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Retainage Policies of Public Agencies,

Findings of a Questionnaire Survey

Irtishad Ahmad and Wilson Barnes

Department of Construction Management

Florida International University

Miami, Florida

Introduction

Like many other industries, one of the main problems in construction is insufficient capital. This lack of capital in the industry, along with some standard-but perhaps outdated-business practices, greatly enhances the problems of inadequate cash flow needed for the proper operation of construction businesses. The continued lack of capital is manifested by low profits, risky bidding situations (underbidding), less investments into plants and equipment, fewer new employment opportunities, and so on. Contractors have seen the reduction of earned profits (based on sales or revenues) from approximately 6% in 1972 to less than 3% in 1986 and even lower in 1991 (1).

A major factor contributing to the increasing number of construction contractors' business failures over the past few years is the shrinking profit margin. Dunn and Bradstreet data (2) indicates major reasons for failure. It was noted that more than 50% of the construction business failures were attributed to "economic factors causes" in most of the years during the 1984-1989 period. There is no reason for the trend to be otherwise during the 90s decade. "Economic factors causes" include insufficient profits, lack of capital and high interest rates, among others. The retainage policy, presently by owners, both public and private, contributes significantly to the increase of "economic factors" in causing business failures in construction.

Text and reference books on the subject do not clearly explain the rationale behind retainage, and in particular the selection of the 10 percent figure. Over the years, the construction industry seems to have complacently accepted the idea of the 10 percent retainage as being the norm. Many years ago, it was normal to retain as much as 15°/a (3). Until the end of the 1960s decade, contractors were still having a positive cash flow even after the 10 percent retainage was deducted from their progress payments. The amount of 10 percent retained had little economic effect on the contractor other than deferring a portion of the profits. Under the prevailing economic situations in the industry perhaps the practice of 10 percent norm is not realistic anymore. Dunn and Bradstreet data indicates that availability of cash or lack thereof determines business survival. It should be recognized, however, that retainage alone does not cause all the cash flow problems. Lack of sound management policies, poor business/accounting practices, and absence of effective quality control measures are the main reasons that cause business failures and cash flow problems in the construction industry.

Recognizing the importance of the problem, the State of Florida through the Building Construction Industry Advisory Committee (B.C.I.A.C.) funded a research project to investigate viable alternatives to the standard 10 percent retainage practice. The project was undertaken to study the concept of retainage with a view to comprehend its intended purpose and to identify alternatives from the perspectives of the industry professionals. This paper presents significant findings of the investigation.

Scone and objective of the par

The issue of retainage, as practiced in public construction, is discussed in this paper from the perspectives of different groups that make up the construction industry. Opinions and ratings of two main groups, the public agencies and the general contractors, on the basis of the findings of a questionnaire survey, are presented in this paper. The survey was conducted in the state of Florida through the mail. The paper presents alternatives that are in use by some agencies and alternatives that are suggested by experienced individuals. Further work must be done before the industry, as a whole, can reach a consensus and adopt alternate methods of retainage. This paper would be useful to those in the construction industry who are responsible for and authorized to initiate and introduce changes for the betterment of the industry.

Background of the retainage policies, specifications related to retainage, and variations practiced by different public agencies are covered in the following section. Next, the approach used to conduct the research project, the design and development of the questionnaire survey, are described. In the "findings" section, we present the significant results obtained from the survey. Opinions and ratings of two diverse groups, the public agencies and the general contractors, on the effects of current retainage practice and variations are contrasted and compared. In the last section, conclusions and recommendations based on the study results are outlined.

Background

Retainage Policies

Retainage consists of holding back a stated percentage (usually 10%) from each progress payment to be paid upon completion of either the contractor's work or completion of the entire project.

The rate of retainage is generally set forth in the Contract rather than the General Conditions. Clough (4) write, "A retainage of 10 percent for the entire project has been typical, although reduced percentages and other retainage arrangements are now the rule. In any event, retainage on larger projects results in the owner having custody of large sums of the contractor's funds for extensive periods of time."

Where performance and payment bonds are required, the withholding of retainage seems to be duplicative protection to the owner. However, this added protection is easier for the owners to access than bond security. Owners regard retainage as an additional inducement for the contractor to maintain orderly progress of the work. Clough (4) continues,

To reduce the undesirable effects of retainage, a number of changes have been introduced in recent years. Although not commonly used, these alternatives, mentioned in Clough (4) have been used to develop the questionnaire survey for the research project. Some of these are:

·        10 percent retainage is withheld only during the first half of the project, with subsequent progress payments made in full. An alternative to this is to apply 5 percent retainage to the entire project.

·        Another variation of the above alternative is, as the project passes the 50% completion point, the normal rate of retainage of 10 percent can be reduced to 5 percent for subsequent payments.

·        A more recent development is where 10 percent is retained on each work category (or work package) of the project until that category is 50 percent completed, after which full payment is made if the work of that category is proceeding satisfactorily.

·        On some public projects, 10 percent is withheld for the entire project but the contracting officer may authorize full payment when satisfactory progress is being achieved. The federal government has discontinued the routine use of retainage on direct federal construction that is on or ahead of schedule and otherwise substantially in compliance with contract requirements.

·        Substitution of certificates of deposit or interest-bearing securities for retention holdback. Securities, whose value is equal to the required retainage, are provided in escrow to the agency by the contractor with all interest earned being paid to the contractor. A recent amendment of Florida Statue Chapter 713 section 255.05 has been passed to allow substitution of cash retainage with approved securities.

Specifications Regarding Retainage

Perhaps the most widely used documents in construction contracting are those published by the American Institute of Architects (A.I.A.). Specifically, the A.I.A. document A201 (5), that has been, in general, approved and endorsed by the Associated General Contractors (A.G.C.) of America, is the document that is considered the keystone document coordinating the many parties involved in the construction process. Article 9 of the A.I.A. document A201 establishes the guidelines by which payments to the contractors are to be processed. This article allows the owner to retain a portion of the payments due to the contractors, basically until final completion. Although this document does not establish the percentage to be retained, the 10 percent figure is the one most widely used in the industry. The A201 document, however, does require the contractor to obtain a consent from the Surety before requesting any releases or reduction of retained amount.

The A.I.A. document also requires that the contractor pay promptly each subcontractor upon receipt of payment from the owner, but it also allows the contractor to retain a portion of the payment from the subcontractors. Again, the retainage amount is not stipulated, but it is customary to withhold the same amount the owner retains from the contractor, usually 10 percent. A.I.A. document states that payments to suppliers and subcontractors will reflect the percentage actually retained from the upper tier contractor.

Associated General Contractors (A.G.C.) of America supports the policy of 5% retainage throughout the project except when the owners retainage is greater than 5%, in which case the higher amount would govern, and provided that the security between the G.C./Subcontractor is the same as that between the G.C./Owner.

In the public sector, most public agencies have developed their own terms and conditions of the contract, which somewhat follows the intent and the basic structure of the A.I.A. A201 document, with their own specific clauses for retainage. They vary from agency to agency. But they all basically require the owner to retain a certain portion from payments due to contractors.

Recent Changes in Retainage Policies of Public Agencies

Most public agencies, including the Federal Government General Services Administration (G.S.A.), have revised traditional retainage policy. The prior standard of 10 percent throughout has been reduced. Many public jobs require only5percent. The Department of Defense (D.O.D.) and G. S. A. have adopted the policy that retainage should be withheld only for specific reasons such as failure to maintain schedule. They experimented with the elimination of retainage provisions and have found that bids for work have come in at comparatively lower prices than in those situations where the general contractor has imposed retainage provisions on subcontractors (3). On most federal government projects the specific agency issuing the prime contract will normally determine the amount of retainage to be withheld. The amount varies from the current D.O.D. "policy" of zero retainage if the project is proceeding satisfactory (10 percent retainage if the contracting officer believes there is any problem with the progress or performance) to the old federal government standard of 10 percent retainage up to 50 percent completion, with zero thereafter if performance is satisfactory.

The underlying principle of the G.S.A. policy is that retainage should not be used as a substitute for good contract management, and contracting officers should not withhold funds without cause. G.S.A. form 3506 (Rev. 10‑90) states:

"If the Contracting Officer finds that satisfactory progress was achieved during any period for which a progress payment is to be made, the Contracting Officer shall authorize payment to be made in full. However, if satisfactory progress has not been made, the Contracting Officer may a maximum of 10 percent of the amount of the payment until satisfactory progress is achieved. When the work is substantially complete, the Contracting Officer may retain from previously withheld funds and future progress payments that amount the Contracting Officer considers adequate for protection of the Government and shall release to the Contractor all the remaining withheld funds. Also, on completion and acceptance of each separate building, public work, or other division of the contract, for which the price is stated separately in the contract, payment shall be made for the completed work without withholding of a percentage."

In the following, current retainage practices of Florida Department of Transportation (D.O.T.) and Hillsborough county in the state of Florida are described.

Florida D.O.T.: "The retainage policy of the Florida Department of Transportation for many years was 10% of monies earned until 50% of the contract was complete‑then 5% until 90% was complete; then 2-1/2% until final acceptance; then, if no problems were ongoing (no disputed claims, etc.) the Department might hold only a nominal retainage (1/2%) while the final review of quantities and other paperwork is being finalized prior to final payment. The F.D.O.T. now allows contractors to substitute securities for retainage. and thereby obtain the release of retainage monies and earn interest on the securities.

Hillsborough County: Hillsborough County's construction contracts currently require 10% retainage until 50% of the project is complete. The contractor may then request that no more retainage be withheld. If the Project Manager feels that the progress of the job and quality of work is acceptable at that point, no additional retainage will be withheld, unless the progress of the work or the quality of the work deteriorates to the point that the Project Manager feels that additional retainage is required.

Purpose and Effects of Retainage

An individual's position within the industry will probably determine his/her opinion relative to advantages and/or disadvantages of retainage. In the following, major concerns of the owners, general contractors, subcontractors, bonding companies and lending institutions, as related to the issue of retainage are outlined.

Owners: Owners, both public and private, tend to believe that there is absolutely no way to get all the necessary work items completed with holding retainage. They are concerned that contractors might walk off the job before completion if no retainage is held or if retainage amount comes close to cost of work to complete project. Owners do not see without retainage, how contractors can be held responsible for items, such as: work not done, poor work that must be corrected, code compliance, delivery of warranties, guarantees, operating instructions, parts information, compliance with mechanics lien law, occupancy and other permits, inspection reports, as-built drawings, etc. Owners do not think that bonds can be effectively utilized to address these concerns.

General Contractors: General Contractors, in general, feel that 10 percent retainage amount is unrealistically high and by holding this amount owners are actually forcing them to finance part of the project. Contractors feel that owners should not be earning interest on retainage. Their major concern is that it hurts their cash flow. They tend to think that owners are being doubly protected, by bonds and by retainage. Contractors also worry that owners would use (or abuse) the retainage fund against backcharges.

Subcontractors: It appears that subcontractors are more adversely affected due to retainage than the contractors. This may be caused by the use of "pay-when-paid" clauses in contracts between contractors and subcontractors. Although most contracts call for "timely" payment to subcontractors by the constructors, the interpretation of the term "timely" is most often subject to disagreement between the contracting entities. The existence of the retainage practice is a cost factor to the subcontractor. If the subcontract provides that the retainage be withheld until completion of the entire project, it is especially unfair to such subcontractors as the excavator and steel erector whose work is completed early in the course of construction. Such a provision create very severe hardships on subcontractors.

