California’s New 5% Retention Cap for Private Construction Contracts Takes Effect in 2026: What Contractors and Owners Need to Know

Starting January 1, 2026, a new California law will cut the maximum retention withheld from private construction contracts to just 5%, down from the current industry norm of 10%. This change, which is due to Senate Bill No. 61 (SB 61), aligns private contract rules with those already in place for public works projects. While the move is designed to ease cash flow for contractors and subcontractors—especially small businesses—it is expected to shift financial risks to project owners, who may respond by requiring new forms of security. If you are involved in private construction projects in California, understanding SB 61’s details and preparing for its impact are essential.

Key Takeaways:

• New limits to retention: SB 61 limits retention on most new private construction contracts to a maximum of 5% of each progress payment and the total contract price, effective January 1, 2026.
• New timeline and revised exceptions: The law is not waivable and applies to contracts entered after the effective date, with exceptions for certain residential projects and contracts where required bonds are not provided.
• Additional forms of security will be requested: Owners and general contractors will likely demand more performance and payment bonds, letters of credit, or other forms of security to offset reduced retention.
• Benefits and drawbacks to be considered: The new rule aims to improve contractor cash flow and support small businesses, but may increase overall project costs due to added security requirements.
• Contracts and other legal issues need to be considered: Stakeholders should update contract language and security protocols to comply with SB 61, with legal guidance recommended for navigating the changes.

I. Retention Historically in California

Retention, a common risk management tool in construction contracts, occurs when owners and direct contractors withhold a percentage of each progress payment owed under a construction contract until the project reaches final completion. Once any defects, liens and other post-substantial completion issues have been resolved and final completion occurs, the retained amount is then disbursed as final payment. Until now, California only regulated the permissible amount of retention for public works contracts, setting a 10% limit in 1993, and lowering it to 5% in 2011. (See, California Public Contract Code Section 7201.) But the new law, Senate Bill No. 61 (SB 61), applies to most private construction contracts. 

II. Changes to Retention for Private Contracts

The new law’s key features are as follows:

• The maximum retention held by owners, direct contractors, or subcontractors cannot exceed 5% of a given progress payment.
• The overall amount held in retention cannot exceed 5% of the total contract price.
• If the prime contract (i.e., the contract where the owner is a party) calls for a lower retention limit, no related subcontract can exceed that limit. For example, if the prime contract provides for 4% retention, related subcontracts must have retention of 4% or less.
• SB 61’s limits on retention cannot be waived, even by the parties’ agreement.
• Reasonable attorneys’; fees may be awarded to the prevailing party for any violations of the new law. 

SB 61 applies to all new private construction contracts, with only two exceptions. 

• First, it does not limit retention for residential-only projects (non-mixed use) that are four stories or fewer. So, contracts to build a typical, single-family residence, for example, would be exempt.
• Second, SB 61 does not apply when the direct contractor or subcontractor, with advanced written notice, requires a performance and payment bond and the other contracting party fails to provide that bond.

Acknowledging that many projects in the private construction industry occur in multiple phases, where pre-construction and construction may be covered by the same prime contract, or separately, where task orders may be subsequently issued under a prime contract—some may consider how SB 61 will apply to contracts made prior to January 1, 2026, when their subsequent phases or orders may occur after January 1, 2026. The new law’s retention requirements only apply to contracts entered into after January 1, 2026, indicating that all contracts or agreements made prior to the new year will not be subject to the 5% limitation on retention. However, task orders or subsequent agreements made between owners, contractors, or subcontractors made after January 1st will be subject to SB 61’s requirements.

SB 61 received strong support from contractors and many construction industry groups. Supporters say the bill will improve contractor cash flow, reduce dependence on lines of credit, and create consistent retention policies for both public and private projects. The law is expected especially to benefit small businesses and union contractors that have limited access to capital. But limiting the retention cap will shift the financial burden onto owners and general contractors. 

III. Likely Impact of the New Framework

As SB 61’s retention requirements mirror existing requirements for public works contracts, that market offers hints for how SB 61 will impact the private construction sector.

With permitted retention cut to 5% from the customary 10%, owners and others issuing contracts will likely seek additional security to offset the protection that higher retention previously provided. This may mean requiring contractors and subcontractors to provide performance and payment bonds--often backed by sureties--or other forms of security.

As with larger public works projects, owners of larger or more complex private projects might require multiple forms of security. Common security options include letters of credit backed by banks, performance and payment bonds, and guarantees from a parent company. Letters of credit and performance bonds are particularly useful because they offer liquidity and quick access to capital.

Although these additional protections can be costly and add to overall project expenses, we expect them to become more common in the future as the alternative is for owners and other contract-issuers to shoulder the risk of non-performance by themselves. Also, given SB 61’s bond-related exemption for direct contractors and subcontractors, we expect that demands for such bonds will become much more common in bid solicitations for future downstream contracts.

IV. Recommendations

To comply with SB 61, we recommend updating contract language to reflect the new 5% retention cap for agreements signed after January 1, 2026, and adopting multiple security requirements, particularly performance bonds, similar to those used in the public sector. Our firm’s project development and real estate attorneys are primed to support owners as they traverse the impact of SB 61 in the construction industry through the coming year. 

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Peter Breckheimer, an O’Melveny partner licensed to practice law in California; Andrew Weisberg, an O’Melveny counsel licensed to practice law in California; and Daniel W. Leal, an O’Melveny associate licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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