Rethinking risk: navigating California’s new 5% retention cap

California has introduced a new law limiting construction project retainers to 5%. This change may seem small, but it hugely impacts how owners delivering major capital programmes manage risk. Now’s the time to explore better ways to safeguard investments from beginning to end.

On 1 January 2026, a new law in California took effect. Its design is simple: the amount of money held back on private construction contracts, known as retainage, is capped at 5%. This cap applies to nearly every contract, from the main contractor down to the smallest subcontractor. 

To those familiar with public sector projects, this might look like a simple alignment with existing practice. But for private-sector owners delivering major capital programmes, such as new campuses, data centres and advanced manufacturing facilities, it’s a big deal. This change marks a structural shift in risk, overturning a long-established industry practice. 

A new norm for construction 

Retention has always been more than just a delayed payment. It’s a legacy practice to safeguard owners against project risks. This financial buffer ensured that corrections were made and paperwork finalised as projects moved toward completion.  

At 10%, that buffer carried meaningful weight for everyone involved. At 5%, the holdback is now too slim to reliably ensure everyone participates in good faith as the project wraps up. 

For owners with projects in California, the leverage once provided by retention must now be rebuilt. This means you’ll need tighter contracts, clearer milestones and stricter day-to-day controls. 

“The construction sector will adapt quickly to this update.” 

Contractors will likely adjust budgets to get more cash upfront. With stronger prompt payment rules, they’ll push for faster approval on payment applications and change orders. With less retainage at stake, a contractor’s willingness to negotiate on a low margin project diminishes.  

In some situations, a contractor might find it more economical to simply cut their losses and walk away from the retainage if a more profitable job is available. 

The cash implications are immediate. When payment schedules are frontloaded, more of your capital is spent earlier. This makes it harder to verify progress in the early stages when there are fewer physical assets to show for the spend.   

If your project is underperforming, you may find yourself overextended while holding less money to protect against defects and incomplete work at the end. 

How can you mitigate these financial risks and ensure your project stays on track while protecting your investments? 

Shifting focus to insurers 

The obvious response might seem to be buying more insurance. We expect owners will seek higher performance and payment bonds, stronger letters of credit and other forms of guarantees.  

These tools are useful, but none are as clear or as well understood as retention.  

“Bonds cost money and can take time.” 

Making a claim is a methodical process that can be expensive to pursue legally. Letters of credit offer speed but tie up capacity and can lead to extra costs being passed to you.  

A blanket approach of just ‘more bonding’ risks adding cost without restoring the leverage that owners need during the crucial stages of installation, testing and closeout. 

Rethinking governance and risk management 

Instead of relying on a simple retainage figure, you’ll need even greater precision in your organisational and project management. Earned value assessments, which measure project performance, should be surgical.  

Your contracts should include payment milestones with objective criteria that are small enough to measure accurately.  

The usual documents that lag at the end of a project must be handled differently. Items like operations and maintenance manuals, training records and warranties must be signed, sealed and delivered on time.  

“Instead of a single final payment at closeout, consider spreading the last 5% across various deliverables during commissioning to maintain your leverage.”  

Your commercial structure deserves the same level of attention. Project packages should be designed to match the contractor’s capacity and you should prequalify contractors with greater scrutiny.  

Ask for evidence of their working capital, bonding capacity and control over key suppliers and supply chains. For deposits and offsite stored materials, clear rules need to be set and enforced. 

Your project governance must also keep pace. Document all your meetings, directives and field decisions in real time. Bring change control forward: preapprove pricing for commodities and escalation, define thresholds for rapid approvals, and insist on cost visibility when early funding is requested.  

Also, make sure your contracts include audit rights and that your contractor maintains an open book policy for all billed expenses. 

Creating a proportional response 

As contractors adapt, owners should respond in kind. Pay closer attention to the usual suspects: excessive mobilisation costs, inflated labour rates and vague allowances that turn into contingency funds.  

Your contract should set caps on mobilisation that reflect real startup costs and request evidence for deposits so you can enforce claw backs when schedules slip.

“Where early payments are justified, pair them with proportionate security.”    

This could be a letter of credit that expires upon delivery or completion of specific milestones, not at an arbitrary date. 

Incentives matter, but they must be tied to outcomes that demonstrate a project is truly ready. 

If your business depends on uptime or energy performance, link a portion of final compensation to those metrics for a suitable start-up period. Liquidated damages or predetermined fines for delays may take a more prominent role in this new reality. 

Adapting to new risk realities 

California’s goal of improving liquidity for contractors is understandable, but it shouldn’t come at the expense of owners’ leverage. But unless you act, it will. Here’s what you can do now: 

• Refresh your contracts: update them to reflect the new legal requirements, flowdown obligations and documentation standards.
• Adopt targeted risk management: match security instruments such as bonds or letters of credit to specific risks. Use them sparingly and only when needed to maintain their effectiveness.
• Rethink procurement: invite competition from firms that meet tighter prequalification standards.
• Build your compliance infrastructure: put systems in place to track deadlines, verify earned value and maintain clear project records. 

Owners who redesign their commercial approach will keep control without writing bigger checks for lower protection. Those who don’t will learn the hard way - that a smaller holdback can create a much larger risk.