Eric Travers presented "Negotiating Retainage" on January 13, 2015, for the ASA Building for Profit Internet Learning Series. He discussed ways to reduce and eliminate retainage and how to negotiate from a position of strength. Eric also provided tips and examples of how to modify bids to eliminate or disincentive retainage.

1. z
Negotiating Retainage
presented by Eric B. Travers. Esq.
ASA Building for Profit Internet Learning Series
January 13, 2015
www.asaonline.com

2. z
Program Goals:
Reveal strategies to convince your customer to
reduce or eliminate retainage
Discuss how to negotiate from a position of
strength when broaching the topic of zero or
reduced retainage
Tips and examples of how to modify your bid to
eliminate or disincentivize retainage

3. z
“The One with the Gold
Makes the Rules”
+ And so it is with retainage – a word foreign to most
dictionaries, but well known to subcontractors
+ Over the years, retainage has become entrenched in the
U.S. Construction industry
+ For too long the construction industry has tolerated
withholding retainage far in excess of current profit
margins until well after work is satisfactorily performed

4. z
What is “Retainage”?
Dictionary of Architecture and Construction,
Second Edition, ed. Cyril M. Harris
“A sum withheld from
progress payments to the
contractor in accordance with
the terms of the owner-
contractor agreement.”
“ “

5. z
Judicial Definition
Van Knight Steel Erection, Inc. v. Hous. & Redevelopment Auth.
of City of St. Paul, 430 N.W.2d 1, 3 (Minn. Ct. App. 1988)
[A] contractually created
security system under which
the owner retains a specified
portion of earned progress
payments to secure itself
against certain risks.
“ “

6. z
Plain English Definition
The holding of otherwise
due funds from a contractor
after the entire contract is
complete.
“ “

7. z
Sound strange? It is.
Yet that is precisely what many subcontractors
have learned to tolerate.

8. z
Justifications
+ Ensures completion of the work
+ Guarantees repairs
+ Funds corrective repairs
+ Finances the project
+ It is traditional
+ The Owner is withholding it

9. z
The reality is that the Owner already has protections
for the common justifications for retainage

10. z
A201 (2007) Sec. 9.5.1
The Architect may withhold a
Certificate of Payment in whole or
in part, to the extent reasonably
necessary to protect the Owner, if
in the Architect’s opinion the
representations to the Owner
required by Subparagraph 9.4.2
cannot be made.
“ “

11. z
ConsensusDOCS 200 (9.3 Adjustment of
Contractor’s Payment Application)
The Owner may adjust or reject a
Payment Application or nullify a
previously approved payment
application, in whole or in part, as may
be reasonably necessary to protect the
Owner from loss or damage based
upon the following, to the extent the
Contractor is responsible therefor
under this Agreement…
“ “

12. z
401k
+ A percentage of each payment is withheld pre-tax
+ Employee sets percentage
+ Possible employer matching
+ Interest bearing/money generally ‘grows’
+ Controlled by employee
+ Paid out with “interest” to employee

13. z
Retainage (vs 401k)
+ A percentage of each payment is withheld post tax
+ Someone else (Your Client) sets percentage
+ No employer (client) matching
+ Not interest bearing, except interest to the party
holding onto your money
+ Controlled by your client
+ May be paid out … may not be

14. z
Retainage Has Evolved
Though Retainage may have originally been created to
ensure the owner that its contractors properly
completed their work, it has evolved into a warranty
against faulty work and/or any other problem that
might arise on a contract.

15. z
+Retainage has outlived its
purpose. Modern forms of
post-contract protection such
as warranties and performance
bonds have eclipsed retainage.
+Worse, retainage harms both
contractors and owners.
Retainage is a Dinosaur

16. z
How Retainage Hurts Contractors
Retainage ties up company capital, sometimes for YEARS:
+ Some large construction projects take years to complete, yet
retainage is often held until final acceptance and sometimes
longer.
+ Contractors simply do not have the working capital to make
up for retainage being held this long. Not when their bills
for the work are due now.

