Substantial Confusion Upon Substantial Completion

If you've worked on a Tennessee construction project, you know about retainage: It's the percentage of earned contract payments an owner holds back as work progresses. What you may not know is that the law governing when those funds must be released has become unsettled. A seemingly straightforward retainage dispute can produce starkly different legal conclusions depending on which statute, court decision or interpretation of the 2020 legislative amendment a tribunal adopts. For owners and contractors, the financial stakes are significant.

So, What Exactly Is Retainage?

Think of retainage as the owner's insurance policy: a portion of each progress payment – capped at 5 percent in Tennessee – that the owner holds back to ensure the contractor finishes the job. The Tennessee Prompt Pay Act (PPA), found at Tennessee Code Annotated § 66-34-101 et seq., places strict guardrails around these funds: 1) they must be deposited into a separate, interest-bearing escrow account, 2) the law treats them as the contractor's "sole and separate property" from the moment they are withheld and 3) the owner may not commingle them with other funds. These requirements are mandatory, cannot be waived by contract and carry statutory damages of $300 per day for each day the funds are not in a proper escrow account.

That much is clear. The real fight begins after substantial completion: Must the owner release the retainage within a certain period of time, or may it rely on contractual withholding rights to continue holding the retainage until its dispute with the contractor is fully resolved?

The Statute at the Center of the Fight

Regarding payment of retainage from the owner to the general contractor, the key provision is Tennessee Code Annotated § 66-34-204 (the Retainage Payment Statute).

Before the 2020 amendment, it provided that when an owner 1) has received a use and/or occupancy permit for an improvement from a governmental agency lawfully issuing such permit, 2) has received a certificate of substantial completion from an architect charged with supervision of the construction of an improvement, or 3) begins to use or could have begun to use an improvement, the owner shall, after any such event and pursuant to the terms of the written contract, pay to the contractor all retainage the owner may have withheld pursuant to the written contract. This excludes any sum that the owner may reasonably withhold in accordance with the written contract between the owner and contractor – provided, however, that the retainage must be paid within 90 days after the date of the occurrence of an event included in subdivision (1), (2) or (3).

The Tennessee Court of Appeals interpreted this pre-amendment language in Beacon4, LLC v. I & L Investments, LLC, holding that retainage must "be paid to the contractor within ninety days of substantial completion of the work or the owner's beginning to use the improvement contracted for regardless of any contractual provisions allowing the owner to reasonably withhold a sum." 514 S.W.3d 153, 200 (Tenn. Ct. App. 2016) (emphasis added). This was a significant ruling: It meant the 90-day deadline was absolute and overrode any contractual withholding rights.

In 2020, the legislature amended the statute, with the changes shown in bold:

When an owner: (1) Has received a use and/or occupancy permit for an improvement from a governmental agency lawfully issuing such permit; (2) Has received a certificate of substantial completion from an architect or engineer charged with supervision of the construction of an improvement; or (3) Begins to use or could have begun to use an improvement; the owner shall, after any such event and pursuant to the terms of the written contract, pay to the prime contractor all retainage the owner may have withheld pursuant to the written contract, except any sum which the owner may reasonably withhold in accordance with the written contract between the owner and the prime contractor; provided, however, that the retainage must be paid within ninety (90) days after the date of the occurrence of an event included in subdivision (1), (2) or (3).

The deletion of "provided, however, that" invites disputes over whether Beacon4 remains good law, setting the stage for the competing interpretations that follow.

The Contractor's Take: Pay Up Within 90 Days, Period

Contractors believe Beacon4 remains the governing standard and that the 2020 amendment reinforced rather than undermined it. They read the statute as straightforward: Once any one of three triggering events occurs – the owner obtains a use or occupancy permit, an architect issues a certificate of substantial completion or the owner begins using the project – the retainage "must be paid within ninety (90) days."

Contractors further contend that the policy argument is equally straightforward. Retainage exists to ensure that the project is completed. Once the owner has a completed, usable improvement, why should it continue holding the contractor's money? The contractor and subcontractors performed the work and earned those funds. If the owner believes it did not get what it paid for, it can sue like anyone else – but unproven allegations should not allow one party to hold another's funds indefinitely.

How do contractors answer the argument that the 2020 amendment weakened the 90-day rule? They contend that the deletion of "provided, however, that" did not retreat from Beacon4 but rather reinforced the decision. The official bill summary for Senate Bill 2681 describes the change as "a grammatical change … to clarify that the requirement for payment of retainage within 90 days of certain events is a requirement and not a proviso." In other words, contractors argue, the legislature intended the 90-day deadline to be a stand-alone, mandatory obligation – not a subordinate clause that could be swallowed by the language preceding it. If the General Assembly had wanted to overturn Beacon4, contractors argue, it would have deleted the words "the retainage must be paid within ninety (90) days" entirely.