Bonding/Surety Companies and Lending Institutions: The issue affects the decisions of credit evaluators (bonding and lending institutions) in several ways. They want timely completion of projects according to specifications. On the other hand, they also desire that contractors, subcontractors and suppliers are able to maintain smooth cash flow. Bonding companies get concerned if they see that the retained amount is too high since it increases the likelihood of contractor-failures. In the event of a failure, however, they would like to get hold of the retainage fund for completing the job. Lending institutions' (banks) concerns are similar. They want smooth cash flow of the contractors/ builders since it ensures repayment of the loan. They try to avoid delay in project completion since it will also delay the process of income-generation of their clients. The higher the percentage of retainage, the more closely these financial institutions (bonding and lending) need to check out the credit worthiness of the customer and the project. On the other hand, with a lower rate of retainage they must monitor the progress of the project and must verify that the subs and the suppliers are being paid regularly.

Banks and bonding companies frequently face another retainage-related issue, and that is, how to treat unpaid retainage when reviewing contractors' financial statements (3). Some do not count retainage as a receivable until the contract is complete. Others record retainage as a current asset throughout an entire project. Thus one needs to know the accounting basis used by a contractor before evaluating his statement. If the retainage is due and payable well in the future and if there is a concern about the contractor's ability to pay promptly in case the owner delays payment, then unpaid retainage cannot be considered as current asset.

Questionnaire Survey

A questionnaire survey was conducted as one of the main approaches of the research project. It was mailed out to different segments of the construction industry throughout the state of Florida.

In October 1991, 808 questionnaires surveys were mailed out to different groups involved in the construction business in the state of Florida. Florida Builders and Contractors Directory 1991(6) was used to generate the survey mailing list. A cover letter was included with each survey. The objective of the research project and the importance of the response were emphasized in the letter. A "no‑postage necessary" return envelope was included with each questionnaire survey. In most of the items readers were asked to respond either by a check mark or a number from a predefined scale.

General Contractors, architects/engineers, subcontractors, developer/builders, design/build firms, and some selected public agencies in the state of Florida were included in the survey. For a complete and detailed description of the research procedure and results, interested readers are referred to (7). Specific questions on how the respondents feel about the existing 10 percent retainage practice, how they think that the policy affects the industry and finally how they rate some of the alternatives, as listed in the questionnaire, were asked. In this paper responses obtained from two diverse groups, the public agencies and the general contractors, are presented.

In the general contractors' group, 55 responses were received out of 260 mailed, with a response rate of 21 % and from the public agencies, 38 responses were received out of 68 mailed with a responses percentage of 55.9%.

Findings

General

A majority of the general contractor (GC) respondents indicated that in 76% to 100% of their work they experience 10 percent retainage throughout the project duration. It can be concluded that although there are other methods of retainage in practice, they are not as widely used as the standard 10 percent method.

Respondents were asked to write in any other method they encountered. Following methods were mentioned.

·          10% until substantial completion than 5%.

·          10% till 50% completion then 5% on balance.

·          0-75% no retainage, 75-100% 10 percent of value of

·          uncompleted work exceeding 75% of contract amount.

·          5% flat retainage.

Most of the general contractors retain from their subcontractors using 10 percent flat procedure. They follow this procedure regardless of the method used applied on them by their clients/owners.

The cost of financing the retainage amount is never added to the bid price by most of the GC respondents.  A majority (70%) of the GC's feel that there are other measures that serve the same purpose as the 10 percent retainage. Only 25% of the public agency respondents agree that retainage is a duplicative measure that protects the owners.

Major Effects of 10 Percent Retainage

Opinions on the effects of the 10% retainage, as it is practiced, were sought from the participants. As predicted, responses are heavily influenced by the responding individual's nature of involvement in the construction industry, or in other words, by the group he or she belongs to. Table 1 shows the responses obtained on the seven major effects from the public agency and the general contractor respondents. These results are expressed in terms of percentage. The percent of respondents who indicated either "agreement" or "strong agreement" are combined and shown in the table along with the total number of respondents. In addition to these two responses participants were allowed to check "disagree," "strongly disagree" and "do not know/no opinion".

