Retainage.

Retainage is simply the withholding of a portion of the payment due to the supplier until such time as a specific event or milestone occurs. When the event or milestone occurs the agreed portion of the retainage will be released. For example, in a construction contract there could be a provision that ten percent (10%) of the value of each payment will be withheld. There could be a limit on the total amount withheld so that once five percent of the total value of the work has been withheld there will be no withholding on further payments. The defined milestones or events that that will cause a release from the retainage could be that fifty percent of the retained amount will be released upon Substantial Completion of the Work. Substantial Completion would be a term defined in the contract. The remaining fifty percent could be paid at Final Acceptance (another term that would be defined in the agreement). There could also be a provision where some portion of the retainage could be held during the warranty period. Where retainage is handy is when payments are being made based upon the estimated percentage of completion of the work. While you would like those invoices to be as accurate as possible, you have both the amount of retainage and the natural lag between invoice and payment to protect you from paying too much too soon.

Retainage is an alternative to requiring the supplier to provide a performance bond or other guarantee that the work will be performed. This means that the value of the amount being retained needs to be significant enough to serve as leverage to have the supplier complete the work before the retainage is released. The same type of protection may be accomplished by simply structuring a payment schedule where you make sure that they payments aren’t front end loaded (meaning the payment schedule doesn’t pay the supplier too much in early stages) and a significant portion of the contract price will not be paid until a final milestone such as Final Acceptance is complete.