Public Owners Beware: Legislation in North Carolina General Assembly Will Cap Retainage in Public Construction Projects

Two Bills moving through the North Carolina General Assembly will, if enacted, have a significant impact on the way state construction projects are administered in the State of North Carolina. House Bill 1121, sponsored by Representatives Goforth, Brubaker, West and Gibson and Senate Bill 1245 sponsored by Senators Jenkins, Atwater, Bingham, Hoyle, Jones and Malone each seek to amend N.C. Gen. Stat. 143-134.1 titled "Interest on final payments due to prime contractors; payments to subcontractors." As one might suspect, however, there are a number of significant differences between the two Bills which could impact how owners, contractors and subcontractors on state construction projects do business. Below are some of the similarities and differences between the two Bills and some thoughts on each Bill.

As an initial matter, both House Bill 1121 and its Senate counterpart would eliminate all retainage on public construction projects with a total project cost of less than three hundred thousand dollars ($300,000). For public construction projects over three hundred thousand dollars ($300,000), both Bills provide a list of restrictions on the amount and use of retainage. In particular, both Bills provide the following noteworthy limitations on the use of retainage:

1. an owner may not retain more than five percent (5%) of any periodic payment due a contractor;
2. when the project is fifty percent (50%) complete, the owner shall not retain any further retainage from periodic payments if the contractor continues to perform satisfactorily. The owner may reinstate retainage if the contractor's performance is or becomes unsatisfactory;
3. for subcontracts, retainage is allowed, however, the amount of a subcontractor's retainage is not allowed to exceed the amount retained by the owner to the prime contractor (the 5% noted above) and if a contractor retains more than the amount held by the owner, it must pay the subcontractor interest at a rate of one percent (1%) in the Senate Bill and one and a half (1.5%) in the House Bill;
4. also, under both Bills, the owner must release retainage held within 45 days of any of the following: (i) the owner's receipt of a certificate of substantial completion, (ii) a certificate of occupancy being issued, or (iii) the owner's receipt of beneficial occupancy of the project as defined in the contract documents. Interestingly, a building department could issue a certificate of occupancy if code and life safety issues are addressed, while a mile-long punch list of aesthetic items can remain. Without retainage, how is an owner to be protected? The House Bill also includes: (iv) a separate usable phase of the project is available for use (whatever that means);
5. both Bills also provide that the existence of outstanding claims or change orders "shall not be a basis for delaying the release of any retainage on payments"; and
6. both Bills also allow for full payment for subcontractors who reach one-hundred percent (100%) completion of their contract by or before the time the project is fifty percent (50%) complete, thereby allowing early stage subcontractors (e.g. site work, structural steel, piling, caisson, demolition, rough grading and utility first-tier subcontractors) to be paid and not made to wait until the entire project reaches substantial completion. Noteworthy, however, is the fact that early payment of these subcontractors does not change the date for warranties to commence from the typical time of substantial completion or beneficial use by the owner as applicable.

The House Bill also adds two (2) additional provisions to its Bill: 1) to allow the owner to release one-half (1/2) of the retainage held once the contractor satisfactorily reaches fifty percent (50%) completion, and 2) to require that all retainage held by the owner or the contractor be deposited in an interest bearing escrow account.

As general contractors and owners on public construction projects consider and weigh in on these two pieces of legislation, a number of issues and questions should be raised in connection with the balance of power on state construction projects. For example, is a cap of five percent (5%) enough retainage to provide an owner or general contractor with the leverage necessary to push the contractor to complete the project on time and per the plans and specifications? Also, who receives the interest earned in the escrow account(s) in which the retainage is required to be deposited? Do both the owner and the contractor each have to open an account or is only one account required? Also, who pays the costs to open and maintain the account? These and many other questions remain unanswered in the Bills as currently written and should be addressed in order to avoid arguments and litigation over these issues after the Bills become law.

If an owner of contractor cannot use the retainage to offset exisitng claims or change orders at the end of a project, there will likely be a number of instances in which a contractor or subcontractor will be permitted to receive all of its retainage notwithstanding the fact that there are a number of claims or outstanding deductive change orders to be processed, thus increasing the contractor or subcontractor's relative leverage in the close out process and leaving the owner or general contractor in the position of either settling for pennies on the dollar or releasing the remaining retainage and then filing suit to recover against the often marginally capitalized subcontractor.

House Bill 1121 has passed its First Reading and is currently being considered by the House Committee on Commerce, Small Business and Entrepreneurship. Senate Bill 1245 passed its Third Reading on May 3, 2007. While the House Bill is silent as to an effective date, the Senate Bill is to become effective October 1, 2007 if enacted. (This entry published by Culley Carson, a member of Womble Carlyle's Construction Law Group.)