The Ultimate Guide to Retainage in the Construction Industry

The practice is also baked right into laws all across the world that regulate the types of contractual provisions that contractors can agree to. Most of these laws were created to regulate and create limitations on the practice, mostly to promote its fair use and to prevent its abuse. Depending on the size of the contract, a retention bond may be a low-cost way to find an agreement that improves the contractor’s cash flow and satisfies their hiring party. A mechanics lien is perhaps the most powerful tool that contractors have to force payment.

• Retainage, also called “retention,” is an amount of money “held back” from a contractor or subcontractor during the term of a construction project.
• From there, the payment chain takes its course–owners issue payments to GCs, who then issue payments to their subcontractors and so forth.
• These caps do not apply to private projects, although contractors will typically reject projects with troublesome retainage language.
• Profit margins on construction projects are already thin—sometimes running as low as 5-10%.
• To manage retainage effectively, contractors should adopt proactive strategies.

Upon Completion

This makes it difficult for all subs and suppliers to plan their cash flow in advance, since a project’s completion date often turns into a moving deadline. There are two main alternatives owners or general contractors typically request in lieu of holding retainage on a construction contract. In this article, we will delve into the the purpose of retainage in construction projects, highlighting benefits, drawbacks and best practices. Retention creates a strong incentive for contractors to prioritize project completion and adhere to deadlines. Knowing that a portion of their payment is contingent on satisfactory performance encourages contractors to maintain quality and efficiency throughout the project lifecycle.

Retainage creates crippling cash flow issues.

Overbilling occurs when a contractor bills for contracted labor and materials prior to that work actually being completed. Lien waivers are an important part of optimizing construction payment. Has your company been in business for a long time with an equally long track record of success?

How to Streamline Construction Processes from Planning to Payments

• If you’ve already sent reminders for unpaid invoices to the GC, and they’re still unresponsive, consider sending them a notice of your intent to file a mechanic’s lien.
• Most of these laws were created to regulate and create limitations on the practice, mostly to promote its fair use and to prevent its abuse.
• 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.
• There is even such a thing as a “retainage bond.”  This type of negotiation is probably going to be difficult, but it never hurts to ask, and your company’s goodwill has value.

The truth is that retainage has remained a legacy practice of a construction era long forgotten. Whether you agree with it or not, it’s not going anywhere any time soon, which means contractors must understand its benefits and drawbacks so they are better prepared to encounter it. As you can see, retainage laws vary significantly from state to state. For this reason, it’s crucial to learn your state’s retainage laws by heart. If you need help getting started, check your local department of labor, talk to your counsel, speak retained earnings with fellow contractors within your trade, and reach out to your local contractor association.

Ensuring that all financial processes align with project goals and timelines. Your final pay app should include conditional final lien waivers from your company and any lower-tier subs and vendors. Failure to provide the correct lien waiver may result in the GC withholding your retainage. Retainage started in the 1840s to prevent construction laborers from not finishing or poorly finishing projects.

What is Overbilling? Construction Industry Accounting

While retainage retainage in construction is sometimes used in predatory ways, contractors can protect themselves by understanding the rules, their rights, and the tools available to them to collect what’s due. Even after the project is finished, inspected, and approved, it can be 30, 60, or 90 days (depending on state laws) before the GC receives its retainage and, in turn, pays you. What’s worse is that subs may never receive their retention payments if the owner or GC goes bankrupt or out of business. The retainage amount for the current contractor project is determined based upon the overall cost of the project or contract price. Once the amount has been established by the contracting parties, the project retainage percentage will be applied. In most cases, the payment of retainage comes out of each payment based on this percentage at that rate determined in the timeline.

• There are different state laws concerning how to file a mechanic’s lien for retainage so check with your state to make sure you are filing correctly.
• By encouraging contractors and subcontractors to deliver high-quality work, adhere to project schedules, and meet milestones it’s clear why retainages have continued to evolve with the profession.
• For example, a $10,000 payment at 10% retainage will result in a $1,000 gap.
• Retainage is a critical aspect of the construction industry that affects contractors and subcontractors alike.
• This dynamic landscape is reshaping the significance of retainage, helping bring more financial security and fair compensation, while also fostering successful project outcomes.

Prime Contractors Can Withhold Retainage from a Subcontractor, but cannot Bill the Government for it

Every contract is negotiable, including what percentage is retained and for how long. Subcontractors who are searching for work need to have the right types of insurance coverage. Subcontractor insurance protects subcontractors and general contractors (GCs) against potential financial risks and liability issues…. The sector’s boom led to hundreds of new construction companies entering the market to capitalize on the opportunity.

If you do go this route, you’ll need to make sure you do your homework and have plenty of supporting documentation and evidence to support your lien actions. As always, consult with a lawyer before signing contracts or enacting your lien rights. Unfortunately, projects in the construction industry can be extremely complex. With contract challenges like retainage, minimizing the number of headaches and hurdles you have to jump through on every project is Partnership Accounting crucial. As an equipment rental marketplace, DOZR helps contractors find the equipment they need, when they need it, at the price that works best for them.

The second request an owner or general contractor may make in exchange for foregoing retention is a letter of credit. A letter of credit provides a financial guarantee from a bank or other financial institution to pay a certain amount upon request. If the contractor or subcontractor fails to perform the work as specified, the owner or general contractor will make this request, making the contractor or subcontractor liable for the amount. Some jurisdictions set limits on the amount of money that may be retained on payments, how that money must be held, and which types of projects are allowed to use retention in the first place. However, many of these inexperienced companies were unable to work to the required standards, which led to a high number of insolvencies. Began to withhold 20% of contractors’ payments as security to ensure a project’s completion.