Owners counter with Section 66-34-104(b), which provides that the contractor's ownership of retainage is "subject to the rights of the person withholding the retainage in the event the prime contractor … defaults on or does not complete its contract." Contractors resist giving this provision an expansive reach. In their view, "default" in the construction context means a material failure to complete the work – not any post-completion breach allegation an owner might assert about the quality of work. Collapsing the distinction between default and ordinary breach, they argue, would render the 90-day payment requirement meaningless.

The Owner's Take: We Bargained for These Protections

Owners see it differently. They emphasize that the PPA was never intended to eliminate their contractual rights. Their argument rests on two provisions: Section 66-34-203, which expressly permits "reasonabl[e] withholding" that is "in accordance with the written contract," and the same Section 66-34-104(b) discussed above. But owners read it far more broadly than contractors do, arguing that it preserves all contractual withholding rights whenever the contractor "defaults on or does not complete its contract."

Owners read the 2020 amendment differently as well. Whereas contractors contend that deleting the phrase "provided, however, that" merely clarified the statute, owners maintain it changed the statutory framework and was specifically intended to overturn Beacon4's rule. In their view, the Court of Appeals in Beacon4 relied on the former language to conclude that the 90-day clock overrode all contractual withholding rights. By removing those words, the legislature severed that connection. Owners therefore read the statute as operating in two parts: 1) the owner pays retainage under the contract, less any amount it may reasonably withhold under the contract's terms, and 2) the 90-day deadline applies only to amounts actually due – not amounts the owner is legitimately withholding. Because Beacon4 relied on language the legislature later amended, owners argue that its "release everything, no exceptions" rule is no longer the law.

Owners also point to Twin K Constr., Inc. v. UMA, Geotechnical Constr., Inc., 2022 WL 880002 (E.D. Tenn. Mar. 23, 2022), in which the U.S. District Court for the Eastern District of Tennessee declined to order immediate payment of retainage and held that the PPA "permits a general contractor to reasonably withhold retainage pursuant to the terms of the parties' contract" – making reasonableness a question for the jury. Although Twin K involved a general contractor-subcontractor dispute rather than an owner-general contractor dispute, owners cite it as support for the broader principle.

Where Does That Leave Us?

The uncomfortable truth is that no Tennessee appellate court has directly addressed the meaning of the 2020 amendment or definitively stated whether Beacon4 still applies. This uncertainty exists in part because most commercial construction contracts require binding arbitration, where subject-matter experts decide the issues in a private tribunal. Arbitration decisions, however, do not bind unrelated cases or create precedent, nor are they published.

Trial courts have reached opposite conclusions, sometimes on essentially the same facts: Some have ordered release within 90 days, while others have allowed owners to continue withholding. Compare 7th Ave. Nashville Hotel Owner, LLC v. W.G. Yates & Sons Constr. Co., No. 22-1259-BC (Davidson Cnty. Tenn. Ch. Ct. Jan. 24, 2023) (ruling that "the Court cannot disregard the mandatory requirements" of the Retainage Payment Statute, quoting the post-amendment version, "which specifically sets forth the timeline for releasing retainage payments"), with The Constr. P'ship, LLC v. Butters, No. 23CV-52900 (Williamson Cnty. Tenn. Ch. Ct. Oct. 7, 2024) (ruling that the 2020 amendment "removed the mandatory requirement to release" retainage within 90 days). The issue has not reached the Tennessee appellate courts.

The practical stakes are significant. If an owner is forced to release retainage, it may have to pursue an insolvent contractor through years of litigation without the benefit of still holding the retainage. Conversely, a contractor that has completed the work may have to wait years to receive retainage, which the PPA calls the contractor's "sole and separate property." Both sides can point to statutes and case law supporting their positions, but neither can identify a clear, binding answer.

What Should You Actually Do?

Until Tennessee's appellate courts resolve the issue or the PPA is clarified, both sides should proceed carefully. Owners should ensure their contracts clearly address withholding rights, follow the escrow rules to the letter, document each defect and default as it arises, and recognize that holding funds beyond 90 days may invite a dispute under a statute designed to protect contractors. Contractors should negotiate whether retainage will be withheld and in what amount, and if their contract includes a retainage clause, assert statutory rights early, verify whether the owner has properly escrowed the retained funds, and recognize that an owner with strong documentation and properly escrowed funds may persuade a court or arbitrator that continued withholding was reasonable under the contract.

Above all, negotiate retainage provisions with this uncertainty in mind. A clause that seems perfectly clear when signed may prove less clear in practice – especially when it collides with a statute whose meaning Tennessee's highest courts have yet to settle.

For more information or questions, please contact the authors.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.