Legislative Update: Retainage and the Right to Stop Losing Money

Legislative Update: Retainage and the Right to Stop Losing Money

July 13, 2016

By Dean B. Thomson

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Dean Thomson is a Shareholder in the firm’s Construction Law Department. Dean can be reached at 612.359.7624 or dthomson@fwhtlaw.com

 

 

 

Despite concerns about increasing regulation, the construction industry in Minnesota continues to pass legislation regulating itself.  This past legislative session was no exception as the industry passed two changes that have good intentions but may have uncertain consequences.

Both changes are found in amendments to Subdivisions 3 and 4 of Section 10 to Minnesota Statutes Chapter 337.  The first limits retainage to five percent (5%) on “building and construction contracts.”  Minn. Stat. §337.10, Subd. 4(b).  The prior version of stated that retainage that an Owner or its agent could reserve was limited to 5% “unless the building and construction contract provides otherwise”, so the change clearly regulates and limits the contractual terms that parties can negotiate in regard to retainage.  As the prior version only mentioned retainage that Owners could withhold, General Contractors argued that it did not apply to them, especially if their subcontracts provided otherwise.  But the recent change applies to all building and construction contracts including not only those between the Owner and General Contractor, but also those between General Contractors and Subcontractors.  The amendment also makes clear that 5% retainage is not necessarily required in contracts.

The legislation addresses two complaints.  First, Subcontractors and General Contractors complained that Owners sometimes withheld excessive retention by contract, and this was especially burdensome for subcontractors that finished their work early in the project but had to wait for release of their retainage until final completion of the entire project.  The change certainly addresses this problem.  It may also, however, have an unintended effect on project financing.  Some lenders require higher than 5% retainage as additional loan security on projects that are marginally capitalized, and a few expressed concern that this new legislative restriction on retainage may make financing more difficult to obtain on more thinly capitalized developments.  In addition, some General Contractors say that they are willing to use lower priced but less financially established subcontractors if they can limit the risk of doing so by withholding higher than 5% retainage.   Now that retainage cannot exceed 5%, General Contractors may be more prone to use more financially secure Subcontractors, and it may drive lenders to demand other types of loan security such as payment and performance bonds that may be difficult for emerging General Contractors and Subcontractors to obtain.

The statute does not specifically mention the State or its political subdivisions, but they have been prohibited from imposing more than 5% retainage on payments since 1980.  Minn. Stat. §15.72, Subd. 2.  Nevertheless, the statutory definition of “building and construction contract” applicable to this new amendment does not specifically mention the state or its political subdivisions, so it is arguable that the amendment does not apply to contracts between General Contractors and Subcontractors on public projects.  As public entities either do not withhold retainage (e.g. MnDOT) or cannot withhold only 5%, this may not become an actual issue as a General Contractor may run afoul of the prompt payment laws if it receives payment for all but 5% retainage on a Subcontractor’s account but withholds more than that amount due to a higher contractual retainage provision in the subcontract.  See, e.g. Minn. Stat. 471.425 (allowing Subcontractor to collect 18% interest and collection fees to recover payment for undisputed services provided).

The second legislative change is more intriguing: it allows suspension of work if undisputed payments are not received within 10 days.  Owner insolvency, especially during the Great Recession, was a great risk to General Contractors and Subcontractors alike.  Often both felt constrained by contract to continue working even if they did not timely receive undisputed payments.  The result was that claims for unpaid work only grew in size until it was clear that the Owner was insolvent and the lender would not continue to fund the project.  The result was that General Contractors and Subcontractors in effect financed a large part of the project without any effective recourse for repayment.  This left General Contractors and Subcontractors fighting between themselves about which one should bear the risk of Owner insolvency, especially when their mechanics lien rights were of not much practical value because they were (as they so often are) subordinate to the mortgage rights of the lender.  To put the risk back where it belonged – i.e. on the Owner not making payment – this amendment gives both General Contractors and Subcontractors the right to suspend their performance if they do not receive undisputed payments with ten (10) days of when it is due.  Work may be suspended “until the undisputed payment is received”, so presumably work must resume upon payment.

