California Caps Construction Retention at 5%

Retention has long been a built-in feature of construction contracting. For decades, many owners withheld ten percent (10%) from contractor and subcontractor payments as financial leverage to ensure quality and project completion. While intended as a protective measure, the practice often placed outsized strain on project teams juggling tight margins, labor costs, benefits, and material expenses.

To address those concerns, California lawmakers passed Senate Bill 61 (“SB 61”), a major update to retention rules for private works. The bill aims to rebalance risk and deliver more predictable cash flow for contractors across the state.

Key Change: A 5% Retention Cap

Under current law, retention amounts on private construction are largely dictated by negotiation. SB 61 changes that framework by instituting a five percent (5%) maximum on most private construction contracts.

For contracts executed on or after January 1, 2026:

• Owners, developers, direct contractors, and subcontractors may withhold no more than 5% from progress payments.
• The total retention cannot exceed five percent of the entire contract value.
• Contractors cannot pass along higher retention percentages to subcontractors than what the owner withholds.

This creates uniformity across payment tiers and reduces financial exposure for downstream parties.

Important Exceptions in SB 61

The law includes several carveouts and clarifications:

Applies Only to New Contracts After Jan. 1, 2026
Existing agreements are not retroactively affected.

1. Limited Residential Coverage
   SB 61 excludes most purely residential projects. However, it applies to:
   • “Mixed-use” developments
   • Residential buildings five stories or higher
   Because the legislation doesn’t define “residential” or “mixed-use,” courts are expected to interpret these terms broadly under California’s mechanics lien protections. Projects combining residential and commercial elements—regardless of percentage split—may fall under the cap.
2. Bond-Related Exception
   If a subcontractor is required to provide a payment and performance bond and fails to do so after receiving written notice at or before bidding, the retention cap does not apply in that specific case.

SB 61 and Prompt Payment Enforcement

SB 61 aligns with, rather than replaces, California’s existing prompt payment laws. It reinforces those rules by:

• Supporting faster fund disbursement
• Ensuring consistency in payment practices
• Requiring courts to award reasonable attorney’s fees to the prevailing party in enforcement actions

While it doesn’t change statutory payment timelines, it strengthens the incentive for owners and prime contractors to release retention promptly.

What Owners and Contractors Need to Do

Beginning in 2026, SB 61 will directly affect contract drafting, negotiation, and administration. Affected parties should prepare by:

• Updating standard contract templates to reflect the five percent (5%) limit
• Aligning retention clauses across owners, general contractors, and subcontractors
• Reviewing internal payment procedures to ensure compliance
• Clearly documenting any bond requirements to preserve exception rights
• Training contract administrators and project managers on the new legal standards

Because over 20 states now have similar retention laws, some large companies may be better prepared than others—but localized implementation still requires careful review.

A Shift Toward Greater Financial Balance

The enactment of SB 61 represents a significant change in how risk and cash flow will be managed in California’s private construction sector. For many contractors and subcontractors, the reduced retention rate offers earlier access to working capital and greater stability on ongoing projects.

For owners and developers, the law introduces a new compliance layer but may also support more competitive bidding and stronger industry relationships over time.

As 2026 approaches, all stakeholders—owners, developers, contractors, and subcontractors—will need to plan ahead to ensure smooth adoption and avoid disputes.

Originally reported by Erinn M. Contreras, Julia Anderson of Sheppard, Mullin, Richter & Hampton LLP in The national Law Review.