The Garrison Report #2005-7

Retainage - Should It Be Eliminated?
The Argument Rages On!

Last month the author explored the idea of whether retainage should be eliminated. The result was numerous e-mails from readers. Therefore, this month's report will discuss some of those responses. As we have stated before we appreciate everyone's views.

One site work and transportation contractor who works as both a prime and subcontractor suggested that owners should focus on payment and performance bonds. Contractors with a good performance record usually pay less than one percent for this bond. This would result in a lower cost to the project than retainage. This particular individual even felt that many contractors would not charge the owner for the bond, if retainage were eliminated. This would be a win-win situation for both the owner and contractor. In essence, it would reduce the financing costs that are passed on to the owner and ease the cash-flow pain on the contractors and subs.

Another company raised a serious concern about the ability of contractors to raise the necessary capital. In an expanding market, both new contractors and rapidly growing contractors can experience limitations placed on them because of the ability to borrow. The author has seen this occur. If a subcontractor does an outstanding job, all the general contractors end up desperately attempting to get him on their projects. However, this can cause serious problems. Sure the subcontractor can decline the additional work, but that can threaten the relationship with the general contractor, who feels betrayed because the subcontractor fails to submit a bid.

The author has observed that on public projects a greater threat can surface. Often public entities encourage the participation of minority firms, yet their practice of retainage hurts minority contractors the most and is therefore counter-productive to their political goals. Often the minority firms are small and have limited ability to borrow. Further, when the minority contractor is a high-performing contractor, all the general contractors want it on their projects. The general contractors apply a great deal of pressure in these situations because they need high-performing minority subcontractors. Unfortunately, this can create a terrible situation for the minority firm. It can't handle the growth because of the cash-flow problems that are only made worse by the retainage issues. This can result in a default. The consequence of this is that the affirmation action policy is attacked instead of the real culprit-retainage.

The contractor further stated that the customer should under if he wants good service; he needs to pay on time and in full. The author couldn't agree more. The focus should be on rewarding top performance and to stop working with poor-performing contractors, thus driving them out of business. There is no evidence that retainage will make poor-performing contractors perform; therefore, the practice of retainage is counter productive since it punishes the higher performers and owners actually pay a premium for that service.

The mistaken view by some owners is that they save money by not paying out the retainage. In all but rare circumstances that is not true. The owner's cost of borrowing is usually less than the borrowing cost of the subcontractors. Since the subcontractors are forced to pass that cost on to the owners, the owners actually pay more than they would if they eliminated retainage.

Delays in Payment

The author received numerous e-mails complaining that payments are often delayed way beyond the 30 days he mentioned in the original article. The author is well aware of that situation and, in fact, agrees that it is very detrimental to the industry. That condition only makes the issue of retainage worse because it further deteriorates the cash-flow situation. However, timely payment is a topic that needs its own discussion. The author elected to assume timely payments with regard to this discussion about retainage in order to illustrate that even with timely payments retainage is not good. The author's aim was to prevent people from focusing on the late payments instead of the retainage issues, but unfortunately, these issues are emotionally interwoven.

New Mexico's Elimination of Retainage

A former president of the ABC chapter of New Mexico wrote to the author: "Ted, in New Mexico, retainage was eliminated as we knew it. . . . I am writing to let you know, I feel you are on target with your statement, that retainage is unnecessary in a sound business relationship. I cannot think of one instance harming our firm since the repeal of it. We have found that subcontractors one would think are causing problems usually let the problems develop early on in the project, so issues can be addressed promptly. Retainage can still be held in New Mexico, but it must go into an interest-bearing escrow account, which is then paid to all subs based on the amounts of money and time it takes to be paid. Most owners from out of state realize the paper work involved becomes too onerous to deal with. We have, however, had owners call retainage by other names and attempt to withhold monies, but they usually relent after we forward them a copy of the statute."

As you can see from the comments of the above reader of The Garrison Report , there are alternatives to retainage.

Another Point of View

Another subscriber wrote, "Unfortunately, retainage is a necessary evil. I have been on both sides of this equation and have argued both sides. Twenty-five years of this business and I concede that this is really the only tool in checks and balances that keeps the ship right." He did acknowledge, "It should be negotiated on a case-by-case basis, but should be more accepted industry-wide."

What do you think a doctor would say if you told him you were going to withhold 10 percent of your payment until you decided his treatment had cured your ailment? Would you consider using retainage to force a poor doctor into taking better care of you? The author doubts it. You probably would select a doctor who you trusted. So why is this business any different?

The industry needs to do its job and eliminate the non-performers since they seem to be the major justification for retainage. This would eliminate the need to punish the performers, and in the end, owners would also benefit. Unfortunately, retainage has been around so long, it has become the accepted way of doing things. It took armies a long time to realize it didn't make sense to line up in straight lines in brightly colored uniforms without protection to fight the enemy.

Instead of using a system that seems to give comfort to owners and some general contractors, but doesn't really work; why don't we all sit down and find a better solution. Unfortunately, organizations such as ABC, AGC, and CURT avoid the problem because it is so politically sensitive. The only group that wants to address it all the time is ASA because retainage has such a negative impact on all of its members.

Managing subcontractors is no different than managing people; after all subcontractors are people. It takes leadership to empower both people and subcontractors. Leadership techniques that reward the desired behavior and encourage cooperation and performance produce much better results than threats and punishment. The author realizes this is a complex problem. Therefore, it's time for the leadership within the construction industry to step forward and provide true leadership and creative ideas in order to produce a better solution for all the stakeholders.

The author agrees that owners and general contractors must protect themselves appropriately, but retainage throws the baby out with the bath water. Unfortunately, this isn't the only issue in construction that does the same thing. Maybe this is the reason the industry has a shortage of qualified workers.

Most of the people in the construction industry pride themselves on their ability to provide creative solutions to complex construction problems. Maybe it's time the industry focus that creative energy on finding better solutions on how to manage the construction industry.

 

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