June 4, 2019
By Dean B. Thomson
Dean Thomson is a Shareholder in the firm’s Construction Law Department. Dean can be reached at firstname.lastname@example.org or 612.359.7624.
Based on subcontractor complaints about over-withholding and late release of their retainage, the Minnesota Subcontractors Association proposed legislation that would mandate sweeping changes to how and when retainage must be released for private and public work. As often happens at the Capitol, however, other industry stakeholders had different ideas, and rounds of negotiation and hearings produced a compromise bill signed by Governor Walz on May 28th that applies to all contracts entered into after August 1, 2019. This Briefing Paper summarizes the legislative changes and comments on some of the issues it may create.
There are two statutes that effect the retainage amendments, one affecting public contracts and the other private work. We’ll discuss the new rules on public retainage first, which will be found in Minn. Stat. § 15.72, Subdivision 2. The first major change is that public contracting agencies must now release all retainage no later than 60 days after substantial completion (subject to certain enumerated exceptions), and the contractor must release or reduce retainage for any subcontractors at the same rate. The contractor on a public contract for a public improvement must pay all remaining retainage to its subcontractors no later than ten days after receiving payment of retainage from the public contracting agency, unless there is a dispute about the work under a subcontract, in which case the contractor must pay out retainage to any subcontractor whose work is not involved in the dispute, and must provide a written statement detailing the amount and reason for the withholding to the affected subcontractor.
Substantial completion is determined in the same way as provided in the statute of limitations applicable to most construction work – i.e. as the date when the construction is sufficiently completed so that the owner or the owner’s representative can occupy or use the improvement for the intended purpose. A special provision was added, however, to address substantial completion of street, highway, and bridge work, which is now specially defined to be when construction-related traffic devices and ongoing inspections are no longer required.
Two Comments: First, the definition of substantial completion is very flexible and subject to disagreement among the parties. Typically, substantial completion is defined by contract, and compliance with the contract’s definition was usually the trigger for release of retainage, but now release must be judged by when the improvement can be beneficially used or occupied – or in the case of road and bridge work, when traffic control or continuing inspection is no longer needed. Presumably, the legislation was attempting to address those instances in which the contract provisions made substantial completion very difficult to obtain, almost approaching final completion, which would delay the release of retainage. The new statutory definition of substantial completion, however, is very subjective and could lead to more disagreement than clarity.
Second, the concept that a contractor should not be able to withhold retainage from one subcontractor due to a dispute with another subcontractor is undoubtedly a fair result, but that rule was already established by case law, so the statute only confirms existing law. Nevertheless, this new statutory restatement of the same may prove useful.
The new law also requires that upon the written request of a subcontractor, a public contracting agency must notify the subcontractor if or when a progress payment, retainage payment, or final payment has been made to the contractor. This will allow subcontractors to monitor whether they are being promptly paid. Again, this provision confirms what was already available pursuant to a request under the Minnesota Government Data Practices Act (MGDPA). If the public contracting entity doesn’t provide the payment information requested, rather than initiate a suit for compliance, it will probably be easier for a subcontractor to resort to a MGDPA request.
Even after substantial completion, the public contracting agency may continue to withhold: The agency can withhold up to but no more than 250% of the cost to correct or complete work known at the time of substantial completion (typically referred to as punchlist work). Any amounts withheld for punchlist work must be paid within 60 days after completion of the work. If the agency withholds for punchlist work it must promptly provide a written statement detailing the amount and reason for the withholding to the contractor, and the contractor must provide a copy of the same to any subcontractor requesting it.
The public contracting agency may also withhold one percent of the value of the contract or $500, whichever is greater, pending completion and submission of all final paperwork by the contractor or subcontractor. “Final paperwork” is defined to mean documents required to fulfill contractual obligations, including without limitation, O&M manuals, payroll documents for any prevailing wage reporting requirements, and withholding exemption certificates. Once final paperwork is submitted, the public contracting agency must pay the amount being withheld with 60 days.
Two Comments: First, the holdback for punchlist work is usually between 150-200%, so the allowance of up to 250% seems extreme, but apparently this amount was necessary for public agency support of the bill. Hopefully, public contracting agencies will choose to specify a more reasonable punchlist withholding. Second, an allowed withholding of 1% of the contract value for required final paperwork gives effect to the typical contractual terms that used to delay release of retainage until all contractual conditions for substantial completion were satisfied. Nevertheless, a holdback of 1% is a substantial improvement over withholding the entire 5% of retainage pending receipt of final paperwork.
Three final changes round out the amendments as they relate to public contracting agencies: First, for any project funded with federal or state aid, the public contracting agency is not required to pay that portion of the contract so funded until those payments have been received. Second, nothing in the amendment requires payment for a portion of a contract that is not complete or for which an invoice has not been submitted. Finally, withholding for warranty work is prohibited, but the provision does not waive any rights for warranty claims. This last point also appears in the statute applicable to private contracts, and is discussed below in that context.