Most standard industry contracts require that parties continue their work in the face of a pending dispute, and such provisions would not be affected by this amendment as it only applies to undisputed payments.  It should, therefore, allow both General Contractors and Subcontractors to better control the amount of risk for non-payment that they have to bear.  At a minimum, it will allow both to “call the question” of why undisputed payment is not being received, and they now have the leverage to get reliable answers – not only from the Owner, but also its lender –  before they choose to continue to perform work.

The amendment does not require prior notice before a General Contractor or Subcontractors can suspend their work, only that they not receive an undisputed payment.  Most standard industry contracts require prior written notice be given to the party causing a breach and providing an “opportunity to cure” or a certain amount of time to cure the breach – e.g. payment must be made within five days or work will be suspended.  It is unclear whether the right to suspend work provided by this amendment will be read in conjunction with other contractual notice and “opportunity to cure” provisions, or whether the General Contractor or Subcontractors can simply stop work if they don’t receive payment.  Presumably, all parties want to prevent a disruptive suspension if it could be cured, so the prudent practice would be to provide written notice to the non-paying party as soon as an undisputed payment is not received stating that unless the non-payment is cured within a certain period of time, suspension of the work may ensue pursuant to Minn. Stat. §337.10, Subd. 3.

 

Announcements

Congratulations to the ten attorneys from Fabyanske, Westra, Hart & Thomson, P.A. who have been named 2016 “Minnesota Super Lawyers”. The polling, researching, and selecting of “Super Lawyers” is designed to identify Minnesota lawyers who have attained a high degree of peer recognition and professional achievement. Only five percent of Minnesota attorneys receive this honor. FWHT’s 2016 “Minnesota Super Lawyers” include Marv Fabyanske, Kyle Hart, Jesse Orman, Greg Spalj, Dean Thomson, Tom Vollbrecht and Mark Westra. Once again, Kyle Hart and Dean Thomson were selected as Top 100 “Super Lawyers”. Dean Thomson was selected a Top 10 “Super Lawyer”.

 

Congratulations to the Fabyanske, Westra, Hart & Thomson, P.A. attorneys who have been named 2016 Minnesota “Rising Stars”. They are Hugh Brown, Jeff Jones and Jeff Weiland. “Rising Stars” are nominated by their peers and must be 40 years old or under, or have been practicing for 10 years or less. No more than 2.5 percent of the lawyers in the state are named to the list.

 

Once again, Fabyanske, Westra, Hart & Thomson, P.A. has been ranked as a Band 1 Construction Law Firm in Minnesota by the well recognized Chambers professional rating service. Here’s what Chambers has to say about FWHT:

The team is known as a “Construction and real estate boutique noted for its exceptional knowledge and experience of the industry. Particularly recognized for its work on behalf of developers, subcontractors and designers.”

Ranked Lawyers:

Marvin Fabyanske (Senior Statesmen Construction Law)
Kyle Hart (Band 2 Construction Law)
Gregory Spalj (Band 2 Construction Law)
Dean Thomson (Band 1 Construction Law)
Mark Westra (Band 1 Real Estate Law)

“Senior statesman Marvin Fabyanske is a luminary in the Minnesota construction Bar, whose wide-ranging practice is highly regarded by his peers.”

Kyle Hart is experienced in litigation construction cases and maintains a strong reputation in arbitration and mediation.”

Gregory Spalj specializes in construction disputes. “He uses his business acumen to provide us with better advice, and he specializes in construction law so you don’t bring him many scenarios he hasn’t seen,” an appreciative client notes.”

Dean Thomson’s construction practice touches on both transactions and litigation, and he has notable expertise in architectural and engineering liability. “He is very knowledgeable, articulate and strategizes well,” reports one impressed commentator.”

Mark Westra is a respected transactional lawyer who has notable experience not just in commercial real estate, but in zoning and land use as well. He is particularly sought after for his expertise in matters concerning office, industrial and residential properties.”

 

Matthew Collins was admitted to the Iowa Bar on April 21, 2016.

 

This discussion is generalized in nature and should not be considered a substitute for professional advice. © 2016 FWH&T.

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