A considerable number of GC's agree with the statement that 10 percent retainage cuts into already marginal profit. 60% of public agency owners disagree or strongly disagree with the statement.

GC's overwhelmingly believe that they are forced to finance the retainage amount. 31 % of public agency owners indicated either agreement or strong agreement and 41 % of them indicated disagreement or strong disagreement.

Majority of the responding general contractors (54%), either agree or strongly agree with the statement that retainage prevents contractors from investment opportunities. 22% of public agency owners agree or strongly agree and 50% disagree or strongly disagree with this statement.

Most of the respondents in the two groups agree to some extent that due to retainage, contractors front‑load construction projects. About 20% in each group disagree.

87% of the responding public agency owners either agree or strongly agree that owners are protected by the use of 10 percent retainage policy. 65% of general contractors either disagree or strongly disagree with the statement.

A majority of the respondents did not any correlation between contractor bankruptcies and retainage. Most of those who indicated agreement or strong agreement are the general contractors (32%).

59% of the responding GC's think that relationship among the various groups in construction will improve (indicates that they agree or strongly agree). 82% of the public agency owners think that it will not (indicated by disagreement or strong disagreement).

Alternatives to Standard 10% Retainage Practice

Responses on the six enlisted alternatives are summarized in Table 2. These alternatives were complied from literature on construction contracts and from the input of experienced individuals. In addition, respondents were also encouraged to suggest other alternative(s). Respondents were asked to use a predefined scale (poor to excellent) to grade the stated alternatives. Numbers given in Table 2 represent the percentage of respondents that rated the stated alternatives as either "good", "very good" or "excellent".

The alternative that received the highest score (85%) from the GC's is "deposit retainage to an interest bearing account." This was also the most favored alternative by the public agency respondents (47%). Responses obtained on this alternative indicate that most people feel it is fair to pay interest on retainage to the contractors.

The second most favored alternative by the GC's (83%) is "retain 10% until 50% complete and none thereafter". 33% of the public agency respondents also favored this opinion. As mentioned earlier, this alternative , or some kind of variations, are being used by many agencies.

General contractors and public agency respondents differed widely on the alternative "reduce retainage to 5% or other realistic rate." 73% of the GC's v.s.. only 19% of the public agency respondents thought it was an acceptable alternative.

Similar responses were indicated to the alternative, "Eliminate retainage, protect owners by bonding only." 11 % of the public agency respondents v.s.. 61% of the GC's respondents favored this alternative. It is interesting to note the "No change is necessary" received favorable response from 72% of the public agency respondents and only 20% of the responding GC's.

Other Alternatives Suggested by the Respondents

Respondents were asked to suggest other alternatives that were not listed in the questionnaire. Following is a summary of the suggestions made by the respondents of the survey.

"Maintain 10% retainage, get waivers for materials and subcontractors work."

"10% until 50% complete if work is on schedule and satisfactory-reduce to 5% with opinion to increase back to 10% if work falls behind schedule."

"The owner holding and releasing 10% of each subcontractor's contract directly to the subcontractor upon ok from contractor."

"Securities of deposit placed on large or extended term projects with a public agency."

"Owners hold actual retainage amounts for unsatisfactory or incomplete work, and release it when work is corrected or completed.

"If the bonding companies would be easier to work with, then the 10% retainage will become unnecessary."

"Write retainage procedure appropriate for the particular project, I favor 10% retainage throughout most of the project with the percentage going down at the end."

"Allow the retainage expense to be a bid item along with insurance, bonds, etc."

"Force GC's to use same method with subs as they receive from the owner e.g., if GC's receive interest they should pay interest to subs on retainage."

"Use a sliding scale, but never reduce to 0% till the final payment. Percentage to vary based on size and nature of project."

