Old habits die hard, and, then again, some just never die. That old saying is proving true with the institutionalized, but increasingly scrutinized, practice of retainage in the construction industry. When it comes to owners and/or general contractors withholding monies, chances are the industry may never abandon this deep-seated tradition, leaving the prospect of some type of broad reform as the next best thing for frustrated subcontractors.
Although the ultimate demise of the practice of retainage is not in sight, lawmakers and construction parties are taking a closer look at how this practice is structured and imposed. In some cases, the scrutiny is yielding new laws governing retainage. In others, there's more agreement between parties on alternatives and restructured policies regarding percentages, holding rules, and release.
Especially vulnerable to the practice because of typically long involvement in construction projects, electrical contractors are watching reform efforts closely. In some cases they're helping spearhead initiatives to encourage state legislatures to hear complaints and introduce reform bills. Take David Miller, for example. Director of purchasing with Jess Howard Electric, located in Blacklick, Ohio, and a past president of the American Subcontractors Association (ASA), Miller has been a vocal advocate for retainage reform for years. Along with a coalition of other Ohio subcontractors, he's recently helped advance reform legislation in the statehouse that would put new limits on the practice, including an 8% cap for public and private projects; no retainage after the contractor's work is half complete; and a requirement that general contractors hold no more back from subcontractors than is being held from them by the owner.
Such reform can only be instituted with the help of lawmakers, Miller maintains, because retainage generally is a practice subcontractors just can't haggle over. Instead, subcontractors remain at the mercy of the dynamics of a crowded marketplace and an inability to convince owners and subcontractors to alter a practice that can severely hobble subcontractors. “As a sub, I don't have direct contact with the project owner who sets the retainage amount, so how am I going to negotiate with someone with whom I don't have a contractual relationship?” he says. “In this case we're dealing with a monopsony, where you have many sellers and one buyer. We have no negotiating power on this issue.”
Putting it on the table. Not all electrical contractors see it that way, however. Some say they're seeing changes in the mechanics of the practice, a result of direct haggling with owners and general contractors over terms and changes brought about by new laws governing retainage practices. While Ohio's legislation is still in bill form, some other states have passed laws forcing owners and general contractors to institute changes that can positively affect subcontractors.
Glen Moss, chief financial officer with Commonwealth Electric Co., Lincoln, Neb., says that while retainage is still a part of much of the company's government-related work, it's at least become less onerous in many of its private jobs. “Maybe it's because of our position in the local economy, but we've been able to negotiate retainage terms and conditions in contracts for private jobs,” he says. “While retention typically starts out at around 10%, the bargaining process usually gets it eliminated, down to 5% or cut from 10% to 5% after our work is half completed. We're finding there are various avenues to get around it, and that's our goal.”
Still, at any one time, Moss says, Commonwealth is carrying some $2 million in retainage on its books — most of which are tied to work the company does for government entities. In the jurisdictions in which it works, a flat 10% retainage is still required by law. “Terms are generally not negotiable on public jobs in the states where we work,” he says.
A relatively new law in Missouri has helped contractors like Schaeffer Electric Co., a St. Louis-based electrical contractor, better cope with retainage in that state. Passed in 2003, the law allows, among other things, contractors to substitute a surety bond, line of credit, or other form of security in lieu of retainage on private projects. Mike Smith, a project manager/estimator at Schaeffer, says the company has selectively taken advantage of the new law. “At the choice of the general or the subcontractor, an agreeable substitute can be used in place of retainage,” Smith says. “On jobs of $250,000 or greater, we'll usually use that option and pay a bonding fee equal to 1 to 1Ω% of the retainage that would normally be held, rather than having our money tied up. We think it's better to have the money that would be held as retainage in our possession rather than having it held over our heads to possibly do additional work that's not part of the contract.”
Lobbying efforts pay off. Reforms like those passed in Missouri are partly the product of intense lobbying by groups like ASA and the Independent Electrical Contractors Association (IEC). Emboldened by the federal government's 1983 decree that retainage should not be held on most of its construction projects without cause, groups representing subcontractors have been arguing that the practice is unfair, unneeded, and often counterproductive. “It used to be that retainage on all jobs was 10%, period,” says Colette Nelson, executive vice president of ASA, an association that's worked on numerous fronts to make retainage less of a burden on subcontractors. “Now, thanks in part to the 1983 guidelines only about 15% of government projects hold any retainage, and we see more and more owners — public and private — looking at no retainage. Most states are starting to address the issue, looking at addressing the practice in the public arena first, and then moving to the private sector.”
Over the years, the practice, Nelson says, has hit subcontractors especially hard. In an unregulated environment, subcontractors have been at the mercy of both owners and general contractors. Especially troubling, she says, has been the routine practice of GCs not tying the amount they hold back from subs to the amount held back from them by project owners. “Anything that can be done to eliminate or reduce retainage and to assure the prompt release of funds benefits everyone in the construction chain,” Nelson says. “In any business, it's all about cash flow. But in the construction industry where the typical profit margin is between 2% and 5%, retention of up to 10% can put a contractor deep in the hole for the duration of the project.”