17. z
Declining Industry Profit
Margins
+ In 1972, Robert Morris Associates noted that contractors
earned approx. 6% profit on each dollar of revenue.
+ By 1986 the profitability rate had declined to 3%. By 2004 it
fell to around 2% of revenue.
+ Retainage Practice in the Construction Industry, Dennis C. Bausman, PhD.
+ A 2011 BloombergBusinessWeek article revealed that
nonresidential/commercial construction contractors are at the
very bottom of the 97 industries studied, with net profit
margins down to 0.78% for contractors and 1.25% for material
suppliers.
+ See http://images.businessweek.com/slideshows/20110118/most-and-least-profitable-business-types#slide2 and
http://images.businessweek.com/slideshows/20110118/most-and-least-profitable-business-types#slide5

18. z
How Retainage Hurts An Owner
Retainage Reduces Competition
+ ASA national study indicated that 91% are more likely to bid
a job with no retainage
+ Many firms are reluctant to bid jobs with excessive
retainage. It ties up capital and forces them to borrow
money to meet expenses
+ Eliminating retainage would increase bid competition (&
lower prices) by bringing in more companies bidding
without the retainage markup

19. z
How Retainage Hurts An Owner
Retainage increases bid prices:
+ Many contractors increase bid prices to absorb the loss of
capital and to pay for the interest on the money they have
to borrow
+ An ASA Study indicates subs would lower bids by an average
of 3.1% for projects without retainage
+ A Clemson University study indicates that prime contractors
increase their bids on jobs with retainage by an average of
2.2-2.4%

20. z
Retainage Makes the
Contractors Finance the Project
0%
10%
20%
30%
40%
50%
60%
70%
80%
5.1-10% 0.1-5% None
47%
37%
16%
55%
36%
9%
45% 43%
12%
73%
15%
12%
%ofProjects Retainage by Occupation
Arch
CM
GC
Sub
Retainage Practice in the Construction Industry, Dennis C. Bausman, PhD

21. z
Retainage Impacts Performance
“[C]onstruction was financed bottom-up - therefore
the weakest and smallest firms (with the poorest access
to credit) bear the financial burden.”
+ The Use of Retentions in the Construction Industry, Specialist Engineering
Contractors Group (2002).

22. z
Time to Payment: Average 160 Days
+ASA surveyed 592 subcontractors from 39 states and
determined that the average subcontractor was
carrying $620,025 in retainage receivables on the
books, for an average of 160 days after the
subcontractor completed its work.
+Because these amounts typically exceed profit
margins, the subcontractors are acting as a bank
for the construction project. The significant
financing costs associated with retainage
are undeniable.

23. z
What Can Subs Do?
Negotiate elimination or reduction of retainage
from a position of strength

24. z
How?
+By understanding the common retainage myths, and
being prepared to both dispel those myths and
discuss how retainage hurts both contractor and
owner; and then
+Being prepared to offer alternative solutions that
meet the parties respective needs and address the
shortcomings of retainage from your customer’s view.

25. z
To Start
Modify your bid, proposal or quote to exclude
retainage or line item closeout requirements

26. z
Negotiation Tip #1
+When addressing retainage, it is important to both
understand why retainage is viewed as necessary or
desirable, so you can rebut those claims
+In other words, there are some common myths
supporting retainage as we know it and it is time to
be dispel those myths

27. z
Myth #1: Without retainage, subs will
never finish their work
+ASA’s survey found that only 17% of subcontractors
believed that retainage was an effective tool in
encouraging work completion.
+Such a conclusion is supported by common sense –
wouldn’t a sub be more likely to finish its work in
exchange for final payment while its workforce is still
on site, instead of months after it has demobilized
(when the final punchlist arrives) while it is working in
earnest on another project?

28. z
What is the True Guarantee of
Satisfactory Completion?
The correct way to assure performance today is:
1. Through Good contract management
2. With Performance bonds and warranties

29. z
Myth #2: The owner needs the retainage
money to finance the project
A study commissioned by the Florida state legislature
admitted that it would be fair to require any retainage
to be repaid with interest, but rejected this because it
would cost taxpayers money.
(Instead, the study recommended the line item release of
retainage by trade)

30. z
+More important, if a project has retainage the owner
(public or private) is already paying for retainage in higher
bids resulting in higher overall project costs
+The ASA study found that if no retainage were held –
+ 91% of subs would be more likely to pursue that work;
+ 69% would lower prices; and
+ The average price reduction by the Subs would be 3.1%.

31. z
The negotiation point to be learned is that
owners (and gcs) will get more and better
bids if they eliminate or reduce retainage,
resulting in lower overall project cost.

32. z
Myth #3: Eliminating retainage requires
tough judgment calls
Owners and architects argue that institutional withholding
of retainage “across the board” protects them from the
consequences of their actions when making decisions
about percent of completion and when a subcontractor’s
scope of work is completed. Without retainage, these
decisions have real consequences which cannot be masked
with a pot of retainage money.

33. z
The Federal Experience Proves
Elimination of Retainage Works

34. z
“[R]etainage should not be used as a substitute
for good contract management” 48 F.A.R. 32.103.
+F.A.R. Para. 32.013 continues that “the contracting
officer should not withhold funds without cause.” Thus,
on federal construction contracts no funds are
retained if there is satisfactory performance.
+This regulation has been in effect almost 30 years
(since 1987) with no ill effect on the feds ability to get
jobs completed by subcontractors.