Summary and Conclusions

The research project, partial results of which are reported in this paper, was undertaken to investigate the practice of retainage as one of the factors that might be contributing to the contractors' lack of profit and difficult cash flow situation. It was considered by the Building Construction Industry Advisory Committee (B.C.I.A.C.) of the state of Florida- as manifested through funding of this project ­as one of the areas that should be looked into for possible modification by the industry participants. Although retainage is not the only factor that causes cash flow problems in the construction industry, it might be one of the most significant factors affecting project cost and cash flow.

Most of the respondents to our study cited 10 percent retainage as a factor that contributes to the general contractors' and the subcontractors' cash flow problem. General contractors and subcontractors think that it is a major problem and the practice should be fundamentally revised. Many felt that it is the subcontractors who eventually carry the burden of retainage; contractors almost always manage to pass-on this burden to the subs. Most contractors retain 10 percent from their subs regardless of the methods used on the GC's by the owners. A majority of public agency respondents to our survey see retainage as a very effective and practical tool for owners' protection; especially to have the punch list items done and the close-out documents handed over.

Most owners use retainage as a protection against unwilling contractors to finish the work. Bonding is not considered as a practical solution to this problem. Enforcement of bonding is a time-consuming and difficult process, most owners would like to avoid. It is unusual to use bonds for finishing punch list items. Obviously, most contractors feel that the owner is being doubly protected, first by bonds and then by retainage. Bonding, however, has direct consequences on the practice of retainage. It is generally believed that bonding price would go up and would become even more difficult to obtain if there were no retainage.

It was found that many government agencies are practicing variations of the flat 10 percent retainage, despite the fact that most of the public agency respondents are not in favor of revising the traditional retainage practice. Many public projects require only 5 percent, and some federal agencies have adopted the policy that retainage should be withheld only for specific reasons such as failure to maintain schedule.

Decreasing the rate of retainage as the project progresses satisfactorily towards completion was suggested. Periodic release of retainage based on trades or work subdivisions was mentioned as an alternative. Payment of interest on retained money to contractors and subcontractors was favored by many as a fair provision. Timely full subcontractors payment, as their work completes, was suggested to alleviate the problems caused by retainage. Many in the industry think it is reasonable to retain lower percentage for larger jobs.

Middle grounds, somewhere in between the flat 10 percent retainage and total of retainage from contract clauses, seem to be favored by most of the respondents. It was expressed by many respondents and interviewees that the retainage policy should be revised so that it does not create excessive pressure on the contractors and subcontractors but at the same time it should also be available to the owner as a tool for protection against irresponsible contractors.

Acknowledgments

The research work presented in this paper was sponsored by the Building Construction Industry Advisory Committee (B.C.I.A.C.) under a grant from the state ofF7orida, Department of Education. The authors are grateful to B.C.I.A.C. for sponsoring this project.

References

1.        Adrian, J.J. (1987). Construction Productivity Im­provement, Elsevier, New York, NY.

2.        "Business Failure Record," (1894-1990). The Dunn and Bradstreet Corporation, New York, NY.

3.        Cushman, R.F. and Bigda, J.P. (1985). Construction Busi­ness Handbook, 2nd ed., McGraw-Hill, New York, NY.

4.        Clough R.H (1985). Construction Contracting. 5th ed., John Wiley & Sons, New York, NY.

5.        "General Conditions of the Contract for Construction," (1987) AIA Document A201, The American Institute of Architects, New York, NY.

6.        Florida Builders and Contractors and Directory, (1991). The Builders Book, Ft. Lauderdale, Florida.

7.        Ahmad, I and Barnes, W.C. (1992). Alternatives to 10% Retainage, Technical Publication No. 107, Dept. of Construction Management, Florida International University, Miami, Florida.

Table 1. Public Agency (P.A.) and General Contractor (G.C.)

Ratings of the Effects of Retainage

Table 2. Public Agency (P.A.) and General Contractor (G.C.)

Ratings of the Alternatives to 10 Percent Retainage