In commercial and governmental construction contracts, it is common for owners to retain from general contractors, and for general contractors to retain from subcontractors, some percentage of progress payments earned until substantial completion (or, less frequently, final completion) of the contract has been achieved. Its purpose is to protect the holder from the financial impact of a breach of contract by downstream parties. Any portion of the retainage not used to correct a breach must be returned. Parem Contracting Corp. v. Welch Construction Co., Inc., 128 N.H. 254, 257 (1986) (“A party owed a retainage does not forfeit the amount owed if it breaks the contract. If it sues to recover the retainage, however, its recovery is subject to the defendant’s counterclaim in recoupment for the actual damages caused by the breach.”).
There are many ways to structure a retainage provision. The percentage of retention – most often 10% – may be reduced or eliminated at some agreed point (say, the 50% completion stage). It may be reduced at substantial completion to an amount tied to the estimated cost of completing punch list items, to be released upon punch list completion. Sometimes a portion of it may be held for the duration of warranty obligations. In New Hampshire, these are all negotiable matters – with one regulatory exception for certain state-funded water pollution control projects.
A performance bond likewise provides protection against the financial impact of a contractor default. If the performance bond surety cures a default, retainage is no longer needed for that purpose. But that doesn’t mean the retainage is then turned over to the contractor. Many performance bonds expressly provide that any retainage must be paid over to the surety as a condition of the surety’s obligations. Even without this express provision, the surety’s right to retainage is implied by most courts under equitable subrogation principles – which have been recognized by New Hampshire in similar contexts. Chase v. Ameriquest Mortgage Co., 155 N.H. 19, 27 (2007), is an example (equitable subrogation “applies where one who has discharged the debt of another may, under certain circumstances, succeed to the rights and position of the satisfied creditor.”).
If the owner chooses to apply retainage to cure a contractor’s default instead of resorting to the performance bond, but the retainage ends up being insufficient to fully cure the default, how does this affect the surety’s obligation to finish any remaining scope of work? In this scenario the owner has impacted the surety’s right to complete the project as it sees fit, and deprived it of money to fund the effort. This is akin to an owner picking its own completion contractor before giving the surety the opportunity to do so – a circumstance which has been held to absolve the surety of liability under its bond. Sleeper Village, LLC v. NGM Insurance Co., 2010 WL 3860373 (D.N.H. Oct. 1, 2010). I expect a similar result would follow the owner’s application of retainage to cure a contractor default.
Because invading retainage while a performance bond is still potentially in play is risky business, most owners won’t risk using retainage to complete a project unless the retainage is clearly sufficient to do so – and even then, they are likely to seek the surety’s permission. The popular AIA-A201 (2017) General Conditions provides for consent of surety to release of retainage to the general contractor at the completion of the project. It is silent on surety consent to use of retainage to cure a breach, but the implications are the same.
There is a wrinkle here. In New Hampshire, when “a bond refers to and is conditioned on the performance of a specific agreement the latter’s terms become a part of the bond,” Paisner v. Renaud, 102 N.H. 27, 29 (1959). Thus, a usage of retainage expressly allowed in the bonded contract could theoretically moot the need to seek surety consent. If, say, a bonded general contract expressly permitted the use of retainage to clear subcontractor liens, an owner who uses retainage held back from the general contractor to pay off a subcontractor’s lien has a decent argument against a performance bond surety’s objection.
There are many ways to structure a retainage provision. The percentage of retention – most often 10% – may be reduced or eliminated at some agreed point (say, the 50% completion stage). It may be reduced at substantial completion to an amount tied to the estimated cost of completing punch list items, to be released upon punch list completion. Sometimes a portion of it may be held for the duration of warranty obligations. In New Hampshire, these are all negotiable matters – with one regulatory exception for certain state-funded water pollution control projects.
A performance bond likewise provides protection against the financial impact of a contractor default. If the performance bond surety cures a default, retainage is no longer needed for that purpose. But that doesn’t mean the retainage is then turned over to the contractor. Many performance bonds expressly provide that any retainage must be paid over to the surety as a condition of the surety’s obligations. Even without this express provision, the surety’s right to retainage is implied by most courts under equitable subrogation principles – which have been recognized by New Hampshire in similar contexts. Chase v. Ameriquest Mortgage Co., 155 N.H. 19, 27 (2007), is an example (equitable subrogation “applies where one who has discharged the debt of another may, under certain circumstances, succeed to the rights and position of the satisfied creditor.”).
If the owner chooses to apply retainage to cure a contractor’s default instead of resorting to the performance bond, but the retainage ends up being insufficient to fully cure the default, how does this affect the surety’s obligation to finish any remaining scope of work? In this scenario the owner has impacted the surety’s right to complete the project as it sees fit, and deprived it of money to fund the effort. This is akin to an owner picking its own completion contractor before giving the surety the opportunity to do so – a circumstance which has been held to absolve the surety of liability under its bond. Sleeper Village, LLC v. NGM Insurance Co., 2010 WL 3860373 (D.N.H. Oct. 1, 2010). I expect a similar result would follow the owner’s application of retainage to cure a contractor default.
Because invading retainage while a performance bond is still potentially in play is risky business, most owners won’t risk using retainage to complete a project unless the retainage is clearly sufficient to do so – and even then, they are likely to seek the surety’s permission. The popular AIA-A201 (2017) General Conditions provides for consent of surety to release of retainage to the general contractor at the completion of the project. It is silent on surety consent to use of retainage to cure a breach, but the implications are the same.
There is a wrinkle here. In New Hampshire, when “a bond refers to and is conditioned on the performance of a specific agreement the latter’s terms become a part of the bond,” Paisner v. Renaud, 102 N.H. 27, 29 (1959). Thus, a usage of retainage expressly allowed in the bonded contract could theoretically moot the need to seek surety consent. If, say, a bonded general contract expressly permitted the use of retainage to clear subcontractor liens, an owner who uses retainage held back from the general contractor to pay off a subcontractor’s lien has a decent argument against a performance bond surety’s objection.
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