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Blog: Clarify Retainage Terms and Entitlement to Payment

Unnecessary retainage can quickly erode a subcontractor’s cash flow. Thus, a subcontractor will want to address the retainage terms during the pre-award process. 

The retainage rate should be no higher than that being retained by the owner from the general contractor and—in any event—should be no higher than 10 percent. A subcontractor should seek entitlement to a retainage reduction when its work is 50 percent complete. 

It might only seem reasonable that a contractor would include any favorable project payment terms in its subcontract agreements, including retainage release. However, contractors may be tempted to negotiate more stringent payment terms with their subcontractors. 

A subcontractor also should clarify when the retainage is to be released in full. The subcontractor should insist on terms making retainage payable upon satisfactory completion of its work. If punch-list work remains, retainage on substantially completed work should not exceed 1.5 times the reasonable value of such unperformed work. 

These payment terms have become a general industry standard because they offer a strong incentive for prompt completion of subcontract work and thus also benefit the contractor and the owner.

One of the biggest challenges to subcontractor cash flow is a subcontract clause that makes its payment contingent on its customer receiving payment first. “Pay-when-paid” clauses are troublesome because these terms can be used by a contractor to justify long delays in progress payments and final payments. A typical “pay-when-paid” clause may read:

“The Subcontractor shall be paid within seven (7) days after the General Contractor receives payment from the Owner for the work of the Subcontractor.”

Such terms may result in slow payment due to disputes and inadequate project funding. However, many state court decisions allow subcontractors to get their money within a “reasonable” time following proper billing. Still, actually getting money owed may take time to overcome the hurdle that pay-when-paid language imposes. 

A few courts have not allowed subcontractors payment entitlement, concluding that pay-when-paid contract clauses mean literally what they say. “Pay-when-and-if-paid” clauses are far worse. A typical “pay-when-and-if-paid” clause may read:

“The General Contractor will pay the Subcontractor only if the General Contractor is paid by the Owner for the Subcontractor’s work. Receipt of payment from the Owner by the General Contractor for the Subcontractor’s work is an absolute condition precedent to the Subcontractor’s right to payment.”

These terms specify that payment by the owner to the contractor is absolutely necessary for a subcontractor to have any entitlement to payment. Courts usually find that such an explicit agreement means a subcontractor has no right to even an eventual payment from the contractor should the owner fail to pay the contractor. 

There are a number of ways for subcontractors to avoid conditional payment terms. One way is to reach agreement on language limiting the general contractor’s right to withhold payment to a maximum of 30 days or 60 days, even if the owner does not pay the general contractor. A second way is to add a provision stating that payment by the contractor may be delayed only for monies withheld by the owner due to some deficiency on the subcontractor’s part. For example:

“Our acceptance of conditional payment language is conditioned on the understanding that these terms apply solely to monies withheld by the Owner due to some deficiency on our part.”

A third way to overcome conditional payment language is to include wording stating that, notwithstanding anything to the contrary, no provision of the subcontract shall restrict the owner’s entitlement to prompt payment for work properly performed. Conditional payment language generally relates to both progress payments and final payments. 

The “pay-when-and-if-paid” variety may cut off your ability to institute suit or assert a surety bond claim. Such terms could even permit a contractor to challenge a lien on the theory that all payments legally owed have been made. Long payment delays are predictable if the owner and contractor have a dispute—even if that dispute does not concern the subcontractor’s work.

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The American Subcontractors Association is a national trade organization representing construction subcontractors, specialty trade contractors, and suppliers. For more information about ASA, visit www.asaonline.com

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