Retainage has proven especially hard on electrical contractors' bottom lines. That's why a Florida chapter of IEC pushed hard for a retainage reform bill that finally passed in 2005 after five years of effort. David Shepp, a contract lobbyist for the chapter, says since electrical contractors are often the first on a job and the last to leave, their money can be tied up for the duration. The new Florida law, which caps retainage at 10% for the first half on public jobs, release of that retainage at the halfway point, and 5% maximum held back on the second half, is giving electrical contractors more breathing room, he says. “There were cases before this where contractors were waiting a year or more to get their money for general contractors,” says Shepp. “This new law has been very helpful. GCs are complying, and electrical contractors have more money freed up to pick up new jobs and bring in more manpower to get jobs done.”
An entrenched practice. Despite such efforts, retainage remains at least an annoyance for many subcontractors. Where it's not been reined in via legislation, owners and general contractors reflexively fall back on the practice, which traces its roots back to the 1840s railroad construction in the United Kingdom.
Instituted as a way to give owners some leverage over contractors to complete work, the practice is increasingly viewed by subcontractors as a method to get them to essentially provide interest-free loans to owners or general contractors. While most subcontractors eventually end up getting their retained funds, many complain release takes far too long and that retainage is sometimes used by owners and general contractors as leverage to have more work performed that was not in the original contract.
These and other contentious issues surrounding retainage were detailed in a recent study done for ASA entitled “Retainage Practice in the Construction Industry.” The author, Clemson University professor Dennis Bausman, PhD, says his research revealed that retainage is “still quite prevalent.” While there's a growing consensus that retainage as commonly practiced might be unfair, there's also a disconnect between owners, general contractors, and subcontractors over the need for retainage and whether it's ultimately harmful or beneficial. “In its purest form, retainage provides zero-interest financing for a project, and there's now some concern and recognition in the industry that may not be fair and may be a burden on contractors, especially as margins in the industry keep drifting downward,” Bausman says.
The study found parties remain at odds, though, about whether retainage adds costs to projects and offers protection to owners or not. “Owners don't think they're paying anything more with retainage, but 65% of contractors we surveyed said they're less likely to pursue a project where it's required,” Bausman says. “The study also found that a majority of contractors said prices would be from 2.2% to 3.6% lower if there was no retainage. Owners, however, said they didn't believe the practice raised prices.”
Some electrical contractors, however, actually factor retainage into their prices. “We try to price it in by looking at the timeline from billing to collection, and sometimes that can be a year,” he says. “We factor in the prevailing interest rate and go from there. I think everyone tries to factor it in somehow.”
As for retainage's value as protection for owners, Bausman found owners believe it affords protection with little or no downside, encouraging “correction of defects, expedites closeout documentation, and ensures completion of the punchlist.” Contractors, on the other hand, find it an unnecessary practice that gives little or no protection to the owner, because as the study's conclusion states, “it treats good and poor performers the same, thereby providing minimal incentive to perform.”
Clearly, despite signs that owners and contractors are attempting to compromise — whether spurred by legislative mandates or recognition that the time is ripe for reform — the practice appears to remain solidly entrenched in the construction industry. For electrical contractors, that means continuing to factor in the economic impact of retainage, while at the same time working to nudge both owners and general contractors toward a reform solution that perhaps substitutes better contractor vetting and vendor management for the practice of withholding money. “Our feeling is that we don't like retainage, but from the owner's standpoint it seems to be a necessary evil,” says Commonwealth Electric's Moss. Due to this ongoing disconnect and barring legislative reform in all states, the two parties just will have to meet somewhere in the middle — at least for the time being.
Sidebar: Driving a Hard Bargain
While hardly in the driver's seat, electrical contractors do have some leverage in setting the ground rules for retainage. Here are a few tips on getting more favorable terms:
Consider quoting two prices — one if retainage is held; the other if it's not. Doing so may help the owner or general contractor better appreciate the financial burden that retainage imposes on you.
Propose some alternate form of protection, such as performance bonds, a punchlist performance guarantee, or some other form of security.
Before bidding on a job, become familiar with the state laws and regulations governing retainage practices. A patchwork of legislation now exists from state-to-state. Knowing your legal rights in the state you'll be working in is essential. For specific retainage laws broken down by state, see an updated version of a “Fifty-State Review of Retainage Laws” written by Richard A. Stockenberg, Gallop, Johnson & Neuman, L.C., St. Louis, available on the Web at http://www.gjn.com/CM/News/Fifty%20State%20Review%20of%20Retainage%20Laws.pdf.
Try to have the retainage designated as trust funds. Doing so may help protect the funds from being disbursed to other parties in the event of an owner or general contractor bankruptcy.
Emphasize your skills and qualifications as well as your willingness to work as part of a team. More owners are looking to bring in expert contractors who can be involved in the project in the early stages.
Try to include language allowing for interest accrual on funds not released in a timely fashion. Better yet, propose a fair rate of interest on all retained funds.