In Tennessee, and many states, owners on major construction projects often hold back or “retain” a portion of any payment otherwise due to a general contractor in response to the general contractor’s invoice (draw request or request for payment). In like manner, the general contractor (GC) can retain funds otherwise due to any subcontractor used by it on a project.

Historically, the maximum percentage that could be retained as retainage was 10%. However, several years ago Tennessee’s legislature capped that percentage at 5%. Thus, and as a simple mathematical example, if the GC’s interim bill is $100,000, the amount paid would be $95,000, with the remaining $5,000 held back, or retained, as retainage until the successful completion of the project.

It sounds simple. But many out-of-state owners and/or developers are unaware of the rigid statutory obligations in Tennessee that surround this protocol. That protocol can create a snake pit for them, and a windfall for the party due to be paid for the project. Here’s a closer look at Tennessee law and how it affects parties involved in construction projects.

Tennessee’s Statutory Law Regarding Retainage is Not Negotiable

Tennessee law regarding retainage and how it is handled is codified in Tennessee’s Prompt Pay Act.¹ This section provides that an owner/developer may withhold a portion of amounts billed to it by a provider (whether a subcontractor or otherwise).

However, that privilege comes with rigid limitations that many owners or GCs overlook. Remember, the maximum amount that can be withheld is 5% of the amount billed.² More importantly, the statute also mandates that the party withholding the funds must comply with certain statutory obligations.

First, the party withholding the funds must deposit the funds in a “separate, interest-bearing, escrow account with a third party which must be established upon the withholding of any retainage.” Second, the party withholding the funds has an affirmative duty to provide written notice that it has complied with this code section. That notice must reveal the following information:

• Name of the financial institution with which the escrow account was established.
• The account number.
• The amount of retained funds that are deposited in the escrow account with that third party.³

The next issue is who owns the funds, once escrowed. However, the statute is clear as to who owns funds withheld as “retainage.” Specifically, the statute states, “As of the time of the withholding of the retained funds, the funds become the sole and separate property of the prime contractor or remote contractor to whom they are owed …” (emphasis added).⁴

This takes us to the next issue — namely, what is the result of a party’s failure to comply with the statute? The Tennessee legislature made it crystal clear. The statute provides for a damage award of $300 per day for “each and every day that the retained funds are not deposited into an escrow account.” The statute’s language says:

If the party withholding the retained funds fails to deposit the funds into an escrow account as provided in this section, then the party shall pay the owner of the retained funds an additional $300 per day as damages, not as a penalty, for each and every day that the retained funds are not deposited into an escrow account. Damages accrue from the date retained funds were first withheld and continue to accrue until placed in a separate, interest-bearing escrow account or otherwise paid.⁵

The Tennessee Supreme Court Interprets This Law

Lest there be any confusion as to the interpretation of this statute, Tennessee’s Supreme Court has addressed it with great clarity. In Snake Steel Inc. v. Holladay Construction Group LLC,⁶ Tennessee’s Supreme Court analyzed the retention portion of the Prompt Pay Act. In that case, the developer held back retainage but failed to comply with the statute by failing to deposit it into a separate, interest-bearing escrow account. When the project ended, the developer turned over the retainage to the contractor. Accordingly, the developer argued “no harm, no foul.”

Tennessee’s Supreme Court rejected that argument. The court held that the Prompt Pay Act is a “remedial statute, designed to help protected individuals and entities timely recover the full amount of funds they have already earned.” The court noted that when the funds are retained, those funds “become the property of the contractor to whom the retainage is owed …” (emphasis added). The court referenced Tenn. Code Ann. § 66-34-104(j) holding that “compliance with the escrow account provision is mandatory and may not be waived by contract.” In ruling, the court also held as follows:

As outlined above, the Prompt Pay Act goes to great lengths to ensure that construction contractors are timely paid. As further protection for contractors, absent an exception, the act obliges persons who withhold retainage to deposit it into a separate interest-bearing account. This ensures the money is set aside and contractors receive interest if their receipt of the retainage is delayed. To put teeth into the escrow requirement, for persons required to deposit the retainage into such an escrow account, failure to do so results in a penalty of $300 per day. The Act adds emphatically that the $300 per day penalty is for each and every day that such retained funds are not deposited into such escrow account⁷ (emphasis added).

The prior version of the statute (and the court’s ruling in Snake Steel) highlighted the word “penalty” in relation to the $300 per day award for violation of the statute. That usage of the word “penalty” gave ammunition to many defense lawyers, arguing that any claim for the daily award of $300 was governed by the one-year statute of limitations for statutory penalties.⁸ To solve the possible windfall related to such an interpretation, the legislature later amended the statute to substitute the word “damages” for penalty. Less there be any doubt, the revised version of Tenn. Code Ann. § 28-3-105 expressly says that the $300 daily award is for “damages, not as a penalty” (emphasis added).

As a result, the three-year statute of limitations found in Tenn. Code Ann. § 28-3-105 applies. This can result in a large windfall for those whose bills were shorted, or short-paid, by 5%. This is because on overly large construction projects, completion often takes many months, if not years, to complete. Thus, the party who has been short-paid the 5% has to wait (and wait) to have his/her final funds released.

However, if the owner or GC did not comply, then he or she are exposed to claims for $300 per day, covering periods of time that can often be in excess of 365 days, or more. This, of course, results in a statutory claim of $109,500 per year. Hence, what is a snake pit for the owner or GC becomes a windfall for the party waiting on payment. As a result, developers, owners and GCs (particularly those based out-of-state) should retain legal counsel to ensure compliance and to avoid running afoul of this law. |||

Phillip Byron Jones is a partner at Evans, Jones & Reynolds and is a Rule 31 Listed Mediator. He received his law degree from the University of Louisville Brandeis School of Law.

NOTES
1. Tenn. Code Ann. § 66-34-101.
2. Tenn. Code Ann. § 66-34-103.
3. Tenn. Code Ann. § 66-34-104.
4. Id.
4. Tenn. Code Ann. § 66-34-104(c).
6. Snake Steel Inc. v. Holladay Construction Group LLC, 625 S.W. 3d 830 (Tenn. 2021).
7. Id.
8. Tenn. Code Ann. § 28-3-104(a)(1)(C)