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BLOG / 01.08.24 /Kenneth R. Jacobs

New Law Reduces Maximum Construction Retainage To 5%; Time Limit Set For Release After Completion

Governor Kathy Hochul just signed a new law, S.3539/A.4167, intended to address delays in payment after “substantial completion” of a construction contract and to establish a 5% cap on the amount retained from progress payments under the contract. Specifically, Section 1 allows contractors to submit their “final invoice” after substantial completion rather than upon ”performance of all the contractor’s obligations under the contract.” Section 2 establishes a 5% cap on the retainage that developers and contractors are allowed to hold back from progress payments in construction contracts, and requires retainage to be released within 30 days after approval of the construction by the owner.

“Retainage” is an amount held back from progress payments in construction contracts to form a de facto reserve pending final approval of the work. Under General Business Law §756-c, owners were entitled to hold back a “reasonable amount” as retainage from contractors (and contractors from subcontractors in subcontracts). Customarily a 10% retainage has been considered “reasonable”. The retainage would be released upon final approval of the project by the owner or their representative.

Contractors (and subcontractors) complained that the 10% retainage unduly interfered with their ability to pay their employees on an ongoing basis, especially if the project was delayed so progress payments were also delayed. Furthermore, owners would fail to release the retainage for several months even after the project was completed.

The new law imposes a 5% cap on retainage (in place of “reasonable” retainage) and requires that owners release any retainage within thirty (30) days after “final completion” of the project. The law also applies to subcontracts; the retainage held by a contractor under a subcontract is also capped at 5% of each progress payment (and in no case more than the retainage under the master contract).

Obviously, a reduction in the retainage reduces owners’ leverage in persuading the contractor to complete its work to the owner’s satisfaction. Owners may now need to negotiate for a lower up-front mobilization payment to retain the same leverage. In addition, since contractors can now submit final invoices after substantial completion, owners should review the criteria for payment of invoices against the criteria for final completion. Under the law, interest on delayed payments accrues at 1% per month.

The law does not address retainage held by lenders. Frequently a construction or capital improvement loan requires an equity injection before the bank is required to make any payment, and the bank is still permitted to hold back a retainage from disbursements. Casualty restoration clauses in a mortgage also call for insurance proceeds to be paid to the lender, but the lender is still entitled to hold back a retainage from any progress payment paid jointly to the borrower and the contractor during the restoration.

Since the bank is not a party to the construction contract, it is not likely to be bound by the reduced retainage requirements in the new law. Therefore, borrowers should negotiate for reduced retainage in their loan documents, or they may need to go out of pocket even after they have met any “equity injection” requirements imposed by the lender, or during restoration when cash flow may be at a premium.