Reacting to industry problems and concerns, lawmakers around the country are enacting retainage reform. While some argue that the government should not get involved in private contractual matters, the reformers counter that it is good business for the industry to get involved in government. Thus, contractors have been successful in influencing laws regarding retainage reform on both public and private projects.
In February 1999, the U.S. Department of Transportation (DOT) found that payment delays have long been one of the most significant barriers to competitiveness — and in some cases the viability of a firm. Contractors complained that long delays in payment of retainage caused severe problems. Subcontractors in particular complained that they frequently finish all of their work on a contract months or years before the end of it, but that the prime contractor does not pay them fully until after it has received payment at the end of the entire project. To ameliorate this problem, DOT now requires prime contractors to pay retainage to subcontractors promptly after a subcontractor satisfactorily completes its work.
Prime contractors complained to DOT that the requirement to pay subcontractors fully before a state pays retainage to the prime contractor is a financial hardship. Therefore, DOT is proposing to require states to take one of three approaches regarding payment of retainage:
A state may eliminate retainage entirely, neither retaining funds from prime contractors nor permitting prime contractors to withhold retainage from subcontractors.
A state could decide not to retain funds from prime contractors, but give prime contractors discretion to hold retainage from subcontractors, in which case the state would require prime contractors to pay subcontractors in full within 30 days after satisfactory completion of the subcontractor's work.
A state could hold retainage from prime contractors, but make incremental inspections and approvals of the prime contractor's work at various stages of the project. The state would pay the prime contractor the portion of the retainage based on these approvals. The prime contractor, in turn, would be required to pay all retainage owed to the subcontractor for satisfactory completion of the approved work within 30 days. (The comment period for the proposed rule ended June 7. DOT is expected to publish the final rule this fall.) See generally Federal Register, Vol. 66, No. 89, page 23213.
Perhaps the most ambitious state retainage legislation enacted in recent years has occurred in New Mexico. Owners, both public and private, are prohibited from retaining more than 5 percent. No further retainage is allowed after substantial completion, and a contractor can withhold no more than 5 percent retainage from its subcontractors, regardless of whether retainage is withheld by the owner.
The New Mexico statute furthermore requires that retainage be held in an escrow account for the benefit of the party from whom the retainage was withheld. All fees and expenses of the escrow agent are to be borne by the owner.
The New Mexico statute also addresses the issue of entitlement to the retainage fund in the event a creditor of either the owner or general contractor tries to enforce a security interest, garnish or levy execution on the fund. The retainage fund, as well as progress payments or other owed payments, are shielded from the reach of these third parties.
Montana is another state that has enacting retainage reform. Its law, adopted earlier this year, caps the amount of retainage a owner can withhold from a general contractor at 10 percent on private contracts. In addition, general contractors are prohibited from retaining from subcontractors more than the owner retains from the general contractor. Montana already has a statute permitting on public projects contractors and subcontractors to withdraw retainage in exchange for depositing substitute securities with the contracting agency. These can be in the form of U.S. Treasury Bonds, notes, treasury bills or notes of the state, as well as certificates of deposit in an amount at least equal to the value of the amount withdrawn.
General contractors are required to allow subcontractors to participate in making withdrawals of retainage in exchange for submitting substitute security. All interest accrued in deposit accounts is payable to the general contractor or subcontractor on a pro rata basis according to participation. A subcontractor participating in making deposits shall not have additional retainage withheld by the general contractor.
In 2000, Maryland contractors secured passage of a bill that caps retainage on contracts for most public works projects at 5 percent. University of Maryland projects, the only initial exemption, were added to the law this year.
Owners should benefit from less onerous retainage requirements. Whether or not a project falls under the jurisdictions cited above, this concept can be tested by alternative bidding. When possible, contractors should bid jobs using the owner's terms for retainage and, alternatively, bid the job on the premise that there will be no retainage.
Funds that remain in the owner's pocket represent a source of real costs to contractors which, directly or indirectly, enter into contractors' calculations on bid day. Relaxed retainage requirements should generally lower the cost of doing business and result in the receipt of more and lower bids. Some bidders, particularly smaller ones, may hesitate to bid jobs with higher retainage requirements.