this circumstance.
The amount of money "kept back" from a contractor or subcontractor during the period of a building project is known as "retention." This is a relatively specific construction industry practice, yet it is pretty prevalent. Most construction contracts require the contractor to hold back a particular proportion of the contract amount (usually 5% or 10%) until the project is substantially completed. This causes cash flow issues in an already cash-strapped industry, the technique is far too frequently abused, and it is, of course, governed by complex regulations that make it challenging to implement.
How Do You Calculate Retainage?
The retainage is usually capped between 5% and 10% of the contract value by state law. Although most of these regulations apply to public projects, certain jurisdictions also have private retainage laws. Research at Clemson University determined these averages:
· 7.59 percent of private initiatives are retained.
· 5.56 percent of state projects are kept.
· 3.26 percent of federal projects are retained.
These caps do not apply to private projects, although contractors will typically reject projects with troublesome retainage language. This frequently pushes private projects to follow industry rates to some extent.
How Long Does Retainment Last?
Various circumstances determine retainage holding length, but most conditions are based on milestone accomplishment. This frequently includes the number of milestones and client satisfaction for each one.
On the other hand, some projects may keep retainage until the project is substantially completed. Others may demand that funds be released at the conclusion of the project. Clients can sometimes specify that retainage is withheld indefinitely, even after the project is completed. Clients frequently do this to ensure their contentment.
Subcontractors face more difficulties with retention than contractors. They are virtually always only available for certain aspects of a project.
As a result, they are frequently required to wait for milestones or entire completion before being paid. As a result, subcontractors' contracts often incorporate early release provisions. To manage work time and milestone accomplishments, some companies have even turned to innovative employee time clocks.
The client decides when the retainage is released. It can also be released early because it can be delayed. To be valid, the contract must include all clauses. As a result, it's often a good idea to bargain for the best retainage terms.
Retainage has been practiced for about 200 years. It is not always possible or wise to pay for construction projects in advance. Retainers protect clients and their money by guarding against substandard and incomplete work.
Sound contracts and well-stated milestone requirements help retainage. Contractors are protected by the mandatory release of retainage, which encourages them to complete projects according to established timelines.
However, both sides of the contract have exploited retainage over the years. Several subcontractors oppose the practice. Beyond the prime contractor, retainage funds are frequently delayed in arriving. To counter these unfavorable characteristics, retainage-oriented state legislation is being introduced around the country.
Retainage: Pros and Cons
While retainage can give you little to no influence over receiving full payment for your completed work, this is not always the case. Before the project begins, both the client and the contractor must agree on the amount of retainage. Retention should also be included in the contract to be enforced.
The advantages and disadvantages of retainage are influenced by where you are in the construction supply chain. Let's find out its effect as an overview.
Pros
1. Retainer protects clients and provides a financial incentive for contractors when used effectively.
2. Tying funding to milestones can keep budgets on track.
3. Retainage ensures that all work is completed according to the client's specifications.
4. Completing projects early and on time will reward contractors if they have solid contracts.
5. In brief, retainage safeguards client funds and ensures contractors are compensated for quality work. However, both sides can overuse these expressions all too often.
Cons
Retention, for all its benefits, is not without its drawbacks. Among them are:
1. Additional local, state, or federal laws to adhere to
2. Contractors and subcontractors have little control over their financial flow.
3. Disreputable clients and contractors engage in predatory or malicious actions.
4. Slow client cash flow, which slows progress. Slow final payment turnaround, especially for subcontractors.
5. Retainer methods can and have been used by clients to avoid making payments. Retention clauses should be included in every contract. They must declare that retainage will be released at particular milestones and the consequences of not doing so. The requirements of both parties must be equally clear. There will be a threat of abuse otherwise.
How does retainage in construction affect the contractor?
When a contractor starts a job with a retainage clause, they know they won't get 100% of the agreed-upon money immediately away. This affects how businesses handle their finances and interpersonal connections.
As for contractors, since building profit margins are low, there may be situations when the retainage % exceeds the expected profit. Long disagreements about completion where there is any doubt can increase cash flow issues. If the dispute necessitates legal action, it can become an even more expensive burden for contractors. When a contractor is cash-strapped for this or other projects, they may compensate by withholding a more significant share from subcontractors. This might harm meaningful subcontractor relationships, and it may be challenging to find individuals willing to work with such a high retainage percentage.
When examining and agreeing to a budget for your next construction project, whether public or private, there are certain factors to consider as a contractor.
· It is deducted from every payment: While payments may be set at a certain sum to equal the project's overall cost, don't anticipate those payments to be in that amount. Retainage is deducted from each payment made during the construction phase.
· It can be negotiated: You have the option of negotiating your project's retainage %. Despite what some owners may try to convince you during the discussion, there is no set % amount. You can negotiate a cheaper rate for longer-term projects that demand constant cash flow.
· Laws establish a limit and deadline: Depending on the state in which the project is being finished, there may be a restriction on the retainage amount the owner can collect. Plus, a deadline for paying it out when the project is completed. All public and federal initiatives are capped at 10% for projects at the federal level. Private jobs offer more freedom and the ability to retain a higher percentage of employees. Retention laws vary from state to state. Some states mandate it to terminate at 50% completion, which means the first half of the project is done before more substantial payments are made until the project is completed. Owners and contractors paying subcontractors have up to 45 days after the project is completed to deliver the retainage.
