In previous article we have discussed the practice of retaining a portion of the Contractor’s payment.
Payment Retainage has been around a long time. It is the practice of withholding a portion of the contractor’s payment until the work is complete. Although this practice has become common, Contractors have always disliked it and have sought ways to avoid it’s impact. In this article we will look at the tactics used by Contractors to avoid retainage.
Before we get into the tactics, we must first remind ourselves about why we do this in the first place.
The practice of retaining (or holding back) a portion of the amount due to a Contractor started as a tactic by Owners to create an incentive for Contractors to complete the work.
The rationale behind this tactic was that the amount withheld would be equal to the percentage of fee owed to the Contractor. This had the net effect of holding back the Contractor’s entire fee as a guarantee that they would complete the work.
Presumably, withholding only the Contractor’s fee would make the amount of the progress payments enough to cover the Contractor’s expenses for trades and materials. This is critical to ensure that the Contractor is able to pay for the work without incurring loans or funding the project with his own money, while still creating an incentive for them to complete the work.
From the Contractor’s point of view, this practice means they have to wait until the project has been completed to receive their fee. This causes them to perform the work in a state of net neutral cash-flow.
The risk to the Contractor is that if the Client does not complete the project or they go bankrupt before the Contractor receives their fee, they might never get paid.
Over time contractors have taken steps to mitigate their risk. Here are a few of the tactics I have seen along with some thoughts.
Trickle down terms
The most common way for Contractors to mitigate the impact of retainage is to trickle down the terms of the Owner’s contract down to the trades.
Trickling down terms means that any terms that are in the Contractor’s contract with the owner will also apply to the trade contractor’s contract.
With respect to retainage, trickling down the terms means that the Contractor can withhold a portion of the trade contractor’s payment. This may happen even if the trade contractor has completed the work and is owed the full amount of their contract.
This practice eliminates the impact of retainage on the General Contractor and transfers it down to the trades.
It also effectively neutralizes the original intent behind retainge because the Contractor’s fee can be claimed by the Contractor at the expense of the trades.
Stepped down Retainage
Another practice used by Contractor’s to mitigate the impact of retainage is to request early release of retainage.
This is often done at substantial completion, but I have also seen Contractor’s write in earlier milestones, such as 50% completion.
As practices go, early release or step down practices are not inherently bad and can be used as a way to mitigate the impact of retainge without compromising the Owner.
The one thing to be leery of is that if you have a Payment and Performance Bond you may need the bonding company’s approval to step down or provide an early release of retainage. Allowing this without approval from the bonding company my void your bond and expose you even further.
Excluding Fee and General Conditions from Retainage
In a recent contract, I had a Contractor write in that all payments were subject to a 10% retainage but then went on to stipulate that the the Contractor’s fee and General Condition’s costs were not subject to withholding.
This clause has the same effect as the trickle down clause.
Excluding the Contractor’s fee and General Condition’s costs from retainage, effectively eliminates the impact of retainage on the Contractor and completely misses the whole point of why we ask for retainage in the first place.
This is probably the worst of all these tactics as it completely negates the point of retainage and elevates the Owner’s exposure to Liens. Allowing this provision creates a de-facto retainage on the trades.
By retaining payment from the trades until the end of the project, you are creating a condition for payment that is tied to the performance of every other trade on the job. This means that even if a trade contractor has performed their portion of the work (and has done so satisfactorily), they might spend months waiting to be paid in full.
This condition elevates the risk that a trade contractor would have cause to place a Lien on the Owner’s property.
The practice of retaining a portion of a payment has been around a long time. We must bear in mind why this practice exists.
We must also be aware of how the terms of our contracts impact the entire supply chain. If we ignore the impacts of these terms, we nullify our own protections and increase our own risk.
We should also understand how provisions such as these impact the Contractor and allow for some relief when we can.
What about you? What terms have you seen related to retainage? Are there provisions you use? Tell me your stories.
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