Resolving Disputes Over Retainage Payments in Construction

Retainage, also known as retention or holdback, is a common practice in the construction industry where a portion of the agreed upon contract price is deliberately withheld until the work is substantially complete[1]. Substantial completion is when the owner can occupy a structure and use it for its intended purpose[1]. A typical retention rate is 5% of which half is released at completion and half at the end of the defects liability period (often 12 months later)[1]. While retainage offers benefits like quality assurance, defect correction, and project completion incentives, it also presents challenges such as cash flow impacts, administrative burdens, and potential payment delays and abuse[2]. This white paper explores the complexities of retainage payment disputes in construction, examining their causes, relevant laws and regulations, alternative dispute resolution methods, and best practices for prevention.

Please note this blog post should be used for learning and illustrative purposes. It is not a substitute for consultation with an attorney with expertise in this area. If you have questions about a specific legal issue, we always recommend that you consult an attorney to discuss the particulars of your case.

Common Causes of Retainage Payment Disputes

Retainage payment disputes arise from various factors, often stemming from ambiguities in contracts or disagreements over project milestones. Some common causes include:

• Contractual Issues:

• Scope of work non-compliance: Disputes may occur when the completed work doesn’t meet the agreed-upon scope, leading to disagreements over the quality or value of the work performed[3]. This can be further complicated by unclear contract language regarding the scope of work, leading to different interpretations of what constitutes satisfactory completion.

• Unclear contract terms: Ambiguous contract language regarding retainage percentages, milestones, and release conditions can create misunderstandings and disputes[4]. For example, if the contract doesn’t clearly define “substantial completion” or the criteria for releasing retainage, it can lead to disagreements and delays in payment.

• Payment Issues:

• Late payment: Delayed payments, whether due to administrative oversights or intentional withholding, can strain relationships and lead to disputes[3]. This can be especially problematic for subcontractors who rely on timely payments to manage their cash flow.

• Failure to release retention: When retainage is not released according to the agreed-upon terms, it can trigger disputes, especially if the contractor believes they have fulfilled their obligations[3]. This can occur if the owner or general contractor delays payment without a valid reason or if there are disagreements over the completion of the work.

• Project Delays: Delays in project completion can lead to disagreements over responsibility and the impact on retainage release timelines[3]. If delays are caused by factors outside the contractor’s control, such as changes in design or unforeseen site conditions, disputes may arise over whether retainage should be released according to the original schedule.
• Documentation:

• Paperwork overload: Disputes may arise from inadequate documentation or record-keeping, making it difficult to track progress payments and retainage accurately[4]. This can lead to confusion and disagreements over the amount of retainage withheld and when it should be released.

Legal Cases Related to Retainage Payment Disputes

Several legal cases have shaped the landscape of retainage payment disputes in construction. Here are a few notable examples:

• United Riggers & Erectors v. Coast Iron & Steel (2018): The California Supreme Court ruled that retainage payments could only be withheld if a dispute was in “good faith” and directly related to the work for which the retainage was held[2]. This case emphasizes the importance of legitimate reasons for withholding retainage and discourages its use as leverage in unrelated disputes. The court clarified that a “good faith” dispute must relate to the subcontractor’s performance of the work, such as incomplete or defective work, or potential liens from third parties[6]. Disputes over unrelated issues, such as change orders, do not justify withholding retainage[6].
• Charles L. Smith, Trustee in the Bankruptcy of Metro Concrete, Inc. v. Des Moines Area Community College and Rochon Corporation of Iowa, Inc. n/k/a Graphite Construction Group, Inc. (2024-2025): This case before the Iowa Supreme Court involves a dispute over the timing of retainage release on a public construction project[7]. The case highlights the complexities of retainage laws and the need for clear contractual provisions to avoid conflicts. Specifically, the case addresses the conflict between a contractor’s right to “bond off” a subcontractor’s claim and the owner’s right to withhold retainage for incomplete work[7].
• J &M Interiors, Inc. v. Centerton Square Owners, LLC (2021): This New Jersey case addressed the enforceability of “pay-if-paid” provisions, which stipulate that subcontractors only get paid if the general contractor receives payment from the owner[8]. The court upheld such provisions if the contract clearly expresses the parties’ intent, shifting the risk of non-payment to subcontractors. This highlights the importance of carefully reviewing and understanding contract terms, especially for subcontractors who may be exposed to greater financial risk under such provisions.

Laws and Regulations Governing Retainage Payments

Retainage laws vary significantly across states, impacting both public and private construction projects. Key aspects of these laws include:

In addition to state laws, federal projects adhere to the Federal Acquisition Regulations (FAR), which limits retainage to 10% and outlines specific conditions for its release[9]. For example, retainage may be released after substantial completion, final inspections, and resolution of claims[9].

It’s crucial for construction professionals to be aware of the specific retainage laws in their state and for federal projects to ensure compliance and avoid potential disputes.

Alternative Dispute Resolution Methods

When retainage payment disputes arise, several alternative dispute resolution (ADR) methods can help avoid costly litigation:

• Negotiation: Direct discussions between the parties involved can often lead to mutually agreeable solutions[14]. This is often the most efficient and cost-effective way to resolve disputes, especially when the parties have a good working relationship and are willing to compromise.
• Mediation: A neutral third party facilitates communication and helps guide the parties toward a resolution[14]. Mediation can be helpful when communication has broken down or when the parties need help finding common ground.
• Arbitration: A more formal process where an arbitrator hears evidence and makes a binding decision[14]. Arbitration can be a good option when the parties want a quicker and more private resolution than litigation.
• Adjudication: An adjudicator reviews the dispute and delivers a decision, often within a short timeframe[14]. Adjudication is often used in construction disputes because it provides a fast and relatively inexpensive way to resolve issues.

