Kentucky received $2.4 billion from the American Rescue Plan Act of 2021 ("ARP"), recently signed into law by President Biden. [1] The state will appropriate a substantial portion of these funds to infrastructure and construction. Already $250 million has been appropriated for upgrading water and wastewater treatment facilities, $127 million to renovate or replace school facilities and $53 million for renovations at the Kentucky State Capitol. [2]
Additionally, private sector investment is ramping up as the COVID-19 pandemic nears an end. Numerous developments and capital projects are in the planning and design phase or have broken ground. The red-hot housing market has left the United States 4 million homes short of buyer demand, driving a boom in residential development. [3]
This mix of public and private construction projects is fueling what could be a record-setting period for the construction industry. Those taking on projects in Kentucky must be versed in the requirements of the Kentucky Fairness in Construction Act. This publication is a primer on the Kentucky Fairness in Construction Act.
The Act
The Kentucky Fairness in Construction Act of 2007 (the “Act”) has four significant impacts. First, it bars some provisions common in construction contracts. Second, it governs when and how parties to a construction contract pay one another. Third, it regulates retainage. Fourth, it penalizes violators of the Act, by taxing that party with interest, costs and attorney’s fees.
A. Barred Contract Provisions
Three contract provisions are barred by the Act. [4] First, a contract may not waive a party’s right to resolve disputes through litigation. [5] Second, a contract may not waive or release lien rights under KRS Chapter 376, except for partial waivers for progress payments. Third, a contract may not waive damages for delay.[6] If a contract term violates the requirements of the Act, the terms of that contract which do not violate the Act are enforceable, with those invalid portions of the contract being severed. [7]
B. Payment Requirements
The Act imposes payment requirements on when owners must pay a contractor, and when a contractor must pay their subcontractors. [8] Owners must pay a contractor undisputed amounts owed within thirty business days after receiving a payment request. [9] A contractor must pay its downstream subcontractors within fifteen business days of receipt of payment from the owner.
C. Retainage
“Retainage” means money earned by a contractor or subcontractor but withheld to ensure proper performance by the contractor or subcontractor and that shall be paid upon completion of contractual obligations. [10] Nearly every construction contract has a retainage withholding. The Act limits retainage at different phases of construction.
i. Retainage Limits
The Act imposes different retainage limits for each of three phases of construction. Until the project is 51% complete, the owner or contractor can only withhold 10% of the “undisputed amount due.” [11] After the project is 51% complete, the owner or contractor can withhold 5% of the “total contract amount.” [12] After substantial completion, the owner or contractor can withhold 200% of the balance of the “contractually obligated . . . work remaining.” [13] A visual summary is below:
ii. Retainage & Material Costs
A common practice on public projects is for the owner to provide materials to downstream parties. This allows the owner to avoid sales tax on materials. Some owners calculate retainage based on the value of materials even if those materials are not included in the contract sum. The language of the Act makes clear retainage should not include the value of those materials provided by the owner.
A plain language reading of these retainage provisions in the Act requires any materials purchased by the owner be excluded from the retainage calculation, because those materials are not part of the “amount” of the contract. The text of the Act indicates retainage should never include amounts for materials purchased directly by the owner or upstream party, which are not amounts due under the downstream party’s contract.
D. Penalties for Violating the Act
There are two steep penalties imposed for violating the Act. First, when a party fails to make payments or release retainage in accordance with the terms of the Act, 12% annual interest automatically begins to accrue on that amount due, from the time it became due. [14] Second, when a party prevails on an action to enforce their rights under the Act, including through arbitration, they are entitled to recover costs and fees if the losing party acted in bad faith.
Conclusion
The Kentucky Fairness in Construction Act applies to all construction contracts in the Commonwealth of Kentucky. [15] Contracting parties within the Commonwealth must be well versed with its requirements. The Act imposes regulations on contracting parties, including when and how payments and retainage must be released. Therefore, contracting parties should ensure they are compliant with the Act to avoid exposure to an assessment of interest, costs and attorney’s fees.
