What’s a Retainage Fee (And How It’s Used)
Retainage fee is an amount withheld from a contractor by the client or project owner. It is usually negotiated and agreed upon before the start of a project.
The purpose of a retainage fee is to give the client a guarantee that the work will be completed on time and as per his needs.
Although the successful completion of a project is expected, contractual details have to be put in writing.
Although the concept of a retainage fee can be implemented in any business setting, it is most common in the construction industry.
This has been necessitated by the complexity of construction projects.
These projects often get delayed as changes are introduced in the course of the work.
If you are a contractor, it is important that you actively participate in the negotiations of the retainage fee.
In case you are not available, then an attorney can help. Just remember that it will cost you.
Attorney costs aside, a construction attorney might be the best option for you especially if you are not experienced enough.
If you are getting your first project with a big client, hiring an experienced attorney for the negotiations can be very helpful.
As a project owner, a retainage fee will protect you from liens, claims and contractor defaults.
The fee is only a small percentage of the full project cost (usually 10%).
Still, you are assured of saving some money to offset any loss and inconvenience brought about by any incomplete work.
History of Retainage Fee
Retainage fees started in the UK during the construction of the UK railway system in the 1840s. The project was obviously a big one and the amount of work was more than the workers could complete.
This created a demand for new contractors to join the project.
Some of them were not only inexperienced, but also lacked the qualification to successfully complete their assigned portions of the work.
This was a problem for the railway companies and they had to come up with a way of mitigating the risks and losses resulting from this.
It became common for them to withhold up to 20% of the total cost of the work. This was however designed to target the contractors’ profits only.
The purpose of this was two-fold, and is still the same today. It is to provide the client with some protection from liens and defaults while giving the contractor an incentive to finish the work accordingly.
There may be cases of contracts not implementing a retainage fee.
This is not common and may not be good practice for big projects. All the same, it happens depending on the relationship between the client and contractor.
The biggest reason a client can decide to ignore this provision is a record of successful work from a contractor.
This will work on a project by project basis and cannot be expected to be the norm with a particular client.
If you have consistently provided great services to a client for some time, he may decide to forego the retainage fee.
This is definitely to your delight as a constructor and can improve your cash flow but comes with extra pressure.
RETAINAGE FEE ACCOUNTS
The retainage fee is part of your business.
As such, it has to be reported in your books. As a transaction by two parties, the amount involved is reported differently by the client and contractor.
Retainage Fee Payables
In accounting terms, money either leaves the company or comes into the company. When money leaves the company, it is termed “payable”. This will be the case for the party making the payment.
In the case of a project you have assigned to a contractor, you are the one paying the money to him. He is the service provider while you are the recipient of the service. As such, your obligations are different.
The full cost of the project will be recorded in your books using a suitable account description. This will be reflective of the kind of work being done. It may be “Boardroom Repairs,” “Ohio Branch Construction” or anything else.
However, the retainage fee slightly differs from this overall cost. Since this is not paid until the end of the project, you will record it as a liability. This is a payment you are expected to make at a later date.
Retainage Fee Receivables
As the contractor, you also have to record the details of the retainage fee in your books.
Because you are to receive payment, this will be recorded as a “receivable”.
Although the payment is a liability to the client, to you it is an asset. You will be like a creditor to the client who now owes you money.
When preparing your financial reports, e.g. your balance sheet, you will record this as a current asset.
When you finally get paid, this can be used for operational purposes as it becomes part of your cash flow.
You can also invest it depending on your business preferences.
STEPS FOR COLLECTING RETAINAGE FEE
The retainage fee is an amount which should be collected.
And for your benefit, you should collect it as soon as possible.
The earlier you receive the full amount payable to you after the completion of the project, the better.
As with other financial obligations, your client is also aware of the need to pay the retainage fee.
All the same, that will only happen after you have done all that needs to be done according to the contract you signed.
Here are the steps you should take to collect your retainage fee soonest and with minimum challenges.
Complete the Punch List
One of the biggest obstacles to receiving the withheld payment is the punch list.
Though closely associated to a checklist, the two are very different from each other.
