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The Retainage Process and Construction Draws

Retainage is too often misconstrued as a burden that the Bank imposes on contractors and owners. The reality is that retainage is the best insurance policy (especially on projects costing less than $1,000,000) that the owner can get! The Bank only benefits because the owner’s financial burden can be eased if retainage funds are available when a project goes "sour".

Requiring a retainage provision in the contract between an owner and contractor has nothing to do with trust or reputation. Very few owners would even use a contractor they didn’t trust or who has a questionable reputation. Rather, retainage does benefit the owner in a couple of ways.

During the course of the construction process, it’s available for use in unusual circumstances that might cause the contractor to be unable to complete the work or unable to fulfill financial obligations to subcontractors or suppliers. These types of circumstances might include:

• Divorce and spousal actions which freeze assets or company actions
• Death or disability of a contractor’s principal or owner
• Mishandling or fraud by a contractor’s accountant or financial manager
• The draining of assets by a separate project "gone bad"
• Subcontractor’s failure to pay suppliers

Note: Retainage is not necessarily available to allow owner’s arbitrary use when there is a dispute over quality or timely completion. Contractor default is typically required before this use is allowed.

At project completion, release of the retainage can be an incentive to complete the scope of work or a "lever" to insure completion. It is also the final funds available which can help to correct any deficiencies or quality of work problems. It is important to note here, that "deficiencies" do not necessarily comment on the contractor’s work product! The best of contractors can be surprised by concrete that doesn’t “cure” right or countertops that de-laminate, etc.

We have seen and/or been involved with projects in every one of the above situations. It would be a disservice to borrowers to not recommend retainage provisions in their contracts. Contract clauses that allow release of retainage as portions of the project are completed or reduction of retainage as progress occurs can be used to satisfy contractor’s objections.

Preferred retainage: 10 percent of the progress billing held until the project is complete. A retainage of 10 percent until the project is 50 percent complete is recommended as a minimum. The release or reduction of retainage after 50 percent complete is at the sole discretion of the Bank and borrower.

Purchased material: Requests to forego retainage on purchased material is determined on a case-by-case basis and may be considered if the material is delivered to the site and is satisfactory.

Partial release: Partial release of retainage may be approved at the discretion of the lender and owner based mainly on the inspector’s recommendation considering the quality of the project as well as the length of the construction process.

Final release: Retainage is released to a contractor upon satisfactory completion of the individual trade construction and upon receipt of the final release of liens. The final release of retainage to the general contractor should be approved upon receipt of the final release of liens, Certificate of Occupancy and/or Certificate of Substantial Completion. If bonded, the consent of the surety may also be required prior to reduction or release of retainage. The construction loan agreement should be consulted for other requirements that need to be met prior to funding the final retainage release.

For more information about this important topic, please feel free to contact Dan at: