Missouri Assembly Adopts Landmark Retainage Reform

by Richard A. Stockenberg

The landmark retainage reform enacted by the 2002 Missouri legislature applies to contracts for private projects entered into after August 28, 2002. In summary, the new law declares all retainage to be a trust fund for the benefit of the contractor and subcontractors, caps retainage at 10 percent (unless the contractor is in default), eliminates cash retainage when substitute security is offered, mandates under certain conditions line item release of retainage, and requires all retainage (less 150 percent of the value of the punch list) be released upon substantial completion.

The legislation had broad support from Republicans and Democrats, labor and management, general contractors and subcontractors and metropolitan and rural legislators. The bill’s opposition came largely from owners. The House bill was sponsored by Representative Tim Green (Dem., St. Louis County) and Representative Neal St. Onge (Rep., St. Louis County). In the Senate, the bill was sponsored by Senator Bill Foster (Rep., Poplar Bluff).

The legislation deals with retainage in the traditional sense, that is, dollars withheld by an owner from a contractor who has earned a progress payment. If a contractor is in default, the act does not apply and the owner may withhold from the contractor whatever sums it needs to withhold to protect itself in accordance with the terms of its contract.

Owners have been complaining for hundreds of years that they need retainage in order to assure timely final completion of their projects. They claim that if they do not withhold 10 percent then the contractors have no incentive to finish the punch list and provide as-built drawings, manuals and warranties.

Contractors, on the other hand, complain that owners abuse retainage by holding excessive amounts for too long a period of time after substantial completion. Contractors are often heard to complain about the never ending iterations of punch lists and in some cases owners diverting contractor’s retainage for other purposes. The new law addresses these issues.

Retainage is a Trust Fund

One of the subtleties of the law is the declaration that retainage, “shall be held by the owner in trust for the benefit of the contract and contractor’s subcontractors, sub-subcontractors and suppliers at whatever tier who are not in default, in proportion to their respective interest.”

By creating a trust fund, this law protects retainage from the reach of others. For example, suppose an owner retains 10 percent of all progress payments from its general. contractor who goes bankrupt after substantial completion, but before receiving final payment. In that case, it is predictable there will be multiple claims asserted against the retainage fund. First, the owner may want to use the retainage as offsets that it may have against the general contractor. In addition, the I.R.S. and the general contractor’s bank could assert claims against the retainage fund. By declaring that the retainage fund is “held by the owner in trust for the benefit of the contractor and contractor’s subcontractors” the retainage dollars will be outside the reach of others. Also, the creation of the trust fund for the benefit of the contractor and subcontractors should put an end to an owner’s ability to use dollars retained from one of the early subcontractors to cure deficiencies caused by one of the later trades.

Substitute Security

Owners may withhold up to 10 percent from a contractor’s progress payments, but contractors may secure early release of the cash by giving the owner substitute security in the form of either a retainage bond, a letter of credit or a certificate of deposit. If a contractor is in default the owner maintains all of its contract rights.

If a retainage bond is used the surety company issuing the bond must be one that is authorized to issue surety bonds in Missouri. Likewise, a certificate of deposit must be drawn and issued by a national banking association located in Missouri or by any banking corporation incorporated in Missouri. The contractor who deposits a certificate of deposit with the owner as substitute security continues to receive all interest and income earned. If a letter of credit is issued in favor of the owner, it must be issued by a national banking association located in Missouri or by a banking corporation incorporated under the laws of Missouri. If the letter of credit is not renewed at least 60 days before it expires, the owner may draw upon it for an amount no greater than the value of the amount of work remaining to be performed.

Contractor/Subcontractor Relationship

The new law treats subcontractors the same as it does general contractors. A subcontractor may tender to the general contractor the same type of substitute security which a general contractor is authorized to tender to an owner. Upon receipt of the subcontractor’s tender, the contractor is required to pass it on to the owner. If the subcontractor is not in default of its agreement, the contractor shall pay to the subcontractor, within five working days after receipt, any accumulated retainage paid by the owner to the contractor on account of the tender made by the subcontractor.

Neither the subcontractor nor the general contractor is required to make a decision at any particular time whether to offer substitute security. If either makes the appropriate tender of substitute security before payments are due, the owner is prohibited from withholding retainage. On the other hand, if the tender is not made until after retainage has been withheld, the owner is required to release the retainage within five working days, but only to the extent of the value of the substitute security. The owner will not ever have to release retainage in excess of the amount of the substitute security.

The new law prohibits a general contractor from withholding from a subcontractor any retainage in excess of the retainage withheld from the contractor by the owner for the subcontractor’s work, unless the subcontractor’s work is deficient.

Subcontractors have the same responsibilities to their sub-subcontractors and suppliers as contractors have to their subcontractors.

Release of Retainage

Some of the greatest victims of abusive retainage practices have been the early trades such as the site contractors. The statute mandates early release of retainage under certain circumstances. If it is determined that a subcontractor’s performance has been satisfactorily completed and the subcontractor can be released prior to substantial completion of the entire project without risk to the owner involving the subcontractor’s work, the contractor shall request that the owner shall release the subcontractor’s retainage.

Once a job reaches “substantial completion,” the owner must release all retainage or substitute security 30 days, less an amount equal to 150 percent of the cost to complete the remaining items. Upon receipt of the retainage from the owner, the general contractor has seven days to release to each subcontractor their proportionate shares of the retainage.

The bill, as originally proposed by the contracting community in the legislature, defined “substantial completion” to have occurred upon the earlier of 1) the issuance by the architect or engineer of a certificate of substantial completion, 2) the issuance of an occupancy permit or 3) when the owner begins to use or could have begun to use the project for its intended purpose.

This language was excised from the original bill and an amendment was made defining substantial completion to occur upon the earlier of the architect or engineer issuing a certificate of substantial completion or the owner accepting performance of the full contract. This amended version is tempered by the fact that when owners are holding substitute security instead of cash, they have less incentive to prolong acceptance of the contract. Many owners will of course continue to want to achieve substantial completion as quickly as possible.

If retainage is withheld in violation of the statute, a court or arbitrator may award attorney’s fees and interest at the rate of up to one percent per month.

The new law will not apply to single family residential construction consisting of four or fewer units.

Richard A. Stockenberg is a construction lawyer with our firm. He and John M. Limbaugh were the primary draftsmen of HB 1403.