Retainage Reform Revisited

Retainage Reform Revisited

July 13, 2018

Illinois is the most recent in a number of states to consider legislation that modifies the practice of withholding payments from contractors and subcontractors as retainage.  The practice of retainage has been regulated by the vast majority of states for public projects, private projects or both.  In its last session, the Illinois legislature passed SB 3052, which restricts retainage. Now it is up to Governor Bruce Rauner to decide if Illinois should join those states restricting retainage on construction projects.  

Illinois Senate Bill 3052 would restrict retainage to 10 percent for the first half of commercial construction projects and reduce it to five percent for the second half.  Public projects and residential projects of 12 or fewer units are not affected by the proposed law.  It is an amendment to the Contractor Prompt Payment Act, a law that already obligates contractors to remit amounts paid by owners, whether retainage or otherwise, to subcontractors within 15 days of receipt.  The CPPA also imposes 10 percent interest on monies not paid timely and, importantly, it raises a presumption that invoices are valid if not objected to promptly in writing.

In the eyes of many contractors and subcontractors, the need for retainage reform is obvious, just as many developers oppose government interference in this issue. Retainage reform provides relief for cash flow problems.  Holding retainage for a year or more from the beginning of a large construction project can be a burden to smaller contractors and subcontractors.  While retainage is withheld, laborers, material suppliers and other expenses must still be paid, often with borrowed money on which interest charges are incurred. The cash crunch may be felt hard by small and minority subcontractors, who frequently have less access to credit markets and can be hampered by the diminished cash flow caused by withholding payment after all parties agree the work is properly performed.   

The practice of retainage became common 170 years ago in a nascent construction industry that may have seen high profit margins, low contractor reliability and great volatility.  With few protections in place then for owners, and a 10 percent reserve being less than a contractor’s profits, retainage seemed a method to keep players in check.  Fast forward to the early 21st century -- with sophisticated project payment protocols, architect and bank inspections before periodic payments, and a solid yet highly efficient construction industry earning lean profits averaging three percent -- and the argument for 10 percent retainage or more may not be as strong.  Some owners and developers voluntarily curtail the percentage of retainage on projects when other protections are in place.    

Some argue that a compelling reason to address the retainage issue is to realize greater economic efficiency.  Though responsibility for borrowing required project capital may be shifted using retainage from the developer to the subcontractor, capital is still required.   If the amount of capital required for a project remains the same, while the cost to borrow the funds is greater because builders, due to their size and sophistication, pay a higher cost to borrow funds, then the overall cost of borrowing for the project increases.  Furthermore, if borrowing costs increase, project costs increase.  Additionally, according to some surveys, the cost of a construction project is reduced when retainage is reduced, because contractors and subcontractors submit higher bids to account for retainage.  Many project owners, public and private, have already implemented the practice of reducing retainage to take advantage of the benefit of lower contractor bids.  SB 3052 may serve to standardize that practice.  

Opponents of SB 3052 believe government should not interfere in commercial contracts.  Proponents, on the other hand, point out many laws that already interfere with contracts between private parties.  Both sides will certainly let the Governor know their positions.

Governor Rauner is expected to consider both sides of the argument and to determine in the next 45 days whether to sign SB 3052 into law.   

If you would like assistance preparing or reviewing construction contracts, please contact me, james.rohlfing@saul.com, or another Saul Ewing Arnstein & Lehr attorney.