Retainage

Retainage refers to the amount of money withheld from the total contract amount allocated for a project until it is completed within the timeframe in the highest quality. It is a powerful motivator and incentive for contractors to do the project as per the instructions of the client.

As per industry standards, it tends to be 5-10% of the total project amount, which is equal to the profit of the contractor. Clients impose it more on new contractors to learn about their performance quality and timely project completion rapport. However, if the project has to be completed in a short duration, they waive the retainage.

• Retainage is the sum of money deducted from the contract sum allotted for construction until it is finished on schedule and to the highest standard.
• It seeks to be a strong motivator and inducement for contractors to complete the project in accordance with the client's specifications.
• Throughout the entire project, clients use a certain proportion of each payment to determine retainage. At times, they may immediately withhold payment to be reimbursed once the project is finished.
• Moreover, it might be between five and ten percent of the overall project cost that the contractor submits and the customer accepts.

Retainage in construction is a percentage of the total project amount that gets upheld by the client from the main or sub-contractor until that project is finished. The amount of retainage gets specified before the construction work starts in the construction contract itself. Hence, in most cases, the percentage of the amount varies according to the type of project. 

Retainage is a requirement for all federal projects, and the contract is canceled without it. Most of the project works involving contractors use retainage as a means to protect the owners or general contractors from:

1. Non-compliance
2. Unwanted project risks
3. Non-performance
4. Low-quality work
5. Extension of project deadlines
6. Smoother workflow

This is how it works:

1. The construction contract between the project owner (client) and the contractor usually stipulates the terms.
2. During each payment, the client withholds a predetermined percentage of the total amount (retainage) and does not pay it to the contractor immediately. The client sets aside and holds the withheld funds, often in an escrow account.
3. Once the construction project is complete or reaches a specific phase, the client conducts a final inspection to ensure that the work meets the agreed-upon standards and specifications.
4. After the final inspection and resolution of any outstanding issues, the client releases the retained funds to the contractor.

Every routine payment application format incorporates it for assistance in retainage accounting. This also occurs due to the pass-through effect as the contractor passes it on to the workers of the project. The most significant advantage of the retainage is the provision of a built-in remedy for failure of project completion by the contractor. Paying from the retainage to subcontractors and suppliers helps the owner complete the work.

Clients calculate retainage at a certain percentage of every payment made throughout the entire project. At times, clients may withhold it at once to pay after completing the project. However, some clients may prefer to deduct the fixed percentage from every payment made to the contractor. Therefore, the retainage payable or retainage fee can range between 5-10% of the total project cost submitted by the contractor and accepted by the client. 

Calculating retainage involves determining the percentage of the total contract value that will be withheld until the completion of the project or a specific phase.

Hence, the formula is:

Retainage = Percentage Withheld x Total Contract Value

Let us use a few examples to understand the topic:

Example #1

Let there be a contractor, Alex, who has
signed a contract with its clients to complete their office construction with
the following data:  

• Alex billed the client at $30000 as the initial payment for two lacs dollars project    
• The contract has a ten percent retainage clause
• The original contract amount shown on the contract would be two lacs
• There would be another line at the end indicating payments due of thirty thousand dollars.

Therefore the calculation of the retainage amount is:

Retainage = Percentage withheld X Total contract value

10% X $30000 = $3000

In this example, for a $30,000 payment, $3,000 would be withheld as retainage, leaving the contractor with a net payment of $27,000. The $3,000 retainage would be held until the completion of the project or a specific phase, as outlined in the contract.

Example #2

Governor Kathy Hochul signed Senate Bill S.3539/A.4167, popularly referred to as the 5% Retainage Bill, into law on November 17, 2023. This bill modifies Sections 756-a and 756-c of the New York General Business Law, which deal with retainage and payment in construction contracts.

This new regulation aims to shorten the time it takes to release retainage for private building projects that have complied with significant completion conditions. According to the law, when a private commercial construction project is valued at $150,000 or more, the owner may withhold retainage of no more than 5% of the total contract amount.

Furthermore, the owner must deliver this to the general contractor within thirty days following the construction contract's final approval of the work. If the party responsible (owner, general contractor, or subcontractor) does not release retainage in accordance with legal requirements, they will incur interest at the rate of 1% per month.

The retention clause has certain disadvantages:

1. It poses a problem to those contractors who work at the beginning of the project as they have to wait many years to get their retention amount. 
2. The retainage amount received by the contractor may be less than agreed upon
3. A general contractor or the owner may go bankrupt, leading to zero payment of retention amount to subcontractors.
4. Moreover, the amount of retention may be more significant than permissible.
5. Owners may use the retention amount as interest-free working capital to fund the project.
6. Contractors become alone to fend for meeting the project cost from their own pockets.

Let us look into the differences between the two using the table below:

This has been a guide to Retainage and its meaning. Here, we compare it with retention, and explain how to calculate it, its examples, and disadvantages. You can learn more about financing from the following articles –

• Construction Accounting
• Schedule Of Values
• External Failure Cost