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What is Retainage in Construction? The Ultimate Guide
7 minute read
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Tim Forestell
August 29, 2023

What is Retainage in Construction? The Ultimate Guide

Serving as an essential element that combines risk management and quality assurance, retainage is commonly used in contract negotiations in construction. While having both advantages and disadvantages, the role of retainage policy is evolving in response to contemporary trends, reflecting an industry-wide push towards equity, transparency, and efficiency.

This dynamic landscape is reshaping the significance of retainage, helping bring more financial security and fair compensation, while also fostering successful project outcomes. In this guide, we'll delve into the intricacies of retainage, its calculation, significance, and its evolving role in the construction industry.

What is Retainage?

Retainage involves reserving a fraction of the project's payment for a specified period. The goal of this process is to ensure an accurate completion of a construction project by a contractor or subcontractor. It stands as a customary procedure in both public and private endeavors, serving as a monetary motivator to produce high-quality work and meet the requirements of the project owner.

How Do You Calculate Retainage?

The retainage for your project will be dependent on the total cost, but the withheld sum is typically predetermined within the contract, often falling within the 5% to 10% range. One way to calculate retainage for a fixed rate agreement is by applying the retainage percent to the entire contract price and then dividing it by the number of payments that will be completed.

For instance, if the total contract is $100,000 with a retainage rate of 5%, $5,000 would be withheld as retainage. Contractors receive the retainage once the project is finalized and any necessary corrections are made.

What's the Difference Between Retainage and Retention?

It can often come down to retainage vs. retention since they are often used interchangeably in many situations. However, in the construction industry, they mean different things. Retainage solely aims to incentivize quality work, maintain project schedules, and provide financial protection for project owners against incomplete work or defects.

Retention in construction, however, can serve purposes beyond just quality assurance, such as covering warranty periods, addressing defects that may arise after completion, safeguarding against potential disputes, or meeting financial obligations.

How Does Retainage Work in Construction?

The retainage process begins at the inception of a construction project with the negotiation and establishment of contract terms. Below are the different stages of retainage that should be discussed before working on a project.

Setting the Retainage Percentage

In this phase, the amount of money held back is decided, usually between 5% and 10% of the total contract value. However, this can change depending on how complicated the project is and what is normal in the industry. This percentage represents the portion of each payment due to contractors and subcontractors that will be withheld until the project reaches its completion.

When setting a retainage percentage, there are a few factors that are essential to consider, specifically, in construction. Contracts are determined through negotiation, reflecting project complexity, industry standards, and regulations, all of which will be reflected in the percentage.

Payment Schedules for Retainage

As the project progresses, the retainage percentage affects the payment schedule. Typically, progress payments are made throughout the project's various phases, with the retained amount subtracted from each payment. This serves as an incentive for contractors and subcontractors to meet milestones, maintain project schedules, and ensure work quality.

When contractors or subcontractors fail to complete their work or to address any defects that arise after completion, the withheld funds can be used to cover the cost of correcting deficiencies or incomplete work. On a more positive note, holding back a portion of payment until the work is fully complete and meets the required standard helps to encourage timeliness and high quality of work.

Release of Retainage

Criteria for the release of retainage are established in the contract and are typically linked to project milestones and completion stages. However, the funds are not fully released until all work is satisfactorily completed, inspections are passed, and any punch list items are addressed.

While the specific requirements may vary based on the project and contract terms, here are some common criteria that are often considered for the release of retainage funds:

Substantial Completion: Retainage is often released when the project reaches a state of "substantial completion." This means that the project or a specific phase has been completed to a degree where it can be used for its intended purpose or occupancy, with only minor items (punch list items) remaining to be addressed.

Final Inspection and Acceptance: Before retainage is released, the project may undergo a final inspection by the owner, architect, engineer, or a third-party inspector. This inspection aims to verify that the work has been completed according to the contract specifications, plans, and relevant building codes. Once the inspection is successfully completed, the owner may accept the work as meeting the required standards.

Submission of Required Documentation: The contractor may need to submit documentation such as warranties, operation and maintenance manuals, as-built drawings, and other relevant records before retainage is released. These documents provide information necessary for the ongoing maintenance and operation of the completed project.

Why is Retainage Essential in Construction Contracts?

Retainage is crucial in construction contracts as it acts as a financial safeguard for project owners. By withholding a percentage of payments, owners ensure contractors complete work to the required standards, encouraging quality and compliance. It also incentivizes timely project milestones and maintains project schedules. Here's a list of advantages and disadvantages:

Advantages of Retainage

  • Quality Assurance: Contractors are encouraged to uphold high standards to ensure retainage release.

  • Issue Resolution: Retainage provides leverage to address any defects or shortcomings before project completion.

  • Project Completion: Clients can ensure that contractors have an incentive to complete the project as agreed. Any failure to do so would require more headaches.

Disadvantages of Retainage

  • Cash Flow Impact: Contractors may face cash flow difficulties due to withheld funds. This can be a really impactful disadvantage as many contractors already have to pay upfront for much of their work.

  • Disincentive for Small Contractors: Retainage can disproportionately affect smaller contractors, straining their resources.

  • Administrative Burden: Managing retainage paperwork can be time-consuming.

Pros and Cons: Is Construction Retainage Beneficial or Problematic?

Pros

1. Risk Allocation: Retainage serves as a buffer for project owners against potential risks, such as contractor default, work defects, or incomplete tasks. The withheld funds can be used to rectify issues without additional cost to the owner.

2. Financial Security: Project owners are protected in case of contractor financial instability, as retainage can provide a source of funds to cover potential liabilities or costs arising from incomplete work.

3. Dispute Resolution: Retainage can facilitate dispute resolution by providing an incentive for contractors and subcontractors to address any disagreements or claims promptly to secure the release of the retained funds.

Cons

1. Contractor Relations: Excessive retainage amounts or delayed release can strain relationships between project owners and contractors, leading to mistrust and disputes. This could affect collaboration and overall project success.

2. Incentive for Disputes: The withholding of funds might lead to disputes, as contractors may feel unfairly treated or that the owner is holding their earnings hostage. This can hinder open communication and scheduling.

3. Lack of Flexibility: In some cases, retainage practices might not be well-suited to the unique circumstances of certain projects. Projects with a shorter timeline or smaller budgets might find retainage to be an unnecessary administrative burden.

Navigating Disputes: How to Handle Retainage Conflicts?

Managing and resolving conflicts related to retainage in construction contracts requires a strategic and collaborative approach. Here are four best practices to navigate such conflicts effectively:

Clear Contract Language: Ensure that the contract clearly defines the terms and conditions for retainage, including the percentage withheld, the timing of releases, and the criteria for its release. By specifying the circumstances under which retainage may be withheld or released, helps to create transparency and trust.

Documentation and Transparency: By keeping updated documentation of project progress, milestones, and any issues related to retainage, you're able to create transparency. This includes all communication, agreements, and disagreements in writing. Providing transparency by sharing accurate and up-to-date information about project status, completion, and any outstanding punch list items, will also help to ensure open and honest communication.

Prompt Payment Laws: Familiarize yourself with any relevant prompt payment laws in your jurisdiction, as these may specify timelines for payment and retainage release. Adhering to these laws can help prevent disputes.

Regular and Open Communication: Maintain open and consistent communication between all parties involved, including the project owner, contractors, subcontractors, and any relevant consultants. Also, make sure to discuss retainage-related matters during project meetings and progress reviews to address concerns early and foster an understanding of each party's expectations.

Modern Trends: How is the Practice of Retainage Evolving?

Just like other aspects of construction, the practice of retainage in construction contracts is evolving. In response to various factors, including industry advancements, changing regulations, and shifts in project management approaches, it is important to remain up to date. Here are some modern trends shaping the evolution of retainage:

1. Reduced Retainage Rates: In an effort to improve cash flow for contractors and subcontractors, some construction projects are adopting reduced retainage rates or even eliminating retainage altogether. This trend acknowledges the financial strain retainage can impose on project participants and seeks to promote more equitable payment practices.

2. Performance-Based Models: Some projects are moving towards performance-based payment models where retainage release is tied to specific performance metrics or project milestones. This approach incentivizes achieving certain quality and progress benchmarks, aligning payment with project success.

3. Technology Integration: Modern construction management software and tools are being used to track and manage retainage more efficiently. These technologies provide transparency, facilitate communication, and allow for better documentation of project milestones and completion.

4. Sustainability and Risk Management: Some projects are focusing on sustainable construction practices and enhanced risk management. This can lead to a stronger emphasis on collaboration, quality assurance, and the timely resolution of disputes, reducing the need for extended retainage periods.

Retainage plays a significant role in construction contracts, acting as both a tool for risk management and a driver for quality assurance. By withholding a portion of payments until project completion, retainage provides project owners with a safeguard against potential issues such as incomplete work, defects, or contractor defaults.

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. However, while retainage offers financial security and project quality benefits, it also presents challenges, including cash flow strain for contractors and the potential for disputes.

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 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. Search the DOZR Marketplace for your heavy equipment rental needs.

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Tim Forestell
Tim Forestell is one of DOZR’s co-founders and CCO. Tim got started in the industry as VP Operations for Forestell Landscaping before founding DOZR with Kevin and Erin. Aside from the amazing team at DOZR, his favourite thing about DOZR are the customers. Working with DOZR renters every day gives him a peek at the evolution of different projects and hearing stories about projects being developed from start to finish.
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