· It usually depends on substantial completion: substantial completion indicates the job has been completed in its entirety and fulfills the owner's and general contractor's quality criteria. Inspections are carried out to check that the job was finished correctly, and any flaws discovered during the initial assessments are corrected to meet quality standards.
· The mechanics' lien deadline is not extended: You most likely have a mechanical lien as a contractor, especially on larger projects. It's critical to note that your retainage and release will not give a mechanics lien extension. That deadline is a strict deadline that has nothing to do with retainage or the retention process.
· Retention bonds can assist you in receiving payment more quickly: Retention bonds are an alternative that many contractors use to ensure that their teams and subcontractors have adequate funding to complete the project (conditional or unconditional bonds). Retention bonds guarantee that the project's contractor and subcontractors will pay the required installments for not operating in cash retention. The customer might use the bonds to get their money back if the contractor does not do a good job or abandons the project.
Subcontractors and material suppliers are impacted by retainage
Subcontractors bear the thrust of the retainage burden. For example, they may finish their job in the first month but must wait another ten months for the entire project to be completed before being paid in full. Meanwhile, businesses must pay 100% of their salaries and other operating expenditures on between 90% and 95% of produced revenue during those ten months.
On the retainage front, material providers have little to no clout. They may float all of their costs at the start and often have to wait for the longest for complete payment. The more a construction project is delayed, the longer it takes for suppliers to recover money owing for items that have already been ordered, delivered, and installed.
Is retainage a necessary evil?
Owners and contractors often blame retention for cash flow issues and payment delays. When the contractor and the owner have opposing perspectives on the project's completion, it is asserted that retainage can be misused, resulting in disagreements and payment delays. This can put a financial strain on the project's subcontractors.
Because it only accounts for a small number of individual draws (up to 10%), any such issues are indeed the product of inadequate budgeting, planning, and procedure execution. This issue can be avoided by establishing a clear contractual definition of substantial completion and a clear deadline for completion and retainage release.
Construction loan software can also assist with the process implementation and retainage tracking aspects.
Despite its reputation as a "necessary evil," retainage has remained a form of leverage for over a century is a testament to its effectiveness. It has been questioned and amended numerous times, and different ideas have been proposed as alternatives even today. However, most alternative solutions aim to alleviate the alleged cash flow disruption caused by withheld resources by effectively eliminating the financial incentive for project completion.
Retainage has often been demonstrated to be the most reliable indicator of a job's completion.
Finally, a realistic budget analysis, well-defined contractual conditions, and effective process execution can avoid any adverse effects (whether intended or not) related to retainage.
Frequently Asked Questions
Is it possible to release retainage early?
Early release from detention is possible, but it depends on your contract. This is something that most subcontractors will strive to get included in their contracts. Otherwise, subcontractors may be forced to wait until the entire project is finished, including work they are not responsible for.
Make sure your payout percentage is specified in the agreement if you wish to get it on time. It may not always be practicable, but it is something to consider.
What are the tips for managing retainage better?
1. Consider including retainage in your contract's initial pricing.
Yes, this will increase the contract amount for your clients, but it is an excellent approach to make sure you have enough money to work with. In some situations, this may persuade clients to forego the retainer entirely.
2. Keep a close eye on your financial flow.
When retainage is used on most of their contracts, construction companies are especially exposed to cash flow problems. As a result, it's in your best interest to set procedures for tracking and managing cash flow.
3. Make use of a dependable accounting programme.
Having competent accounting software in your business toolset can make a big difference when it comes to retainage and other financial management. You may track spending, income, and cash flow with QuickBooks Online and get precise financial information about your company.
4. Create a sizable business savings account.
Retention can be highly taxing on your operations when you're first starting, especially on large-scale initiatives. Establish cash reserves and a savings account as soon as possible to offset the burden retention places on your finances. This can help guarantee you have extra money available when you need it, such as when clients try to withhold funds after completing a job.
Can clients refuse to pay retainer once a job is finished?
A client may be entitled to withhold funds if the agreement allows it. Another reason to read contracts thoroughly before signing them is to avoid surprises.
Clients may include these requirements in the contract to ensure that they are satisfied with the final product. If a chunk of work has not been finished or has been completed erroneously, retainage may be withheld after the project is completed.
Allowing clients to keep retained monies after the project is completed, on the other hand, is hazardous because they may try to avoid final payment.
To protect your firm, you should insist on payments being released as soon as the project is completed, if not sooner. Verifying that every component of the project is completed to the highest standards is another technique to assure fast payment.
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Key Takeaways
· The idea of retainage is to strike a balance between the needs of contractors and their customers. It encourages contractors to complete all components of the assignment while also guaranteeing that they have the funds necessary to finish the project. Construction contracts specify retainage ratios and payment mechanisms, varying from project to project.
· Retainage inhibits a contractor's and subcontractor's cash flow, leading to financial abuse.
· Retainage restrictions differ depending on the state and whether the project is public or private.
· Other solutions, such as bonds or individual security, can also be employed, but retainage is still one of the most effective ways to ensure that a task is finished correctly.
· Businesses can use financial management software to better manage their retainage receivables and payables.
· Retainage provides clients and contractors with financial security, fairness, and reliable project completion when handled correctly.