35. z
“[R]etainage should not be used as a substitute
for good contract management” 48 F.A.R. 32.103.
+Similarly, on private work owner representatives
should not abdicate their meaningful responsibilities
to monitor project completion by figuring that ‘the
retainage will cover it”
+Owners would still be able to hold back money for
work not satisfactorily or timely performed

36. z
Myth #4: The owner, contractor or bonding
company need the retainage in the event of a
default
This cynical approach was best characterized by a Past
President of ASA, Floyd Warkol, who stated “The
[retainage] system is antiquated and begins with the
premise that the contractor won’t fulfill his obligations.”

37. z
ASA Position on Retainage
“The retainage system has become increasingly inequitable
and counterproductive. ASA supports the elimination of
unnecessary retainage on all construction projects.
ASA [also] supports legislation to prohibit a prime contractor
from retaining a higher percentage from its subcontractors
than the owner is retaining from it.
Finally, ASA supports legislation that requires retained funds
to be held in escrow with interest accruing to … the party to
whom funds are owed.”

38. z
How Should Retainage be
Reformed?
ASA supports five reform paths:
1. Reducing the allowable amount of retainage
2. Tying the amount of subcontractor retainage to the
amount held by the owner
3. Charging interest on retainage
4. Line item release of retainage
5. Banning retainage

39. z
AGC, ASA + ASC Joint Position
on Retainage
The above trade associations have approved a ‘joint’
position concerning retainage practice as follows:
+Whenever possible, retainage should be eliminated or
reduced
+If the need for retainage cannot be eliminated, an
acceptable alternative form of security in lieu of
retainage may be used
+If retainage is required, the percentage retained
should be as low as possible

40. z
AGC, ASA + ASC Joint Position on
Retainage
+ Where retainage is held, the % should be the same for subs as
for the prime contractor
+ Early (including line item) release of retainage should be
encouraged
+ Reduction in retainage and release of retained funds should
not be delayed because work under change orders has not
been completed
+ When retainage is used, retained amounts should be
deposited in an escrow account that bears interest
inuring to the contractor and subcontractor in their
respective shares

41. z
Reducing the Allowable Amount
of Retainage
Some states have capped the amount of retainage
allowed:
+ Delaware caps the amount of retainage on state work at 5%
+ New Mexico prohibits retainage on the majority of private
and public work, though 5% retainage may be held on road
contracts

42. z
Tying Retainage to the Amount
Held by Owner
+ Georgia: On public work subcontractors are entitled to the
same retainage rate as the contractor
+ North Carolina: On public work there is no retainage for
contracts under $100K. For the rest, 5% max retainage and
retainage on subs may not exceed retainage on contractor
While all these changes help alleviate the problem and keep the
playing field more level, they generally do not address the
underlying problem

43. z
Charging Interest on Retainage
+Michigan public work: Retained funds are placed in an
interest bearing account and paid to the contractor with
final payment
+The money held as retainage belongs to the
subcontractor. And time is money.
+Retainage held should accrue interest since that money is
being held over time from the contractor and
subcontractor

44. z
Line Item Release of Retainage
+Several states require release or reduction of
retainage after 50% completion
+Since subcontractors finish at different times during a
project, retainage held from each sub should be
released after his/her work is complete

45. z
What Can I Do?
+Sit down and determine the cost to your company of
retainage and provide an incentive to contractors and
owners for paying promptly and without retainage
+This could be a discount for prompt payment, a
reduction off the final bill after substantial completion
of your work, or something similar

46. z
Bid Modification Ex. 1
This bid is based on monthly payment in full for all work
properly performed and excludes the withholding of any sums,
either as a percentage of work performed or on a line item
basis, pending completion of the Subcontractor’s Work on the
Project. Any contract requirement for withholding of sums
based on a percentage of the work performed or on a line items
basis shall result in an increase in the bid price to be
negotiated between Subcontractor and Contractor.

47. z
Bid Modification Ex. 2
This bid is based on monthly payment in full for all work
properly performed and excludes the withholding of any
sums, either as a percentage of work performed or on a line
item basis, except out of Subcontractor’s final payment
application, pending completion of Subcontractor’s Work or
the Project. Any contract requirement for withholding of sums
except out of Subcontractor’s final payment application, shall
result in an increase in the bid price to be negotiated between
Subcontractor and Contractor.

