When to Withhold Retention Payments on Private or Public Projects

To ensure that construction contractors and subcontractors receive timely progress and retention payments, the California Legislature enacted statutes that impose deadlines and penalties on owners and direct (general) contractors who delay payments. (Cal. Civ. Code, §§ 8800, 8802, 8812, 8814; Pub. Contract Code, §§ 7107, 10262.5; Bus. & Prof. Code, § 7108.5.) However, there is an exception to these deadlines and penalties on both private and public projects. The exception allows an owner or direct contractor to withhold payment¹ when there is a good faith dispute between an owner and a direct contractor or between a direct contractor and a subcontractor. (Civ. Code, §§ 8800, subd. (b), 8802, subd. (b), 8812, subd. (c), 8814, subd. (c); Pub. Contract Code, §§ 7107, subds. (c), (e), 10262.5, subd. (a); Bus. & Prof. Code, § 7108.5, subd. (a).)

But the term “good faith dispute” has been a source of confusion where direct contractors owe subcontractors retention payments, but want to withhold the payment because of a dispute.² California appellate courts were split, with one court finding that any type of bona fide dispute justified withholding, and another finding that only disputes related to the payment itself justified withholding. (Compare Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc. (2009) 179 Cal.App.4th 1401 [any bona fide dispute could justify withholding] with East West Bank v. Rio School Dist. (2015) 235 Cal.App.4th 742 [disputes related to the payment itself may justify withholding].) In May 2018, the California Supreme Court clarified that for a direct contractor to withhold a retention payment on a private project, the good faith dispute must somehow relate to the payment itself. (United Riggers & Erectors, Inc. v. Coast Iron & Steel Co. (2018) 4 Cal.5th 1082, 1097-1098.)

In United Riggers, a direct contractor and subcontractor disputed the total amount owed to the subcontractor for a project. (United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., supra, 4 Cal.5th at p. 1086.). The subcontractor demanded roughly $350,000 more than the amount authorized by the contract and approved change orders because the direct contractor allegedly mismanaged the project. (Ibid.) When the project owner eventually released the final retention amount, the direct contractor refused to provide the subcontractor with its share of the retention even though the retention payment itself was undisputed. (Ibid.) The subcontractor sued for the late retention payment and for mismanagement of the project. (Ibid.) At trial, the direct contractor prevailed on all claims. The appellate court, however, reversed on the issue of the late retention payment, and the Supreme Court affirmed. (Id. at pp. 1086-1087.)

Although the direct contractor admitted it did not timely pay the subcontractor the retention amount, it claimed that the “good faith dispute” exception under Civil Code section 8814 justified the delay. (United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., supra, 4 Cal.5th at p. 1089.) Section 8814 requires that on private projects, direct contractors pay subcontractors retention payments within 10 days after receiving them from owners unless a good faith dispute exists between a direct contractor and a subcontractor. (Civ. Code, 8814, subds. (a), (c).) The direct contractor argued that because there had been an ongoing dispute about the direct contractor’s alleged mismanagement of the project and the total amount owed to the subcontractor when the direct contractor withheld the retention payment, the withholding had been justified. (United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., supra, 4 Cal.5th at p. 1089.) The subcontractor responded that because the dispute about the direct contractor’s alleged mismanagement of the project and the total amount owed did not directly relate to the retention payment—an amount that was undisputed—the direct contractor had not been justified in withholding it. (See ibid.)

After comparing Section 8814 to other prompt payment statutes and analyzing the legislative history of those statutes, the Supreme Court concluded that Section 8814 permitted retention withholding only where disputes concerned the retention payments themselves. (Id. at pp. 1092-1093, 1097-1098.) The Supreme Court emphasized that this would further the purpose of the prompt payment statutes to ensure timely payment of undisputed amounts, without undercutting contractors’ rights to withhold disputed amounts. (Id. at p. 1097.) Thus, where direct contractors owe retention payments to subcontractors on private projects, direct contractors may withhold retention amounts only where there are good faith disputes relating to those particular payments. (Ibid.)

Notably, although the Supreme Court’s holding concerned Section 8814, which applies only to private projects, the Supreme Court’s holding and reasoning also likely apply where direct contractors owe subcontractors retention payments on public projects. First, the Supreme Court indicated that generally legislators can reasonably anticipate that courts will accord the prompt payment statutes with a common construction. (United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., supra, 4 Cal.5th at p. 1090.) Moreover, the Supreme Court specifically overruled the appellate opinion Martin Brothers Construction, which held that Public Contract Code section 7107 allowed direct contractors to withhold retention proceeds from subcontractors on public projects for any kind of dispute, to the extent Martin Brothers Construction was inconsistent with United Riggers & Erectors. (Id. at pp. 1095-1098.) In doing so, the Supreme Court noted that the opposite twin to the Martin Brothers Construction case, East West Bank, which held that section 7107 did not permit withholding for any kind of dispute, rested upon sound reasoning. (Id. at p. 1096.) Thus, most likely, direct contractors must timely pay retention amounts to subcontractors in the absence of a good faith dispute regarding those particular retention amounts, regardless of whether a project is public or private. (See id. at pp. 1095-1098.)
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¹ The statutes authorize an owner or direct contractor to withhold up to 150 percent of the amount in controversy.
² Most of the prompt payment statutes clarify that a good faith dispute must involve a dispute over the specific payment due. But Civil Code section 8814, relating to retention payments from a direct contractor to subcontractor on a private project, and Public Contract Code section 7107, relating to retention payments from a direct contractor to subcontractor on a public project, do not contain express language limiting the good faith dispute to a dispute over the payment due.