A checklist is a list of the things which should be done as part of the general project work. This is essentially a breakdown of the major tasks you are to work on.
A punch list is different in that it is generated almost at the end of the project.
Normally, you will have checked all the items on the project’s checklist.
The client will then do a visual inspection of the project and list down what needs to be worked on in order to give approval for the payment.
Depending on the construction work you were doing, the punch list could include things like fixing leaking taps, unfinished paint jobs, faulty wiring detected in some rooms etc.
All in all, the punch list is the project owner’s list of the small details you need to check on. This is the work which will make the client approve of the project’s completion.
Provide Close-out Documents
After successfully dealing with the punch list, there is one more thing to do. You have to provide the close-out documents.
The close-out documents are those detailing the usage of the property and anything that is a core part of it.
This will include copies of the legal documents indicating the agreements between you and the client.
You will also need to provide warranty documents showing the relevant guarantees you are providing to the client.
If the construction has used materials from your subcontractors, those materials should have a warranty.
In many cases, these will include HVAC systems and other electrical systems.
Whether the client knows your subcontractors or not, the retainage fee is based on his agreement with you.
It is therefore upon you to ensure that all these are provided.
If you sourced for material from other sources, you can give the client a copy of the documents while maintaining the original.
These documents give the client an assurance of a good job done and availability of support.
Submit the Retainage Invoice
After all these, the last thing to do is provide the client with an invoice for the retainage fee payment.
The invoice is the legal document indicating your claim of the payment initially withheld.
Without an official submission of the invoice, you will not be deemed to have requested for the payment.
At the same time, you will be mistaken to think that the client will go ahead and make the payment without you requesting for it.
Although he is obligated to pay, he will most likely wait for your invoice.
For accounting purposes, no payment can be done without the supporting documents.
You therefore have to provide this in a timely manner to prevent further delays.
CHALLENGES WITH RETAINAGE FEE
The retainage fee, as good as it is for project owners, it is a serious challenge for contractors.
Where subcontractors are involved, they tend to be the most affected.
This is because the general contractor will often withhold some amount from them, just as the client has done.
Withholding money from subcontractors has been proven to cause practical issues, especially with regards to cash flow.
Since the subcontractor is meant to perform well yet needs the money to work, business relations can become strained.
In 2004, the American Subcontractors Association published a report on the practices of retainage fee.
It showed that a majority of the main contractors abuse the retainage principle. Here are some of the findings.
- After a successful completion of the project, subcontractors waited between 30 to 900 days before getting the retainage paid. The average wait time was reported to be 167 days (almost 6 months).
- The worst wait times were reported to be an average of 529 days (almost 1.5 years) with the longest time being 2,500 days (almost 7 years)
- In more than 10% of their jobs, subcontractors have received less than the full amount withheld from them.
- There was reported a widely-held belief that retainage was not being used to ensure work completion. Instead, it was being used by the main contractor and project owner as leverage to push the smaller players into weaker positions.
SPEEDING UP COLLECTION OF RETAINAGE FEE
The process of getting paid the retainage fee may take a short or long time.
This is dependent on many factors and some of them may be beyond your control.
For example, the client may not have the money to pay at the time you make the request.
This can be due to cash flow problems. The client may also have planned for other expenses which according to him, are more urgent.
This can be very unfortunate but it happens all the same. Money is never in constant supply and budgeting has to be done. This calls for prioritizing payments as a means of handling financial obligations.
This is why debtors are usually given notification for payment so they can plan accordingly. Many business payments are done within 30 days after the request is made.
This can change depending on the specific agreement between the parties.
For a smoother flow, use these tips to speed things up.
Stay Aware of the Retainage Receivables
If you have several projects you are working on, you can easily forget about the retainage fee. You can work to meet the needs of the other clients and lose memory of the pending payment.
When this happens, it will definitely be long before you get paid. Remember that it in many cases, your client may not be in a hurry to pay you as he prioritizes other payments.
Keeping in mind that there is some money owed to you is the first step towards working on receiving the money.
This will remind you of whatever needs to be finished.
There are two lists which will guide you in completing the work.