48. z
Bid Modification Ex. 3
If Subcontractor is paid in full for each progress payment
application within 30 days of the date the progress payment
application is submitted to Contractor, and no amounts are
withheld (either as a percentage of the work performed or on a
“line item” basis) pending completion of the Subcontractor’s
Work, Contractor shall be entitled to a reduction in the bid
price of % to be taken out of the final payment
application.

49. z
Follow Up
+All the bid modification clauses do is give you the right to
negotiate the terms under which retainage will be held,
percentage withheld, and time of release
+If you do not actually negotiate the additional cost (or you
then sign a subcontract allowing retainage or line item
closeout), then you have likely waived your right to receive
additional compensation or to rely on your bid proposal

50. z
Sample Retainage Hierarchy
1. No Retainage
2. Final payment application only
3. Alternate security
4. Interest bearing
5. Limited retainage
6. Equivalent with Owner retainage
7. Early release

51. z
Sample Subcontract language:
No Retainage
No provision of this Subcontract shall serve to deny
Subcontractor’s entitlement to full payment each calendar
month for properly performed work or suitably stored materials.
No amounts shall be withheld from any payment application
submitted by Subcontractor based on a percentage of the work
performed during the application period and no amounts shall
be assigned to line items, other than as assigned by
Subcontractor in its payment applications.

52. z
Sample Subcontract language:
Final Payment Only
All amounts withheld from Subcontractor as retainage, based on
a percentage of the work completed, or as a line item tied to
completion of the work shall be retained solely out of
Subcontractor’s final progress payment application. Payment of
any funds withheld from Subcontractor’s final progress payment
application shall be released to Subcontractor within 30 days
after completion of Subcontractor’s Work.

53. z
Sample Subcontract language:
Alternate Security
The parties agree that retainage of any amounts based on a
percentage of the work completed (or as a line item tied to
completion of the work) is duplicative and unnecessary if either:
(i) a performance bond is in place for the Project, or (ii)
Subcontractor posts alternative security in the form of a bond or
letter of credit in the amount of the agreed upon retainage
based on Subcontract Price. Thus, if either of the above exists,
no provision of this Subcontract shall serve to deny
Subcontractor’s entitlement to full payment each calendar
month for work performed with no amounts withheld or
deducted for retainage.

54. z
Sample Subcontract Language:
Interest Bearing
Contractor shall pay Subcontractor interest on all funds
withheld at % annual percentage rate. Final payment,
including release of retainage and interest, shall be due within
30 days after completion of Subcontractor’s Work.

55. z
Sample Subcontract Language:
No Greater Retainage than withheld by Owner
Contractor shall not withhold from Subcontractor as
retainage or as a line item based on completion of the work
a percentage or dollar amount that is higher than the
percentage or dollar amount held by Owner on
Subcontractor’s Work. Final payment, including release of
retainage and interest, shall be due within 30 days after
completion of Subcontractor’s Work.

56. z
Limited Retainage/Cap
Notwithstanding anything to the contrary in the
Subcontract, Contractor shall not withhold from
Subcontractor as retainage (or as a line item based on
completion of the work) a percentage that is higher
than ____% of the work performed, but it is agreed
that retainage shall not be withheld for any line items
or costs of materials delivered to the site for
incorporation into the Subcontractor’s work.

57. z
Sample Language:
Prompt Payment Discount
No provision of this Subcontract shall serve to deny Subcontractor’s
entitlement to full payment each calendar month for properly
performed work or suitably stored materials. Payments shall be due
thirty (30) days after a progress payment or final payment application
is submitted to Contractor. If Contractor has paid Subcontractor in
accordance with the provisions of this clause, then Contractor shall
be entitled to a reduction in the Subcontract Price in the amount
of $ , which amount shall be deducted solely from the amounts
due Subcontractor on its final payment application.

58. z
Other Negotiation Ideas
If retainage is going to be withheld, consider
negotiating the time for release, such as at:
+ Line item completion
+ Substantial completion
+ Acceptance/completion of your work

59. z
Other Negotiation Ideas
Remember that if faced with the argument that
retainage is necessary to ensure satisfactory progress
and completion of the work...
+ The Federal Experience negates this
+ And the correct way to assure performance is through good
contract management, hiring quality subs, with surety
bonds, and adequate warranties for most work

60. z
Conclusion
+Being prepared to negotiate retainage through bid
conditioning and contract clauses remains the best way to
immediately deal with the problem.
+Use ASA resources to help build a toolbox of options you
can consider and propose to help negotiate retainage for
your contracts and work.
+Support ASA’s legislative state and federal retainage
reform efforts.

61. z
Thank You
Eric B. Travers
Director
etravers@keglerbrown.com
keglerbrown.com/travers
614.462.5473