Many jobs go without a hitch, and small problems are usually resolved peacefully through negotiation. However, if unresolved problems remain at the end of the job, final payment can become a contentious issue. It is important to have some financial leverage at the end of job to help motivate the contractor to take care of any loose ends, and to do it promptly. In fact some contracts have a liquidated damages clause specifying financial penalties for missing the contracted completion date.
SUBSTANTIAL COMPLETION
Most contracts require full payment for the job, minus any money held back for punch list items, at substantial completion or at the issuance of a Certificate of Occupancy (CO). Substantial completion means that the project is complete and usable, except for a few minor loose ends. When the job has reached the point of substantial completion, but before the final check is cut, the owner and contractor do a formal “walk-through” of the project. Together, they compile a punch list, noting any loose ends that need to be resolved before the owner accepts the work as complete.
I would recommend that you tie your last big payment to both substantial completion and to the owner receiving a certificate of occupancy (CO). Substantial completion has a legal definition. It means that the project is complete enough that it can be used as intended. That still leaves room for disagreement, but if all parties are reasonable, there should not be a problem. And having the certificate of occupancy is required to legally move in, so you want that nailed down before releasing payment. In general the CO is issued to the builder or entity that applied for the building permit. Before you agree to hand over the last big check, make sure that the hold-back is enough to cover any unfinished work, which should be documented on a written punch list that both parties agree to.
RETENTION
If you are working with a bank or an architect (using an AIA contract), there will be language holding back 5% to 10% of the cost of the job until it is “substantially complete.” This amount, called retainage gives you leverage toward the end of the job, when the contractor may be more focused on starting the next job than finishing yours. At substantial completion, you should still retain an amount equal to twice the cost of completing the punch list. Whatever amount of retainage is agreed to is deducted proportionately from each draw. For example, for a 5% retainage, each draw would be reduced by 5%.
If the contract does not specify any retainage, make sure that the last check is not due until substantial completion, and that you reserve the right to retain funds (hold-back) to cover all punch list items. Regardless of the specific contract language, if the job is nearly done and the contractor is anxious to get the final check, you should negotiate a partial payment, making it clear that you will pay the rest when the punch list items are completed. The standard hold-back amount is about twice the value of the punch list items.
How much retainage? Retainage is typically in the 5% to 10% range, although some contractors will negotiate for a fixed fee or limit. It’s hard to generalize, but in my opinion, 10% works well on smaller jobs up to, say ₹100,000, while 5% is probably adequate on larger jobs. It’s important to have a little leverage at the end of the job when the contractor’s focus is usually on the next job and it’s easy to let things drag on. Once you release the final large payment, you should still retain a small “hold-back” of at least twice the value of any remaining punch list work — enough to get another contractor to complete the job if necessary.
THE PUNCH LIST
Upon substantial completion, but before you release the final large check (or retainage, if specified in the contract), you and the contractor should do a walk-through to identify any loose ends that need to be tied up. The final walk-though and “punch list” procedure should be spelled out in the contract.
It’s a rare job that has no loose ends: a special-order fixture that has not arrived, a missing moulding, a gap in the woodwork, a cracked tile, torn screen, sticking window or door, and so on. All these items are noted on a written punch list jointly developed by the contractor and owner (or owner’s representative).
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