1. The project’s checklist – the main items on the project’s checklist have to be completed. If you had envisioned finishing the whole project in two years, then try to complete the checklist in a year and a half. This gives you time to work on the punch list.
For example, you may be constructing a new office block. The checklist for this may include a 10-story main building, a food court, parking lot and installing security systems. Once these are done, the client carries out an inspection.
2. The project’s punch list – the client’s inspection will provide a report indicating whether everything is according to his requirements. This process may take some days depending on the size of the project.
Anything outlined by the client as needing your attention has to be worked on. From fixing plumbing problems to making slight adjustments, anything can be required. It is only thereafter that you can proceed with your retainage request.
Focus on Closing Out Projects
Closing out projects may sound easy but often involves many activities. As such, the process can easily get derailed if you don’t focus on it.
In working on closing out the current project, document everything that has been done in the course of the project. Ensure you have the relevant documents for whatever installations have been done.
There will be a need for you to provide user manuals to facilitate quick troubleshooting in case of any problems. Some of the installations requiring user manuals are elevators and security systems.
There may also be need to train the people who will be operating these systems.
Technical training will be necessary to avoid unnecessary calls to your support center.
This also empowers the client and gives them control over their property.
You can easily get overwhelmed by all the work involved in closing out projects. To avoid this, have a dedicated team to handle it.
You can have project managers who follow up with the workers and stay updated to any changes which occur to the project.
This is also the person who will follow up with the client on the payment in case you don’t have a dedicated debt collector.
Here is a video on some tips on what to do after closing out the project.
Stay in Contact with the Client
Having done all that you were expected to do and probably even exceeded your client’s expectations, do not cut off communication.
Do not leave the task of getting paid to the project manager or debt collector.
You can stay in contact with the client and find out his experience of the new facility.
In the communication, remind him of the pending payment and work on sustaining good business relations.
If you are the owner of a construction company, calling the project owner can go a long way in pushing for the retainage fee to be released.
Just make sure that all the documentation has been done and there is nothing pending from your side.
RETAINAGE FEE ALTERNATIVES
Retainage has been in existence for a long time.
Over the years, there have been complaints and calls to abolish it.
There have been attempts at implementing different strategies of ensuring the involved parties still achieve the same goals.
The reasons for calls for change have mainly been revolving around cash flow challenges.
Three of the suggested alternatives are mentioned below.
Propose to your client the one you think might work best for you. Maybe you will form part of the change.
A trust account can be implemented in various ways. Whichever way is agreed upon, these remain to be one of the contractors’ most relished options available.
When a contract agreement includes the clause that the retainage fee will be held in a trust account, the contractor is most happy.
In this arrangement, the retainage is deposited in a trust account and a trustee assigned to maintain it. The trustee must be impartial in his dealings with both you and the client.
That said, the trustee has the opportunity to invest the money deposited to the contractor’s benefit.
This gives you the peace of knowing that your money is sure to come, but it’s also growing.
The client on the other hand has nothing to lose.
In the even that there are any disputes, you will follow the stipulated process as outlined in the trust account’s terms and conditions.
A performance bond is a promise given to a client to insure him against the risks of a contractor failing to successfully complete a project.
The bond provides compensation which is similar in amount to the retainage fee.
Performance bonds are usually given as a guarantee that a contractor will finish the job. In the event that he doesn’t, then the issuing institution compensates for the loss which has been experienced as a result.
Another option which can be attractive to project owners is the deposit of collateral.
If you deposit collateral with the bank or directly with the client, you put that asset on the line for possession in case you fail to hold to the terms of the contract.
Collateral can be anything of value ranging from land, a house or a car.
This gives you the opportunity to receive the full payment of the project so you can comfortably work.
Upon completion of the project, you get your deposited security back.
Retainage fee has been used in the construction industry for a long time.
The concept seeks to ensure the contractor finishes the job according to plan.
Normally at 10% of the total project cost, it can hinder smooth flow of work especially for the subcontractors down the line.
As more options are considered, there might be an end to this practice.
The underlying intentions will however remain: the contractor must prove that he will deliver the work he promises to do.