The State of Minnesota and other public entities such as cities, counties and school districts, enter into many large contracts with private contractors to perform services and provide goods to the public entities. Typically, in large contracts, the contractor is entitled to receive progress payments during the term of the contract; that is, the contractor may receive partial payments along the way rather than receiving the entire payment at the end of the contract. Progress payments are usually necessary where performance of the contract will require a relatively long period of time.

M.S. 15.72 allows a public contracting agency to reserve as retainage an amount not to exceed five percent of any such progress payment. The rationale for such retainage is that the public agency is somewhat protected (to the extent of 5% of the payment) in the event the work for which it is paying is unsatisfactory. Under some circumstances, the law allows the contractor to use an alternate form of retainage rather than the cash reserve assumed in M.S. 15.72 referred to above. See the discussion below about Alternate Forms of Retainage.

M.S. 15.73 allows a contractor to deposit bonds or securities with a contracting agency in lieu of the cash retainage referred to above. The statute further states that the "bonds and securities deposited or acquired in lieu of retainage...shall be of a character approved by the Treasury Division, including but not limited to:

            (a) Bills, certificates, notes or bonds of the United States;

            (b) Other obligations of the United States or its agencies;

            (c) Obligations of any corporation wholly owned by the federal government; or

            (d) Indebtedness of the Federal National Mortgage Association.

The Treasury Division has approved only those alternate forms of retainage referred to in the statute above. (M.S. 15.73), and only when they are deposited directly with the public entity. The Treasury Division is frequently asked to approve an arrangement whereby bonds and securities such as those referred to in the statute are deposited with a third party (such as a bank) rather than being deposited with the public entity. The Treasury Division has not approved such agreements because, if necessary, attempts to obtain possession of the bonds and securities could require legal action against the third party. By its nature, retainage should be immediately available to the public entity if contracting work is not performed satisfactorily.