California contractors and project owners will see a major shift in payment practices beginning January 1, 2026, when a new state law limits retention on most private construction contracts to 5%. The change, enacted through Senate Bill No. 61 (SB 61), cuts the long-standing industry standard of 10% in half and brings private projects in line with retention rules that already apply to public works.
The law is designed to improve cash flow for contractors and subcontractors—particularly small businesses—by reducing the amount of money withheld from progress payments during construction. However, industry experts expect the reduced retention to shift more financial risk to owners and general contractors, likely prompting new requirements for alternative security such as bonds or letters of credit.
Under SB 61, retention withheld from any individual progress payment may not exceed 5%, and total retention across the life of a contract may not exceed 5% of the overall contract price. The law also establishes a “flow-down” requirement: if a prime contract sets retention at a lower percentage, related subcontracts may not exceed that same limit. Importantly, these limits cannot be waived by agreement, even if both parties consent.
The legislation applies to private construction contracts entered into on or after January 1, 2026, with limited exceptions. Residential-only projects of four stories or fewer are exempt, as are situations where a contractor or subcontractor provides written notice requesting performance and payment bonds and the other party fails to provide them. Contracts executed before the effective date are not subject to the new retention cap, though task orders or subsequent agreements issued after January 1 will fall under SB 61.
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Supporters of the bill argue that the reduced retention will ease financial strain across the construction supply chain by lowering reliance on credit lines and accelerating access to earned funds. Contractor groups have pointed to public works projects—where similar retention limits already exist—as evidence that lower retention can function without undermining project delivery.
At the same time, owners and developers are expected to respond by seeking additional protections. Performance and payment bonds, letters of credit, and parent company guarantees are likely to become more common, especially on larger or more complex projects. While these tools provide liquidity and risk mitigation, they also carry added costs that could increase overall project budgets.
Legal and industry advisers caution that SB 61 will require careful contract updates and revised risk-management strategies. Contract language, payment provisions, and security requirements should be reviewed to ensure compliance with the new law, particularly for projects that span multiple phases or involve downstream subcontracting.
As California’s private construction market adjusts to the new framework, SB 61 is expected to reshape negotiations between owners, general contractors, and subcontractors—balancing improved cash flow against heightened demands for financial security.
Originally reported by O'Melveny in OMM.
