Retainage vs. Set-Off: The Real Margin Killers in Heavy-Civil and Industrial Work

“You’re doing the work, but someone else is holding your profit.”

Construction contracts often hide dangers behind familiar language. Two of the most misunderstood—and costly—mechanisms are retainage and set-off. Retainage withholds a percentage of every progress payment until project completion, straining cash flow and delaying profit. Set-off allows an owner or general contractor to deduct alleged damages or costs—sometimes from entirely different projects—before paying what’s owed.

On paper, both appear to be standard risk-allocation tools. In practice, they silently drain cash, erode profit, and give upstream parties leverage you can’t afford to lose. If you work in heavy-civil, industrial, or infrastructure construction, you ignore these clauses at your peril.

When Contract Clauses Become Weapons

In many projects, retainage and set-off move far beyond their stated purpose of ensuring performance or covering legitimate claims. They become financial weapons—deployed to control cash, delay payment, or pressure subcontractors into accepting unfavorable change orders and settlements. A withheld retainage check can force smaller firms to absorb costs they shouldn’t, while an aggressive set-off clause lets an upstream party recover unrelated losses without due process. Misused, these provisions shift risk entirely downstream and turn fair contracts into instruments of leverage.

What Is Retainage?

Purpose and Intent

Retainage (also called retention or holdback) represents a portion of contract payments—typically 5 % to 10 %—that owners or general contractors withhold until specific milestones are reached, such as substantial completion or the close of a defects-liability period.

Contractors often justify retainage as a safeguard intended to:

Ensure final quality and punch-list completion
Provide leverage to keep contractors accountable
Serve as a buffer against default, defects, or unfinished work

In reality, retainage rarely motivates better performance. Instead, it becomes a systemic drag on cash flow and profitability.

How Retainage Works in Practice

The paying party deducts retainage from each progress payment, so you never receive full earned value.
Many contracts release part of the retainage at substantial completion and hold the rest until final acceptance.
Some agreements apply a variable rate—10 % early in the project, dropping to 5 % later—to ease pressure on working capital.
General contractors often retain more from subcontractors than the owner retains from them. (Siteline)

The Hidden Cost of Retainage

Retainage directly impacts working capital and profit:

In low-margin projects, retainage can equal—or exceed—your entire expected profit.
You must pay labor, materials, and overhead long before receiving full compensation.
Disputes over definitions such as substantial completion or acceptable defects delay release.
Lingering retainage effectively turns your money into interest-free financing for the owner.

When delayed release and dispute costs pile up, retainage becomes a silent killer of liquidity.

Recent Legal Developments

Several states have started capping or redefining retainage terms to prevent abuse:

New York now limits retainage on private construction contracts to 5 %. (Peckar & Abramson, P.C.)
California will enforce a 5 % cap on both public and private projects beginning January 2026. (Allen Matkins)
Disputes continue where contracts use vague or overly broad retainage clauses. (Tish Law)

What Is Set-Off (or Offset / Recoupment)?

Understanding the Distinctions

Many contracts use set-off, offset, and recoupment interchangeably, but the differences matter:

Recoupment (Offset): The paying party withholds funds on the same project to cover defects, damages, or other legitimate claims.
Set-off (Cross-Project): The paying party withholds funds across projects or contracts, using claims unrelated to the specific job in question.

A typical clause might read:

“Contractor may set off against any amounts due under this subcontract (or any other agreement) all claims, damages, costs, or liabilities which Contractor may have against Subcontractor.”
— Frantz Ward LLP

Key Risks and Legal Constraints

Statutory limits: Many state laws and trust-fund statutes restrict or void broad offset clauses. (ConsensusDocs)
Project boundaries: Courts favor recoupment (same-project) and often disallow set-off (different projects).
Bonded projects: Offsets can conflict with surety or payment-bond obligations, creating disputes.
Public policy: Several states—including Virginia—explicitly ban cross-contract offsets.

As Frantz Ward notes:

“Offset is generally more favored. Set-off, on the other hand, occurs when a contractor offsets payments due on one project for damages incurred on a completely different project.”

Why Retainage and Set-Off Kill Margins

Together, retainage and set-off deliver a double hit to profitability. Here’s how they undermine project economics:

Deferred Payment = Deferred Profit – You deliver value but wait months—or years—for payment. In thin-margin contracts, delay alone can erase profit.
Leverage Works Against You – Upstream parties hold your cash and prolong disputes to maintain control.
Cross-Project Contagion – A dispute on Project A can freeze payments on Project B if set-off rights are broad.
Cash-Flow Volatility – Multiple contracts with retainage and offset provisions make receivables unpredictable.
Financing Costs – You fund your client’s operations while covering your own.
Legal Exposure – If a court invalidates an offset, you may owe penalties, interest, or refunds.
Administrative Drag – Tracking, disputing, and reconciling withheld funds consumes time and resources.

Example: If your contract allows 8 % retention and 5 % offset, you’ve placed 13 % of revenue at risk—often more than your total margin.

Mitigation Strategies and Best Practices

You don’t have to accept these terms passively. Use the following strategies to reduce exposure and protect profit.

Strategy	Goal	Sample Language / Approach
Cap Retainage	Limit withheld funds (e.g., max 5 %)	“Retainage shall not exceed 5 % of Stored Value.”
Phased Release	Tie release to milestones	“50 % of retainage released at completion; balance after 12-month defects period.”
Retention Bond or Escrow	Substitute security to free cash	“Contractor may provide a retention bond in lieu of withheld funds.”
Carve-Outs	Exclude material or pass-through costs	“Materials delivered to site are exempt from retention.”
Restrict Set-Off Scope	Limit offsets to project-specific, liquidated claims	“Only damages from this project may be offset; cross-project claims disallowed.”
Notice and Dispute Protocol	Require written notice before withholding	“Contractor must provide 30-day notice and mediation before offset.”
Mutuality Requirement	Force offsets to be raised as counterclaims	“Offsets must be asserted as counterclaims in the same dispute forum.”
Reserve and Tracking	Budget for potential deductions internally	Track “retainage and offset reserves” in your cost forecast.
Jurisdictional Review	Align contracts with local law	Review anti-offset or trust-fund statutes before signing.
Lien and Claim Strategy	Secure retainage through statutory rights	Maintain lien and bond notice procedures.

Pro Tips

Negotiate retainage and set-off terms before award, not after.
Train estimating and finance teams to model worst-case payment delays.
Require upstream parties to pass through the same retention limits they accept.
Monitor your overall exposure—retention plus offset can quietly multiply across bids.

“Retainage is your built-in working-capital loan to the owner—except they pay no interest.”
“A cross-project offset clause lets a dispute on Job A wipe out your payment on Job B.”
“Limiting retainage to 5 % and banning cross-contract offsets isn’t aggressive—it’s financial sanity.”
“If your margin is 7 % and your contract allows 10 % retention plus offset, you’ve already lost the deal.”