REAL ESTATE NEWS

California?s construction industry has entered a new era with Senate Bill 61 (SB 61) taking effect, which imposes a mandatory 5% retention cap on most private construction contracts.

Signed by Governor Gavin Newsom in July 2025, the law took effect for contracts executed on or after Jan. 1. While public works projects in California have operated under a similar cap for more than a decade, the extension of this limit to private projects represents a significant structural change ? one that will meaningfully reshape cash flow, risk allocation and project management practices across the industry.

At its core, SB 61 prohibits owners, direct contractors and subcontractors from withholding more than 5% retention on private works of improvement, except in limited circumstances.

Retention, traditionally used as a financial safeguard to ensure satisfactory completion of work, has long been a point of tension between owners seeking protection and contractors seeking liquidity.

By standardizing the cap, the legislature aims to address what California State Senator Dave Cortese, who represents the 15th State Senate District (Silicon Valley/Santa Clara County), described in published remarks as ?chronic cash flow challenges caused by excessive retention withheld on privately financed projects.?

It?s noteworthy that SB 61 does not apply to most residential projects (unless they are mixed-use or exceed four stories), but terms like ?mixed-use? and ?residential? are not clearly defined in the statute, creating potential legal disputes. This uncertainty may require case-by-case interpretation or litigation.

?The new 5% retainage cap under Senate Bill 61 for private construction contracts in California represents a meaningful shift that improves cash flow for contractors and subcontractors while shifting more risk management to project owners and developers, according to Zachary Streit, founder and president with Priority Capital Advisory.

He told GlobeSt.com that for owners delivering large-scale capital programs like multifamily developments, data centers or advanced facilities, this change underscores the importance of creative structuring and strong alternative protections, such as robust performance bonds and broader lender relationships to maintain execution certainty from day one through completion.

Jay Maddox, principal of capital markets at Avison Young, told GlobeSt.com that to mitigate risks associated with lower retention, owner/developers may need to implement stricter performance monitoring, tighter milestone-based payment schedules and a reassessment of prequalification processes for contractors and subcontractors.

Who the Law Helps

The most immediate beneficiaries of SB 61 are contractors and subcontractors, particularly small and minority-owned firms. These businesses often operate with thin margins and limited access to working capital.

High retention rates?sometimes 10% or more?can tie up hundreds of thousands of dollars for months or even years, creating financial strain. By capping at 5%, SB 61 accelerates cash flow and reduces the need for short-term financing, which can be costly and difficult to secure.

Legal analysis from firms such as Stoel Rives emphasizes that the law ?fast-tracks payments? and aligns private-sector retention practices with public-sector norms, creating more predictable financial conditions for contractors. For subcontractors, who are often the last to be paid and the most vulnerable to upstream delays, the cap provides a measure of protection and stability.

Cutting this holdback to 5% gives these subcontractors additional liquidity to invest in tools, hire staff or take on additional work they may have previously been unable to pursue, according to Andrew Pollard, director of Turner & Townsend.

?In theory, this creates a healthier subcontractor pool and enables general contractors to complete projects with fewer cost-related disputes that often arise while subcontractors wait for retention to be released,? Pollard told GlobeSt.com.

Who the Law Hurts

While contractors gain liquidity, owners and developers may feel the downside. Retention has historically served as a risk-management tool, giving owners leverage to ensure timely and high-quality completion. A lower cap reduces that leverage.

Owners may respond by tightening other contract terms, increasing performance bond requirements or adopting more aggressive quality-control measures to compensate for the reduced financial buffer.

Some general contractors may also face challenges. Although they benefit from improved cash flow, flexibility is lost in negotiating retention with subcontractors. The uniform cap may limit their ability to manage performance risk across complex project scopes.

?On highly complex projects, the cost of completing corrections can potentially exceed the 5% held back, and contractors may simply choose to walk away, leaving owners in a difficult position,? Pollard said.

A Shift in Industry Dynamics

SB 61 represents a philosophical shift in California construction law, moving toward greater liquidity and fairness in the payment chain, even at the expense of traditional owner protections. King & Spalding notes that the law ?materially influences the structure and administration of construction contracts? and will require owners to rethink how they manage project risk.

Owners and developers need to respond in kind by applying greater oversight to project costs and closely monitoring payment applications to ensure cash out the door aligns with actual progress, Pollard said.

?Contracts should be reassessed to confirm compliance with new payment and retention requirements, and risk management practices updated accordingly,? Pollard added.

?Owners need to rethink their procurement standards and only bring on qualified contractors who can be trusted to deliver in this new environment. Lastly, project leaders need to refocus on day-to-day project controls and ensure documentation is delivered and maintained in accordance with contractual terms.?

Source: GlobeSt/ALM