New Washington Law Applies Limitations to Retainage on Private Construction Projects

Originally published by the Daily Journal of Commerce on August 18, 2023.

On May 9, Washington Gov. Jay Inslee signed into law Senate Bill (SB) 5528, which limits the percentage of retainage withheld from contractors on private construction projects in Washington.

During a construction project, the withholding of retainage is a common practice and a frequently negotiated business term of a construction contract. This generally accepted custom in the industry is primarily regarded as security for an owner or contractor to ensure prompt and faithful performance by downstream contractors. The concept of retainage is an important tool to mitigate the risk of default by a contractor or its subcontractor, since monies withheld by an owner or contractor can be used to correct or complete defective or deficient work on a project.

Before the bill, Washington retainage statutes only applied to public works projects. See RCW 60.28.011. However, as of July 23, 2023, a similar statute will now apply to private construction projects in Washington. Since the retainage statute has recently taken effect, it is crucial for owners and general contractors to understand their obligations under the law and the potential impact these changes have on their construction contracts executed on or after July 23.

The new retainage statute, which will be codified as a new chapter in Title 60 RCW, largely mimics the retainage limits that exist in the public works context. SB 5528 sets forth two sections. The first of which limits retainage on private construction projects to no more than 5 percent of the contract price of the work completed and imposes interest, at the rate of 1 percent per month, if payment is not made after notification is received that the work (for which payment is requested) is complete. The second section of the approved law creates an opportunity for contractors or subcontractors to tender to the upstream owner or contractor a retainage bond in lieu of retainage.

The new statute focuses on private construction projects and does not apply to public improvement projects or single-family residential construction of fewer than 12 units.

Retainage Limited to 5 percent

SB 5528 limits the amount of retainage that can be withheld by an owner, contractor, or subcontractor on private construction projects. The retainage amount that can be withheld is capped at “5 percent of the contract price of the work completed.”

Interest Imposed on Amounts Owed for Completed Work

Another significant addition by SB 5528 relates to the owner’s or contractor’s obligations to pay after receiving notification from downstream parties of completed work and interest imposed for failure to pay for the completed work.

The statute imposes an interest rate of 1 percent per month on final payments due a contractor or subcontractor. The interest commences 30 days after the contractor or subcontractor has completed and the owner has accepted the work.

The statute also outlines a procedure regarding a contractor’s or subcontractor’s notification of its final completed work and the commencement of interest on unpaid final contract amounts. After completion of all the contracted work, the contractor or subcontractor must notify the party for whom the construction work is performed under the contract. The exact form of this notification is not specified in the statute. Within 15 days of receiving the notice of completion, the party for whom the work is performed must (1) accept the work or (2) notify the contractor or subcontractor of what portion of the work remains incomplete under the contract.

It is noteworthy that SB 5528 reflects that the contractor may notify the owner of completion of a subcontractor’s work, and the statute seems to require the same notification process: 30-day notice from the contractor, 15-day notice from the owner, and, in the event the owner does not respond, interest (at the rate 12 percent per annum) commences 30 days after the end of that 15-day period (whether or not the owner accepts the work or fails to provide notice) in the event of nonpayment. This new law appears to place an obligation on the owner to determine whether a subcontractor’s work is complete, to mitigate the risk of accruing interest on unpaid amounts. An owner can manage this risk by independently verifying the completion of the subcontractor’s work (an onerous task since the owner does not have direct contractual relations with or oversight over the subcontractors) or by relying on a certified statement of the general contractor that the work is complete and reserve rights to pursue the general contractor (e.g., via indemnity) if that statement proves false.

If the owner or contractor does not accept the work or notify the contractor or subcontractor of the incomplete work within 15 days after receiving the notice, interest at the rate of 1 percent per month on the final payment due to the contractor or subcontractor commences 30 days after the end of the 15-day period. The interest runs until final payment is tendered to the contractor or subcontractor.

A contractor’s obligation to pay interest to a subcontractor does not begin until that contractor receives payment of the subcontractor’s retainage, provided that the contractor submitted the subcontractor’s retainage request to the owner or upper-tier contractor within 30 days of the contractor’s receipt of the subcontractor’s retainage request. This language of the statute seems to address the risk of imposing interest on the contractor based on delayed payment from the owner (or an upper-tier contractor).

