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Owners, developers, and lenders take note: moving forward, you will need to scrutinize the inclusion of retainage in your construction contracts. For projects with a contract value of $2 million or more, owners must deposit any amounts held back from progress payments into an escrow account. While a version of this requirement has been on the books for decades, participants in construction projects have generally ignored it. Effective as of June 27, 2025, the Kentucky General Assembly put an end to this practice.
Retainage is a common risk mitigation tool on construction projects. As monthly progress payments come due to the contractor, the owner holds back, or retains, a percentage of each payment. The balance of this retainage accrues over the course of the project and incentivizes the contractor to properly complete its work. Released upon satisfactory completion of the project, the withheld funds provide a powerful protection to the owner.
Conversely, retainage imposes a significant burden on the contractor and its subcontractors. Effectively, these entities are forced to finance a portion of the project until the owner releases the reserved funds. If the relationship between owner and contractor sours, a truculent owner can force the builder to chase money properly earned through years of costly litigation. Worse, if the owner enters bankruptcy, the contractor may never recover expenses it incurred to improve the owner's property.
Kentucky's General Assembly passed the Kentucky Fairness in Construction Act to "level the playing field between contractors and owners." Louisville and Jefferson Cnty. Metro. Sewer Dist. v. T+C Contracting, Inc., 570 S.W.3d 551, 558 (Ky. 2018). The Act legislates several aspects of the owner-contractor relationship, including establishing limitations on retainage. Id. Before a construction project is 50% complete, retainage is capped at 10% of the amount of any undisputed payment due. KRS 371.410(1). Once 51% of a project is finished, retainage held "shall not be more than 5% of the total contract amount." Id. If any retainage due under the statute is not paid on time, the owner must pay the contractor interest at a rate of 12% per year. Id. 371.410(3).
Likewise, in 1990, the General Assembly sought to protect contractors from the harsh consequence of losing retainage through bankruptcy of the owner. KRS 371.160(1) requires owners of large, private projects to place retainage in an escrow account. The deposited funds "become the sole and separate property of the contractor to whom they are owed." KRS 371.160(2). That statement may prove critical if the owner becomes insolvent. Federal law gives bankruptcy trustees immense power, but state law determines the existence of property rights. Butner v. United States, 440 U.S. 48, 54–55 (1979). While untested, KRS 371.160(2) may provide contractors with a powerful tool in a variety of bankruptcy scenarios.
Due to recent amendments by the General Assembly, KRS 371.160 now provides additional benefits to contractors. Retainage must be deposited into an interest bearing escrow account, and all interest earned on the escrowed funds must be paid to the contractor. KRS 371.160(2)–(3). If an owner refuses to release escrowed funds upon completion of the contract, the statute allows Kentucky courts to order release of the funds to the contractor. KRS 371.160(6). As of June 27, 2025, these requirements apply to any construction contract valued at $2 million or more.
For years, owners (and contractors) have either ignored this rule or avoided it by including waivers of the escrow requirement in construction contracts. But this practice is no longer permissible under Kentucky law. KRS 371.405(2)(c) now renders any provision void and unenforceable "that purports to waive, release, or extinguish" the escrow requirements in KRS 371.160. Accordingly, moving forward, owners of private projects with a contract value of $2 million or more must deposit all retainage into an appropriate escrow account, and all interest earned on the escrowed funds must be paid to the contractor upon final completion of the project.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
