On Aug. 8, 2014, Massachusetts Governor Deval Patrick signed into law “An Act Relative to Fair Retainage Payments in Private Construction” (the “Act”). The Act’s primary feature is the establishment of a 5% limit on retainage on private construction projects for which the general contract amount is $3 million or more. The Act, which becomes effective on November 6, 2014, is the culmination of over three years of negotiation and development by industry trade groups, who persuaded the legislature that reducing owner withholdings will reduce overall costs of construction and promote a timelier project closeout process.

Overview of Requirements

There is much more to the Act than the 5% cap on retainage. The Act also establishes new, strict procedures and timetables for invoicing and release of retainage, all of which are keyed to a new redefinition of “substantial completion.” The Act’s essential components and timetables are as follows:

• Five-percent cap on qualifying projects. Retainage is limited to 5% of each progress payment on private projects of $3 million or more (based on prime contract value).
• Initial notice of substantial completion. The general contractor must send the owner notice of substantial completion, in the form required by the Act, within 14 days of achieving that milestone. If the owner fails to respond within 14 days, the project will be deemed substantially complete under the Act.
• “Substantial completion” redefined. The Act defines substantial completion to mean that the project is “sufficiently complete in accordance with the contract for construction so that the project owner may occupy or utilize the work for its intended use.”
• Submission of punchlist. Once the owner accepts substantial completion – expressly or by default for failure to respond – it has 14 days to submit a punchlist to the general contractor (GC). The GC has 21 days from acceptance of substantial completion – 14 days plus an additional seven days by virtue of being one tier below the owner – to submit to all applicable subcontractors that punchlist, which must include any additional items identified by the GC.
• Limit on punchlist amount. The punchlist amount cannot exceed 150% of the value of the incomplete or defective work. For project deliverables – e.g., contractually required closeout documents, including as-built drawings or lien waivers – the punchlist cannot exceed 2.5% of the total contract value, unless a different value is agreed to by the parties. An owner cannot withhold subcontractor retainage based on claims against the GC involving unrelated work, unless the GC has defaulted.
• Invoicing. GCs and subcontractors can invoice for their retainage within 60 days of substantial completion. The owner must pay the invoiced amount within 30 days of being invoiced, after which GCs have seven additional days to pay their subcontractors.

Other Issues and Requirements to Consider

The Act also institutes several formalistic requirements that are intended to complement similar requirements of the Massachusetts Prompt Payment Law. All written submissions related to the release of retainage, including the certification of substantial completion and submission of punchlists, must be certified in good faith. Moreover, an owner’s rejection of substantial completion or rejection of payment must be supported by written statements describing the “factual and contractual” basis of rejection. If the contractor disputes the owner’s rejection, the contractor must within seven days initiate the dispute resolution process required by the contract.

Also, both the owner and the GC retain the right to withhold amounts from retainage for, in addition to punchlist items, outstanding deliverables and “claims,” which the Act appears to define as claims for breach of contract. The Act caps the withholding amount for deliverables at 2.5% of the adjusted contract price, and it limits the withholding amount for claims to the “reasonable value” of the claims, plus any costs permitted by contract and/or statute.

As with the Prompt Payment Law, the requirements of the Act cannot be modified by contract. Any contract provision that would attempt to waive, limit, redefine, or alter the terms of the Act, including by changing or relaxing the conditions for establishing substantial completion, will be “void and unenforceable.”

Implications for Contractors

Although the Act provides potential benefits to contractors and owners alike in the form of increased cash flow, reduced risk for contractors, more timely completion of closeout, and perhaps reduced construction costs, contractors should be mindful of the pitfalls posed by the Act. Among them is the seemingly less-concrete definition of substantial completion, which makes no reference, for example, to the issuance of a certificate of occupancy or actual beneficial use by the owner. This vagueness could foster disputes over whether certain types of project are “sufficiently complete” for their “intended use.” Another potential risk lies in the right to offset retainage for “claims,” which, by being limited to claims for breach of contract, appears to exclude withholding money for potential claims by third parties, that may arise from personal injury or other claims. The Act’s seven-day dispute resolution requirement might also have implications for how claims are resolved. Although that provision explicitly addresses only an owner’s rejection of substantial completion, it logically should include any other claims between the contractor and owner (because the rejection likely will be caused by such pending claims, and both parties would want to include all claims and avoid multiple arbitrations on a given project). Assuming that this is the case, the Act could significantly accelerate the dispute resolution process.

As with all new legislation, the risks posed by the Act can be mitigated and resolved through proper contract negotiation and drafting. Contractors with concerns about the Act’s new requirements should consult with counsel to ensure firm-wide compliance once the Act takes effect on November 6.