For the past 20 years, it has been the law in Tennessee that retainage withheld on construction projects with a value over $500,000 must be deposited in a separate escrow account. Until recently, however, the only possible penalty for a failure by the owner to escrow retainage was the imposition of interest on the amount not escrowed. See ABC Plumbing & Heating, Inc. v. Dick Corp., 684 S.W.2d 84, 1985 (Tenn. 1985); Rentenbach Eng’g Co. v. General Realty Ltd., 707 S.W.2d 524, 1985 (Tenn. Ct. App. 1985). For this reason, the escrow requirement was often ignored.

The situation changed dramatically on July 1, 2008, when new Tennessee Code Section 66-34-103 became effective. Under subsection (e) of Tennessee Code Section 66-34-103, failure of an owner to escrow retainage is now a Class A misdemeanor, punishable by a fine of $3,000 per day for each day that retainage is not escrowed. The new statute mandates that owners strictly comply with the escrow account requirements, or be exposed to very severe penalties.

KEY RETAINAGE PROVISIONS

The following key provisions are now part of the Tennessee Code:

  1. Retainage is capped at five percent of the contract value;
  2. Retainage must be deposited in a separate, interest-bearing escrow account with a third party;
  3. The escrowed retainage (including interest) for “work completed” at the time of substantial completion must be released within 90 days after substantial completion (TCA § 66-34-103); and
  4. All retainage, including retainage on work not completed at the time of substantial completion, must be paid within 90 days after the contractor has completed all of the work and all terms and conditions of the contract, including delivery of appropriate releases. (TCA § 66-34-103 (b) and TCA § 66-34-104 (c)).  

Aside from the need to make sure that all retainage is properly escrowed, the principal practical concern raised by this statutory change is the need to make sure that the contractor has sufficient incentive to complete the punch list, after retainage for work completed is released at substantial completion.  

FULL TEXT OF THE NEW STATUTES

Tennessee Code Section 66-34-103: Withholding of retainage — Violations — Penalties.  

  1. All construction contracts on any project in this state, both public and private, may provide for the withholding of retainage;, provided, however, that the retainage amount may not exceed five percent (5%) of the amount of the contract.
  2. The owner, whether public or private, shall release and pay all retainages for work completed pursuant to the terms of any contract to the prime contractor within ninety (90) days after completion of the work or within ninety (90) days after substantial completion of the project for work completed, whichever occurs first. As used in this subsection (b), work completed shall be construed to mean the completion of the scope of the work and all terms and conditions covered by the contract under which the retainage is being held. The prime contractor shall pay all retainages due any subcontractor within ten (10) days after receipt of the retainages from the owner. Any subcontractor receiving the retainage from the prime contractor shall pay to any subsubcontractor or material supplier all retainages due the subsubcontractor or material supplier within ten (10) days after receipt of the retainages.  
  3. Any default in the making of the payments shall be subject to those remedies provided in this part.  
  4. In the event that an owner or prime contractor withholds retainage that is for the use and benefit of the prime contractor or its subcontractors pursuant to § 66-34-104(a) and (b), neither the prime contractor nor any of its subcontractors shall be required to deposit additional retained funds into an escrow account in accordance with § 66-34-104(a) and (b).  
  5. (1) It is an offense for a person, firm or corporation to fail to comply with subsection (a) or (b) or § 66-34-104(a).  

(2) ( A) A violation of this subsection (e) is a Class A misdemeanor, subject to a fine only of three thousand dollars ($3,000).  

(B) Each day a person, firm or corporation fails to comply with subsection (a) or (b) or § 66-34-104(a) is a separate violation of this subsection (e).  

(C) Until the violation of this subsection (e) is remediated by compliance, the punishment for each violation shall be consecutive to all other such violations.

Tennessee Code Section 66-34-104: Retention of portion of contract price in escrow — Applicability — Mandatory compliance.

  1. Whenever, in any contract for the improvement of real property, a certain amount or percentage of the contract price is retained, that retained amount shall be deposited in a separate, interest bearing, escrow account with a third party.  
  2. As of the time of the deposit of the retained funds, the funds shall become the sole and separate property of the prime contractor or remote contractor to whom they are owed, subject to the rights of the person withholding the retainage in the event the prime contractor or remote contractor otherwise entitled to the funds defaults on or does not complete its contract.  
  3. Upon satisfactory completion of the contract, to be evidenced by a written release by the owner or prime contractor owing the retainage, all funds accumulated in the escrow account together with all interest on the account shall be paid immediately to the prime contractor or remote contractor to whom the funds and interest are owed.  
  4. In the event the owner or prime contractor, as applicable, fails or refuses to execute the release provided for in subsection (c), then the prime contractor or remote contractor, as applicable, may seek any remedy in a court of proper jurisdiction and the person holding the fund as escrow agent shall bear no liability for the nonpayment of the fund to the prime contractor or remote contractor; provided, however, that all claims, demands, disputes, controversies, and differences that may arise between the owner, prime contractor or prime contractors, and remote contractor or remote contractors regarding the funds may be, upon written agreement of all parties concerned, settled by arbitration conducted pursuant to the Tennessee Uniform Arbitration Act, compiled in title 4, chapter 5, part 3, or the Federal Arbitration Act, 9 U.S.C. § 1, et seq., as may be applicable.  
  5. This section shall be applicable to all prime contracts and all subcontracts thereunder for the improvement of real property when the contract amount of such prime contract is five hundred thousand dollars ($500,000) or greater, notwithstanding the amount of such subcontracts.  
  6. Compliance with this section shall be mandatory, and may not be waived by contract.

Tennessee Code Section 66-34-602: Nonpayment — Notice of intent to seek relief under chapter — Remedies — Attorney’s fees — Bond.

  1. (1) A contractor who has not received payment from an owner, or a subcontractor, materialman or furnisher who has not received payment from a contractor or other subcontractor, materialman or furnisher, in accordance with the provisions of this chapter, shall notify the party failing to make payment of the provisions of this chapter and of the notifying party’s intent to seek relief provided for within this chapter.  

(2) The notification shall be made by registered or certified mail, return receipt requested.  

(3) If the notified party does not, within ten (10) calendar days after receipt of such notice, make payment or provide to the notifying party a response giving adequate legal reasons for failure of the notified party to make payment, the notifying party may, in addition to all other remedies available at law or in equity, sue for equitable relief, including injunctive relief, for continuing violations of this chapter, in the chancery court of the county in which the real property is located.  

(4) The failure to make the only payment due under the contract may be considered to be a continuing violation under this chapter.  

  1. Reasonable attorney’s fees may be awarded against the nonprevailing party; provided, that such nonprevailing party has acted in bad faith.  
  2. A bond in double the amount claimed or ordered to be paid shall be filed with good sureties to be approved by the clerk prior to the issuance of any injunctive relief.