The amendments also revised Minn. Stat. § 337.10, Subdivision 4 to address retainage on private construction contracts. Most of the changes made for private work mirror those applicable to public work. If an owner reduces the amount of retainage, the contractor must reduce retainage for any subcontractor at the same rate. Just like the public contract amendments, the owner or the owner’s agent must release all retainage no later than 60 days after substantial completion, which is defined in the same way as above, except there is no special definition of substantial completion for road or street work. Contractors must pay all remaining retainage to subcontractors within ten days after receipt of retainage, unless there is a dispute about a particular subcontractor’s work, but contractors may not withhold retainage from subcontractors not involved in the contractor’s dispute with a particular subcontractor. The contractor must also provide a written statement detailing the amount and reason for the withholding from the particular subcontractor with which it has a dispute.
The same exceptions for withholding as enumerated for public contracting agencies apply to private owners: up to but no more than 250% may be withheld for punchlist work; one percent of the contract value can be withheld for final paperwork (which is defined in the same way as above); and payments for punchlist work must be made within 60 days of the completion of that work and within 60 days after submission of final paperwork. The owner must promptly provide a written statement detailing the amount and basis for the withholding to the contractor, and the owner and the contractor must provide the same to any subcontractor that requests it. Just like the public agency statute, nothing in the amendment requires payment for a portion of a contract that is not complete or for which an invoice has not been submitted. Finally, withholding retainage for warranty work is prohibited, but this provision does not waive any rights for warranty claims.
Three Comments: First, remember that if a contractor or subcontractor receives a payment and fails to promptly pay an undisputed sum from that payment to a lower tier subcontractor, then Minn. Stat. § 337.10, Subdivision 3 allows recovery of 18% interest and attorney fees to a successful claimant that proves the payment was undisputed and not timely made. This makes the rather flexible definition of substantial completion in the amendment a concern as disputes could arise over the rather subjective determination of whether or not beneficial occupancy was achieved and retainage release was due. The promise of attorney fees and 18% interest will likely encourage such disputes. Perhaps an expanded contractual definition of beneficial occupancy could help reduce this risk – i.e. a more detailed explanation of when the work will be considered sufficiently completed so that the owner can occupy or use the improvement for its intended purpose.
Second, some prime contracts are drafted so that retainage is reduced by 50% once the project is 50% complete, but if the contractor must reduce retainage to all its subcontractors to the same extent the owner reduces retainage to the contractor, then the contractor may be required to reduce retainage by 50% to all subcontractors even if some have barely started their work. Such a result could leave contractors under-secured in regard to those subcontractors that haven’t achieved 50% completion of their work. Several prime contractors have already indicated that they will no longer advocate for a contractual term providing for retainage reduction at 50% completion due to this risk, but perhaps good communication and coordination among the owner, contractor, and subcontractors could solve this problem. For example, the owner, contractor, and subcontractors could condition a 50% retainage reduction to subcontractors that have actually achieved 50% completion.
Third, the clarification that retainage cannot be withheld for warranty claims is a good development. Too many owners do not understand the distinction between known punchlist work that should be identified at the time of substantial completion and warranty claims which, by definition, should arise only after substantial or final completion. This clarification should result in more instances of proper retainage release.
Mark Becker is presenting a Construction Early Dispute Resolution Fundamentals live webinar on June 28th, at 1 pm ET. For more information, including how to register, click here.
Dispute resolution in the construction industry is moving in new and game-changing directions as industry participants demand earlier and more efficient resolutions. Hear from two front-runners in early dispute resolution, Mark R. Becker, a shareholder with Fabyanske, Westra, Hart & Thomson and Paul M. Lurie, an experienced construction mediator and a member of the AAA Master Panel. He is also a Fellow of the International Academy of Mediators and the American College of Construction Lawyers and a member of their ADR Committee. He is a founder of the Guided Choice Mediation Interest Group. Paul can be reached at email@example.com
The 2019 International Who’s Who Legal for Construction Law has recognized Dean Thomson, Kyle Hart, and Marv Fabyanske as Minnesota members, the most members of any of the seven Minnesota firms so recognized.
Chambers and Partners once again recognized Fabyanske, Westra, Hart & Thomson in 2019 as one of the two top Tier One construction law firms in Minnesota and specifically referenced six shareholders, the most of any other construction law firm: Dean Thomson, Kyle Hart, Greg Spalj, Mark Becker, and Jesse Orman.
This discussion is generalized in nature and should not be considered a substitute for professional advice. © 2019 FWH&T.