Retainage is a contractual practice that is unique to the construction industry. Most construction contracts entitle project owners as well as lower-tiers to withhold a percentage of each progress payment to contractors or subcontractors until the contracted work is substantially or finally completed. Retainage ensures that contracted work is completed properly, incentivizes timely completion of the work, and provides financial leverage attendant with defects in construction. While contracts largely govern the specific terms as to how much retainage will be withheld and when it will be released, there are federal and state laws that address retainage rights. It is, therefore, essential that each contracting party fully understand these provisions and any limitations on their enforceability to sufficiently manage risk in both public and private construction projects.
Limitations on Retainage Amount
Retainage cannot be withheld when a contract does not include an explicit retainage clause. Even where a construction contract contains an explicit retainage clause, many states have enacted laws regulating the amount of retainage, the timing of payment and limiting the enforceability of conflicting contract clauses. These laws vary from state to state and may only apply to a certain construction projects. For instance, Virginia law limits retainage to no more than 5% of the total earned sum on public construction contracts and governs all tiers of contracts. The District of Columbia requires a retainage of 10% on public construction contracts, which may be lowered at the discretion of the Mayor at 50% completion, but is limited to contracts between the prime contractor and District government. Neither Virginia nor the District of Columbia have laws regulating the amount of retainage that can be withheld on private project contracts. Whereas Maryland construction law caps retainage at 5% of the total contract amount for both public and private projects, provided 100% payment and performance bonds are furnished.
Federal construction projects are subject to the Federal Acquisition Regulations (the FAR) which permit the federal government to withhold up to 10% of the earned sum on a federal contract. The FAR does not similarly limit the amount of retainage that may be implemented by prime contractors and/or subcontractors on federal construction projects. Contractors must look to the applicable state law that would govern that subcontract to determine any limitations on retainage.
Limitations on Timing of Release
While retainage is generally permitted under a federal construction contract, the Prompt Payment Act effectively limits how long such retainage can be withheld following the completion and acceptance of all work. Specific to federal construction contracts, the Prompt Payment Act provides that the due date for the federal government to make final payments, including retainage, is the later of (i) 30 days after the designated billing office receives a proper invoice from the contractor, or (ii) 30 days after acceptance by the federal government of the work or services completed by the contractor. In turn, the Prompt Payment Act governs the release of those payments accordingly to subcontractors within 7 days of receipt of payment. The Prompt Payment Act, however, does not limit retainage clauses in subcontracts or withholding rights.
While nearly every state has enacted its own version the Prompt Payment Act, applicable to both public and private construction projects within that state, these laws do not always apply to the retainage provisions in a construction contract. For instance, while Virginia law requires a prime contractor (or subcontractor) to pay its subcontractor(s) within the earlier of (i) 60 days of the receipt of an invoice following satisfactory completion of the portion of the work for which the subcontractor has invoiced or (ii) 7 days after receipt of amounts paid by the owner to the prime contractor (or prime contractor to its subcontractor) for work performed by a subcontractor, the limitation explicitly does not apply to retainage provisions. Instead, Virginia law simply provides that all retainage amounts withheld may be included in the final payment. This language suggests that retainage is intended for release upon final contract completion rather than upon substantial completion but leaves the specific completion criteria to be defined by contract terms.
Under the District of Columbia’s prompt payment statutes, owners on construction contracts without specific payment terms must pay undisputed amounts within 15 days of the earliest of (i) occupancy permit issuance, (ii) owner taking possession, or (iii) receiving the contractor’s payment request. Where contracts specify payment dates, owners must pay within 7 days of the contractually specified date. Subsequently, the contractor or subcontractor shall pay undisputed amounts owed to its subcontractor within 7 days after receipt by the contractor or subcontractor of each payment received for its subcontractor’s work or materials. The District of Columbia defines an “undisputed amount” as “an amount owed on a contract or a subcontract for which there is no good-faith dispute, including any retainage withheld.”[1] Thus, the District of Columbia’s 7-day limitation on payment specifically applies to any amount withheld as retainage.
Under Maryland law, the timing applicable to the release of retainage depends on whether the contraction contract is public or private. Maryland applies what is commonly referred to as the “120-Day Rule” in the case of public contracts, and the “90-Day Rule” in the case of private contracts. Maryland law specifically requires public entities to release retainage within 120 days after satisfactory completion of construction, or 120 days after resolution of any dispute concerning satisfactory completion. For private construction contracts over $100,000, Maryland law mandates that undisputed retention proceeds must be paid within 90 days after substantial completion as defined by the applicable contract. Maryland’s prompt payment statutes set forth payment deadlines that are distinct from its retainage timing requirements to the extent project owners must pay undisputed amounts to contractors within either 30 days after occupancy permit issuance or owner possession (whichever is earlier) when no payment dates are specified, or within 7 days after contractually specified payment dates. Like the District of Columbia, Maryland law requires contractors and subcontractors to then pay undisputed amounts to their subcontractors within 7 days after receiving payment for the subcontractors’ work.
Takeaway: Retainage clauses serve as a powerful tool by which contracting parties can mitigate the risk of incomplete and/or inadequate performance on construction projects by contractors or subcontractors. Alternatively, these clauses can limit a contractor or subcontractor’s access to capital over the course of a construction project, creating a financial chokehold that is subject to the hiring party’s sole discretion. These clauses should, therefore, be carefully considered in conjunction with any applicable limitations to enforceability under state and federal law when negotiating construction contracts. If you are a prime contractor or subcontractor and need guidance on the enforceability or consequence of a retainage clause, or assistance with a related claim, please contact Jessica duHoffmann, Jonathan Neri, or another member of PilieroMazza’s Construction practice group.
[1] D.C. Code Ann. § 27A-101.
