November 19, 2019

General contractor focus - Be mindful about subcontractor retainage

Most construction projects succeed because of the strong relationships between the general contractor and subcontractors. This prosperous rapport is typically built on trust — through experience — that the other party is going to fulfill its obligations and not create any problems for the other, nor the project owner.

One source of conflict that can quickly sour the relationship is retainage. Usually when this subject comes up it involves the owner releasing retainage to the general contractor. And this is indeed an important topic. (See “Managing the risk of slow-paying owners.”) But your subsequent remittance of retainage to the sub is also a key issue.

Communicate clearly

If a general contractor holds retainage for an excessively long time on a subcontractor or refuses to pay it, do you think that subcontractor is going to want to work for that general contractor again? Probably not. Now the subcontractor may not have a choice if the general contractor is a major player in the market. But the resulting bad will and distrust can hurt everyone in the long run.

First and foremost, look at any retainage problem realistically and objectively. When money is involved at this critical point in a project — that is, the end — things can escalate quickly.

Both sides need to be understanding and compassionate enough with each other to avoid turning a disagreement about retainage into a serious legal dispute that could adversely affect future work. Going to court is expensive and almost assuredly going to be a negative experience for everyone. Even turning to an arbitrator or mediator will lead to a “boardroom showdown” during which heated arguments can hurt the relationship.

In addition, handle retainage matters as quickly as possible. When general contractors immediately and clearly explain to subcontractors why retainage is being withheld, an amicable solution becomes much more feasible. Of course, this doesn’t mean rushing into the conversation; do your due diligence first to gather pertinent information regarding precisely why the money isn’t forthcoming.

Consider a bold move

When retainage on a big project is put on hold, a subcontractor could face serious difficulties meeting his or her financial obligations on other jobs. In worst-case scenarios, subcontractors have even been put out of business. This is another reason that general contractors should never handle retainage brazenly — the existence of a fellow contractor’s business could depend on it.

To cement or maintain a particularly valuable relationship, one approach that may be appropriate in some limited instances is fronting money to a sub who has been known to perform well and could experience financial harm if he or she doesn’t receive the retainage. Again, this isn’t something to do with every subcontractor. Create a list of preferred subs by carefully evaluating their work on:

  • Adherence to schedules,
  • Core competencies,
  • Quality of work, and
  • Ability to work well with others

Fronting subcontractor retainage works best for long-standing relationships that you want to preserve. After all, among the most typical reasons that owners withhold retainage is because of disagreements over whether the project in question is truly completed as specified. A sub who has regularly shown up on time and performed excellent work has likely helped you avoid such conflicts and, thus, contributed to your construction company’s bottom line by ensuring you receive an owner’s retainage as soon as possible.

Where might the money come from? A sound financial strategy for every general contractor is to set aside whatever excess cash you can, without hindering business performance, into a cash reserve account. You can primarily use the money in this account to save for long-term objectives and improve your company’s financial position when applying for loans or attracting outside investors. But you can also occasionally use it to remit a subcontractor’s retainage under the assumption you’ll eventually get those dollars back when the owner finally releases your retainage.

Value your relationships

The practice of retainage remains controversial. As of this writing, many states have passed laws capping contract retainage on privately funded contracts at 10% or less. More states may pass similar laws in the future. Meanwhile, retainage remains an issue that general contractors and subcontractors must continue to deal with. Don’t let it ruin the valued relationships you’ve spent years building.

Managing the risk of slow-paying owners

Some owners like to withhold retainage until long after a job is done so that they can achieve that “warm fuzzy feeling” of seeing the project completed to their exact liking (regardless of what’s in the contract). As you’re no doubt aware, this can seriously irritate a contractor who has monthly bills to pay, payroll to meet and contract rights to uphold.

When dealing with a slow-paying owner, evaluate not only the value of the contract in hand, but also the potential profitability of future work you might perform for that owner. Sometimes it’s worth being patient if you believe the problem is a one-time thing and you’ll want to work with that owner again.

In other cases, you may need to act differently. For midsize or larger construction companies, an avoidance tactic is to spread out your labor force across multiple jobs pertaining to different, unrelated owners. If you encounter a retainage dispute with one owner, you can pull your workers off that jobsite and deploy them on another with a different owner until the financial matter is reconciled.

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