Illinois Gov. Jay Robert "J.B." Pritzker (D) has signed into state law a new regulation that sets the maximum retainage clients can withhold from contractor payments on private projects and that will help many general contractors and subcontractors receive bigger checks earlier on in the project timeline. The change went into effect Aug. 20.
The new law forbids customers from withholding more than 10% retainage from contractor payments and requires retainage to be reduced to 5% once the contractor has completed 50% of the contract. The change applies to all construction contracts, whether they are between the owner and general contractor, a general contractor and subcontractor or a subcontractor and lower-tier contractor.
An analysis of states' laws shows that 20 states have capped private contract retainage at 10% or less through the enactment of legislation. New Mexico law prohibits any retainage from being withheld from a construction contract.
As far as other states are concerned, there has been a trend toward restricting the ability of clients to hold excessive amounts of retainage for long periods of time, according to attorney David Nightingale, principal with law firm Much Shelist in Chicago, and in many states it's often open to political debate. For instance, former Illinois Gov. Bruce Rauner (R) vetoed a similar piece of legislation almost a year ago.
The Illinois action could prompt other states to go this route as well, Nightingale said, but that might depend on which is stronger in each state, the developer or contractor lobby. “I don’t know if it’s a hill anyone would want to die on, but it seems like [reduced retainage] is beneficial [to contractors]," he said.
Retaining 10% of contractor payment is standard operating procedure in the commercial construction industry, and, oftentimes, so is reducing that amount to 5%. However, many clients opt to reduce the retainage amount to 5% when the job is closer to substantial completion than to 50%.
Chuck Taylor, director of operations for Englewood Construction in suburban Chicago, told Construction Dive that 10% is the typical amount of retainage it holds out of subcontractor payments and reflects the same amount owners withhold from Englewood.
The decision around when to release subcontractor retainage, he said, follows the owner's lead as well. However, there are some circumstances under which Englewood might hold retainage a little longer, like when it hasn't received important subcontract paperwork or closeout-related documents.
It doesn't benefit Englewood to hold retainage, Taylor said, because being able to pay subcontractors as quickly as possible helps build a productive, long-term relationship. Subcontractors, he said, will gravitate toward better-paying clients.
"We have lost subcontractors simply because of the client's slow pay or drawing out [of] closeout," Taylor said.
In addition, with many general contractors and subcontractors working on tight margins these days, retainage could represent a great deal, if not all, of a contractor's profit.
However, there are some items that are non-negotiable when it comes to collecting all the legal and other documents at the end of a project. "We’re protecting four entities — us, the sub, the end-user and the property — with this paperwork," he said.
Nightingale said the move by the legislature could be considered a codification of what is already standard industry practice. It also should provide some relief down the construction chain since both general contractors and subcontractors will be able to pay their bills a little sooner with the extra 5%.
It could also increase the ability of subs to grow or take on work they wouldn’t have been able to before because they were waiting longer on retainage money to be disbursed, Nightingale said. The new law might also reduce the number of mechanic's liens filed toward the end of a project as contractors, who are complete with their work but still await a retainage payment, rush to protect their rights.
But the amendment doesn't go into much detail, so there might be some additional shaping of the new regulation in the months and years to come. For instance, he said, there could be a question around whether the 5% applies to amounts billed after contractors reach the 50% benchmark or if they apply to the entire amount billed to date.
For owners, Nightingale said, the new rule might affect their lender relationships or at least prompt more discussion. Owners will have to make sure the bank understands that this could affect project cash flow.
"Also, [the change will] definitely require additional diligence on the part of owners to make sure that contractors have reached 50% completion," Nightingale said.