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Can I withhold retainage for claims I have against the contractor?

Jul 12, 2019

Retainage is an important component of commercial construction projects, and a good understanding of retainage-related issues can give you significant leverage over contractors while the work is being completed.

That being said, it’s important to note that as an owner or developer, you face significant exposure for mishandling retainage. In the previous installments of this blog series, I discussed some of the basics regarding retainage for Tennessee commercial construction projects, including:

  • whether withholding retainage is required;
  • the amount of retainage allowed to be withheld;
  • whether retainage must be kept in a certain type of account;
  • and the deadline for paying retainage to contractors

In this post, I address a retainage-related question that tends to give owners a constant headache: can I withhold retainage as a setoff for claims I have against the contractor? 

As an owner or developer, you likely have been faced with this dilemma: a project nears completion, but there have been projects delays or the project is plagued with defects. Because you are holding five percent of the contract amount as retainage, the seemingly logical next step is to use that retainage to offset the damages caused by the defects/delay or as leverage so the contractor will remedy the defects. Unfortunately for owners, the Prompt Pay Act does not allow that approach – even if the construction agreement between the owner and contractor provides for holding retainage as an offset is such situations.

While the Prompt Pay Act allows you to “reasonably withhold [retainage] in accordance with the written contract between the owner and the contractor,” it instructs that the “retainage must be paid within ninety (90) days” of the occurrence of the earliest of the three milestones discussed in my previous post:

  1. issuance of a Use & Occupancy Permit
  2. issuance of a Certificate of Substantial Completion
  3.  use of the improvement

Owners frequently withhold retainage as a setoff beyond this 90-day window, presumably because they are unaware of this relatively clear language in the Prompt Pay Act and the accompanying legal liability for doing so. In some states, that would be permissible, but not in Tennessee.

This precise issue was addressed by the Tennessee Court of Appeals in Beacon4, LLC v. I&L Invs., LLC, where the owner argued that the setoff provision in the construction agreement allowed it to withhold retainage beyond the 90-day period due to claims it had against the contractor. In keeping with the statutory language discussed above, the court rejected the owner’s argument explaining, “the Prompt Pay Act requires that retainage be paid to the contractor within ninety days of substantial completion of the work or the owner’s beginning to use the improvement contracted for regardless of any contractual provisions allowing the owner to reasonably withhold a sum.”

So again, even if your agreement with the contractor contains setoff provisions, retainage cannot be withheld longer than 90 days after the project is complete.    

While you would probably prefer to hold the retainage indefinitely as a setoff for claims against the contractor, there are other options you can utilize in such situations. If feasible, one option is to hold off on seeking a Use & Occupancy Permit or a Certificate of Substantial Completion and purposefully delay the project’s completion.

Though this is rarely a viable option for owners, you should consider this approach after evaluating the circumstances of the project and the dispute. The other option is to pay the retainage in accordance with the Prompt Pay Act’s requirements, and then assert whatever claims you have against the contractor after the project’s completion. Just because you pay the retainage does not mean you lose your claims against the contractor. 

While every project is different, the key takeaway is that owners on Tennessee construction projects need to understand and adhere to these retainage-related provisions of the Prompt Pay Act.

Missed Part One or Two of this series? Click to read.

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