Payment applications and retainage

Cash is the lifeblood of construction. Contractors and subcontractors finance labor, materials and equipment for weeks or months before they are paid, often on thin margins. The rules on how and when money moves down the contract chain, and how much of it is held back until the work is finished, decide whether a profitable job is also a solvent one. This lesson covers progress payment applications, the schedule of values, payment certification, the money withheld from each payment, substantial completion and final payment. The next lesson covers the statutes that now set deadlines for paying.

Progress payments

Except for small jobs, construction contracts pay in installments as the work progresses, usually monthly. The contractor submits an application for payment showing the value of work completed to date; the payment certifier, often the architect or engineer, checks it; and the owner pays the certified amount less any money withheld.

Under AIA A201-2017 Article 9, the contractor submits an application for payment, usually on AIA forms G702 and G703, at least ten days before the payment date; the architect issues a certificate for payment within seven days, or withholds certification with reasons; and the owner pays the certified amount, less retainage, by the date set in the agreement. On federal work, FAR 52.232-5 sets the payment process for fixed-price construction contracts and the Prompt Payment Act sets the deadline.

The core of every payment application is the schedule of values: a breakdown of the contract price into line items, each with a value, against which progress is measured. A good schedule of values is agreed early, follows the work breakdown structure, and separates labor, materials and general conditions so that progress can be measured fairly.

What can be claimed

A payment application normally includes:

• Work in place, measured as a percentage of each line item.
• Materials delivered to site and suitably stored, if the contract allows.
• Materials stored off site, sometimes, if the contractor proves title, insurance and security, for example with a bill of sale and photos.
• Approved change orders, and sometimes undisputed amounts for pending changes.

Front-end loading, inflating the value of early line items so that the contractor is overpaid at the start, is a common temptation. It weakens the owner's security, can mislead sureties, and may breach the contract and, in some places, the law. Payment certifiers resist it by comparing the schedule of values with the estimate.

Retainage

Most construction contracts allow the owner to withhold retainage, a percentage of each progress payment, usually 5 or 10 %, as security for completion and correction of the work. Retainage is mainly contractual, but many states regulate it by statute, especially on public work, capping the percentage, requiring reduction after 50 % completion, requiring retainage to be deposited in escrow or interest-bearing accounts, or setting deadlines for release after completion. On federal fixed-price construction contracts, FAR 32.103 says retainage should not exceed 10 % and should be withheld only when performance is unsatisfactory or for specific reasons, and should be released once performance is satisfactory.

Retainage usually flows down: a general contractor withholds the same percentage from its subcontractors that the owner withholds from it. Many state statutes require a contractor to release retainage to subcontractors within a set number of days after receiving it from the owner.

Substantial completion

Substantial completion is the key milestone for retainage, warranty periods and liquidated damages. Under A201-2017 § 9.8, the work is substantially complete when it is sufficiently complete in accordance with the contract documents so that the owner can occupy or use it for its intended use. The architect inspects, prepares a punch list, and issues a certificate of substantial completion that fixes the date, the responsibilities for utilities and insurance, and the time to finish the remaining items. Some states also tie mechanics' lien deadlines to completion or to a recorded notice of completion.

Reduction and early release of retainage

Many contracts and statutes reduce retainage once the work is half complete, for example from 10 % to 5 %, or stop withholding further retainage if progress is satisfactory. Owners may release retainage early to subcontractors who finish early, such as excavation or foundation trades, particularly when a statute or a surety's consent allows. Some states allow contractors to substitute securities or a bond for cash retainage.

Final payment

Final payment is made after the work is fully complete, deficiencies are corrected, closeout documents such as as-built drawings, manuals, warranties and statutory declarations or lien waivers are delivered, and the release conditions are met. Final payment can have legal consequences: many contracts provide that accepting final payment waives claims not already made, subject to exceptions for latent defects and warranties.

Under A201-2017 § 9.10, the contractor submits an affidavit that payrolls, bills and debts have been paid, a certificate that insurance remains in force, consent of the surety to final payment and, if required, releases and waivers of liens. Acceptance of final payment by the contractor waives its claims except those previously made in writing and still unsettled.

Good payment practice

• Agree a detailed schedule of values early and keep it aligned with the schedule.
• Submit complete, accurate applications on time with the required backup.
• Track holdback or retainage at every tier and diarize release dates.
• Keep stored-material documentation: bills of sale, photos, insurance.
• Read the final payment clause before accepting final payment.

The payment certifier's role

The architect or engineer who certifies payment occupies a delicate position. It is engaged and paid by the owner, but when it certifies payment or decides disputes under the contract it must act fairly and impartially between owner and contractor, using its professional judgment rather than following the owner's instructions. A certifier who refuses to certify amounts plainly due, or who withholds certification on the owner's direction to manage the owner's cash flow, may expose itself and the owner to liability, and the contractor may have remedies for non-certification.

Certification is not a guarantee. A certificate states the certifier's opinion, based on reasonable observation, that work of the stated value has been done; it does not certify that all the work complies with the contract, and payment does not mean acceptance of defective work. Contracts usually say so expressly. Certifiers also rely on the contractor's applications and supporting documents, so false statements in a payment application can lead to claims for misrepresentation and, on public work, to statutory penalties.

Set-off and back-charges

Payers often reduce payments by amounts they say the payee owes them: back-charges for cleanup, damage or rework, or claims for delay. This is set-off. Contracts and statutes limit it in several ways. Many subcontracts allow set-off only for amounts arising under the same subcontract, only after written notice and an opportunity to remedy, or only for liquidated, agreed amounts. Prompt payment statutes generally require any withholding to be identified in a timely written notice. And statutory trusts may limit set-off against trust funds. A payer that sets off unproven claims against undisputed amounts risks interest, statutory remedies and, in some cases, liability for breach of trust.

Good payment administration therefore rests on three habits: document every potential back-charge as it arises, follow the notice and remedy procedure exactly, and keep disputed amounts separate from undisputed ones so that the undisputed money keeps flowing.

Finally, payment terms interact with financing. Lenders on private projects usually release construction loan advances only after their own cost consultant confirms progress and title searches show no liens, so a late or inaccurate payment application can delay the owner's funding as well as the contractor's. Coordinating the application date with the lender's draw schedule, and providing the supporting documents the lender needs, keeps money moving down the whole chain.