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By Lauren M. Lyon-Collis
During construction of a development project, the owner
typically retains a percentage of each progress payment
otherwise payable to the contractor. The retained funds are
usually released upon substantial completion, with the owner
holding back 150% or 200% of the amount necessary to complete
“punch-list” items. The industry standard is to retain 10% of
the amount of the progress payment otherwise payable. The
purpose of this practice is to ensure that if a contractor fails
to complete the work correctly, or at all, the owner may use the
retained funds to do so.
A recently-adopted Maryland law limits those amounts that may be
retained by an owner to guarantee completion of a construction
contract. As of October 1, 2008, owners will only be able to
retain up to 5% of the amount of each progress payment for
certain construction contracts in Maryland. The new law does not
apply to contracts under $250,000 or contacts funded through the
Department of Housing and Community Development. State
regulations presently impose this cap in certain state
construction contracts. The new law also applies to the
retention of funds by a contractor to guarantee a
sub-contractor’s completion of a construction contract.
The new law attempts to balance the interests of contractors and
owners, but, in the end, may be unsuccessful. For example, the
new law immediately benefits contractors who may need to advance
a portion of their own funds to complete the final stage of a
project. The change in the law means that an additional 5% of
the contract value could be available, lessening the financial
impact in those instances when a contractor must pay “out of
pocket” in order to complete a construction contract.
While the new law does not apply to contracts under $250,000,
the new law does, however, disadvantage owners by limiting funds
available to correct or complete unfinished work under affected
contracts. Depending upon the type of work and workmanship, the
5% cap on the amount of payments retained may leave owners with
insufficient funds to correct or complete unfinished work.
Capping the amount of payment retained to half of the industry
standard also diminishes the financial penalty that a contractor
would experience by simply leaving the job unfinished.
Yet, some protections remain for owners under the law. First, if
the owner or contractor determines that the contractor’s
performance provides good reason for withholding an additional
amount, the new law provides that the owner may exceed the cap.
But an owner may not be able to make that determination in time
to retain an additional portion of future payments sufficient to
protect the owner from the risk of needing to spend additional
funds to hire another contractor. While the new law appears to
allow owners to unilaterally withhold additional amounts,
contractors may have defenses available to them should an owner
elect to do so.
Second, the law imposes the 5% cap only where the contractor has
provided payment and performance bonds. The purpose of these
bonds is to guarantee the contractor’s performance of the work
and the payment of subcontractors and sub-subcontractors for
labor and materials in the event the contractor’s performance is
inadequate or the contractor fails to pay for materials or
labor. An owner’s attempt to exercise its remedies under the
bonds may require considerable time and expense and bonding
companies often have defenses to enforcement of bonds. Thus, an
owner may be inclined only to attempt to enforce its rights
under the bonds when completion of the construction work will be
very expensive. When weighing the possible time and expense to
enforce its remedies under the bonds against the time and cost
of using one’s own funds to complete the work, the most
reasonable option may be to complete the work with the owner’s
additional funds “out of pocket” after spending the retained
payments.
Thus, by capping the amount of retention proceeds to one-half
the industry standard, the new law may reduce the effectiveness
of the practice of holding retained funds, both as a protection
to owners and an incentive to contractors to complete work.
Lauren M. Lyon-Collis is currently an associate in the Baltimore
office of Ballard Spahr Andrews & Ingersoll, LLP
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