Magazine article Business Credit

Retainage: An Idea Whose Time Has Come, and Gone

Magazine article Business Credit

Retainage: An Idea Whose Time Has Come, and Gone

Article excerpt

Communique

Imagine how your dentist would react if you told him or her, prior to an appointment, that you were not planning on paying the full amount of the bill until you were convinced the dental work was "defect-free". Using common sense, most people either wouldn't go to that dentist appointment, or would be pretty concerned about how their teeth would feel the day after! Yet in the construction industry, the practice of the customer holding back funds until a project has reached "final completion" or is considered "warrantable," or until some other criterion is met, functions in exactly the way described. This peculiar practice, which is widespread in the construction industry, is known as retainage.

The origin of retainage was a burgeoning railroad industry in 1840s Britain that was growing so quickly that too many construction firms started up for the amount of work that was available. Railroad companies hedged their investments against the resulting wave of bankruptcies by demanding a deduction of 20 percent or more from payments in case a contractor couldn't complete the work it promised. Given the volatile circumstances in which retainage originated, it is a historical oddity that retainage remains commonplace today when construction markets are so very different. While subcontractors have made progress against working with high leveles of retainage, the practice is widespread enough that they must still take steps to protect their companies from the economically damaging effects of retainage.

Even with warranties, bonds, alternative securities and the ability to extensively qualify subcontractors, many customers (i.e., owners, general contractors and construction managers) still see "all subcontractors as the same" and collect retainage as if all subcontractors were in immediate peril of bankruptcy (as was arguably the case in 1840s Britain).

The practice of retainage is truly a vestige of another age.According to FMI Corp., most construction subcontractors enjoyed their secondbest year on record for revenues in 2002. The difference between contemporary markets-- even during a recession cycle-and the markets in which the practice of retainage emerged couldn't be greater

To counter retainage, subcontractors have worked hard at educating all of the players in the construction industry about problems such as reduction of subcontractors' access to capital, bid inflation to account for retainage, and the lack of motivation that retainage provides to complete punch list work. …

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