Bonds in Lieu of Retainage

The second section of SB 5528 introduces a mechanism for contractors or subcontractors to get paid their retainage prior to full completion on a project and allows for contractors or subcontractors to post a retainage bond as a means to obviate the withholding of retainage and receive their earned contract billings as the work is performed and accepted on the project.

Under the new law, in lieu of retainage, a contractor or subcontractor may tender a retainage bond, which the owner or contractor “must accept,” not to exceed 5 percent of the amount earned by the contractor or subcontractor.

When an owner accepts a bond in lieu of retained funds from a contractor, the statute mandates the contractor to accept like bonds from any subcontractor or supplier from which the contractor has retained funds. The contractor must release funds retained from the subcontractor or supplier within 30 days of accepting the bond from the subcontractor or supplier.

Additional requirements include that a contractor or subcontractor must provide a good and sufficient bond from an authorized surety company, conditioned on the contractor or subcontractor: (1) faithfully performing the provisions of the contract; (2) paying all laborers, mechanics, subcontractors, and material suppliers, and all persons who supply such contractor or subcontractor, or other subcontractors, with provisions and supplies for the carrying on of such work; and (3) paying the taxes, increases, and penalties incurred on the project.

The contractor or owner may require that the authorized surety have a minimum A.M. Best financial strength rating so long as that minimum rating does not exceed A-. The contractor may withhold the subcontractor’s portion of the bond premium, provided the contractor tenders a retainage bond to obtain a release of the subcontractor’s retainage.

SB 5528’s Effect on Current and Future Private Construction Contracts

Construction industry stakeholders will be curious to learn whether or to what extent the enactment of this new legislation will apply to and affect their contracts executed before July 23. Although the statute is phrased in terms of future actions (withholding), it raises questions about the enforceability of contracts made in the past and therefore raises questions about whether the statute should be given retroactive effect. See, e.g., Gillis v. King County, 42 Wn.2d 373, 255 P.2d 546 (1953) (analyzing amendment to street vacation statute); In re F.D. Processing, Inc., 119 Wn.2d 452, 832 P.2d 1303 (1992) (analyzing amendment to agricultural lien statute); Cameron v. Atlantic Richfield Company, 8 Wn.App.2d 795, 442 P.3d 31 (2019) (analyzing amendment to construction statute of repose).

A statute is presumed to have prospective effect only unless the legislature indicates otherwise, or unless the statute is deemed “curative” or “remedial.” See, e.g., Densley v. Dep’t of Ret. Sys., 162 Wn.2d 210, 223, 173 P.3d 885 (2007). Neither SB 5528 itself nor its legislative history indicates the legislature’s intention to have the statute apply retroactively. SB 5528 is not curative or remedial in the relevant sense.

Even if a statute is intended to be retroactive, it may not be applied to interfere with vested rights, which include contractual rights (see, e.g., Gillis, 42 Wn.2d at 376), nor may it “impair the obligation of a contract,” Scott Paper Co. v. City of Anacortes, 90 Wn.2d 19, 35, 578 P.2d 1292 (1978).

Based on these legal principles, it seems reasonable to conclude that SB 5528 does not have retroactive effect and that contracts existing on its effective date (July 23) calling for retainage greater than 5 percent are not affected. Contracts made on or after July 23 should be subject to the 5 percent retainage provision. If an owner has an ongoing relationship with a contractor, questions may arise whether a new contract is formed or an existing contract amended. The answers to these questions may determine how the new statute will apply.

Conclusion

The enactment of SB 5528 represents a significant change to how owners and contractors can withhold retainage on private projects in Washington. To comply with the new law, owners and contractors alike should carefully prepare their contracts to ensure precision in defining completion of the work and consider strategies for implementing security, via limited retainage rights or bonds in lieu of retainage, to manage and mitigate the risk related to delayed or incomplete work.

Emily Vo, a 2023 summer associate at Stoel Rives LLP and current student at the University of Washington School of Law, assisted in the drafting of this alert.