Choosing the appropriate ADR method depends on the specific circumstances of the dispute and the parties’ preferences.

Best Practices for Preventing Retainage Payment Disputes

Proactive measures can significantly reduce the likelihood of retainage payment disputes:

• Clear Contract Language: Ensure contracts clearly define retainage percentages, milestones for release, and procedures for dispute resolution[15]. This includes clearly defining “substantial completion” and any other terms that might be subject to interpretation.
• Proper Documentation: Maintain meticulous records of work completed, payments made, and any communications related to retainage[4]. This documentation can be crucial in resolving disputes and demonstrating compliance with contract terms.
• Open Communication: Foster clear and consistent communication between all parties involved to address potential issues promptly[4]. Regular meetings and updates can help prevent misunderstandings and ensure everyone is on the same page regarding retainage.
• Financial Planning: Contractors should plan for the impact of retainage on their cash flow and explore options like retention bonds to mitigate financial strain[15]. Retention bonds can provide a guarantee of payment, allowing contractors to access funds that would otherwise be withheld4.
• Alternatives to Retainage: In some cases, it may be possible to negotiate alternatives to traditional retainage, such as letters of credit or surety bonds[4]. These alternatives can provide similar financial guarantees while reducing the impact on cash flow.
• Negotiation: Proactively negotiating favorable retainage provisions in the contract is crucial to minimize potential disputes later on[16]. This includes negotiating lower retainage percentages, clearer milestones for release, and provisions for handling disputes.
• Technology: Construction accounting software can play a vital role in managing retainage by helping track retainage, automate calculations, and improve accuracy[1]. This can help prevent disputes arising from errors or misunderstandings about retainage amounts.
• Compliance with Laws: Stay informed about state retainage laws and ensure contract terms comply with relevant regulations[15]. This includes understanding the specific requirements for retainage caps, release timelines, and escrow accounts, if applicable.

Impact of Retainage Payment Disputes on the Construction Industry

Retainage payment disputes can have significant consequences for the construction industry:

• Financial Strain: Withheld funds can create cash flow challenges for contractors, especially subcontractors, potentially impacting their ability to pay employees and suppliers[5]. This can lead to project delays, financial instability, and even business failures.
• Project Delays: Disputes can delay project completion, leading to increased costs and potential penalties[17]. Delays can also damage reputations and strain relationships between project stakeholders.
• Damaged Relationships: Disputes can strain relationships between project stakeholders, hindering collaboration and future projects[4]. This can make it more difficult to work together effectively on future projects.
• Increased Litigation: Unresolved disputes may escalate to costly and time-consuming legal battles[13]. Litigation can further strain relationships and divert resources from project completion.
• Impact on Subcontractors: Retainage disproportionately affects subcontractors, who often face longer waiting periods and greater cash flow challenges due to withheld funds[18]. This can make it difficult for subcontractors to manage their finances and complete their work effectively.

By understanding the causes and consequences of retainage payment disputes and implementing preventive measures, the construction industry can foster a more stable and collaborative environment.

Accounting for Retainage

Retainage is tracked as either a liability or an asset, depending on whether it is withheld from subcontractors or retained by the project owner[1].

• Retainage Payable: These are funds withheld by a contractor from payments to subcontractors. They are recorded as a liability in the contractor’s ledger until the funds are released[9].
• Retainage Receivable: These are funds withheld from the contractor by the project owner. They are recorded as an asset on the contractor’s balance sheet but are not recognized as revenue until the retainage is paid out[9].

These amounts are not recognized as revenue until the retainage is released, and managing these balances effectively can be challenging—especially for large projects, multiple projects, or projects spanning multiple jurisdictions with varying retainage laws[9].

How Retainage Payment Disputes are Handled in Different Countries

While retainage is a common practice in the United States, its application and regulations vary across the globe. In some countries, retainage is strictly limited or even prohibited, while others have different mechanisms for ensuring project completion and quality. For example:

• United Kingdom: Retention is typically held until the end of a defects liability period, often 12 months after project completion[1].
• Australia: Retention monies are typically held in trust accounts, with specific regulations governing their management and release[1].
• Canada: Retainage practices vary by province, with some provinces having specific legislation governing retainage on public and private projects[1].

Understanding these international variations is crucial for construction professionals working on global projects.

Conclusion

Retainage payment disputes are a persistent challenge in the construction industry, often arising from unclear contracts, communication breakdowns, and disagreements over project milestones[13]. These disputes can have significant financial and operational consequences for all stakeholders, particularly subcontractors who often face disproportionate impacts[17]. By understanding the common causes, relevant laws, and available dispute resolution methods, construction professionals can take proactive steps to prevent and resolve these disputes effectively. Implementing best practices, such as clear contract language, meticulous documentation, and open communication, can foster a more collaborative and financially stable environment for all stakeholders. Additionally, leveraging technology, such as construction accounting software, can improve accuracy and efficiency in managing retainage. As the construction industry continues to evolve, addressing the complexities of retainage remains crucial for ensuring project success and maintaining healthy business relationships. Further research could explore the effectiveness of alternative mechanisms to retainage, such as project incentives or performance-based payments, in promoting project completion and quality.

References

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