When to Withhold Retention Payments on Private or Public Projects

By on August 24, 2018
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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.

Filed under Good Faith Dispute, Prompt Payment Laws, Uncategorized

Prompt Payment – What Do Owners and Generals Have the Right to Withhold?

By on July 21, 2017
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Under California Civil Code section 8814, if a direct contractor has withheld a retention from a subcontractor, the direct contractor must pay the subcontractor the retention amount within 10 days of receiving a retention payment, unless a “good faith dispute exists between the direct contractor and the subcontractor.” In turn, section 8818 provides that if an owner or direct contractor does not make retention payments as required by section 8814, then the owner or direct contractor is liable for a penalty of 2 percent per month on the amount wrongfully withheld.

So what then constitutes a “good faith dispute?” Under Martin Bros. Constr. Inc. v. Thompson Pacific (2009) 179 Cal.App.4th 1401, a “good faith dispute” for private projects included both contract price disputes and change order disputes; however, in East West Bank v. Rio Sch. Distr. (2015) 235 Cal.App.4th 742, the Court of Appeals held that a “good faith dispute” in a public project did not extend to disputes over change orders. Once the legitimate purpose for retaining the funds ends, the public entity must release the funds or suffer the statutory penalties.

Seems straightforward enough, right? On private projects, a good faith dispute means contract price disputes and change order disputes, on public projects it only means contract price disputes.

Enter United Riggers & Erectors v. Coast Iron & Steel, Co. (2015) 243 Cal.App.4th 151, which extends the East West Bank decision from the public works context to private projects. In the matter, Coast Iron withheld retention from United Riggers for claimed additional change order costs and damages related to mismanagement.  The trial court found in favor of Coast Iron, citing Martin Bros.; however, the Court of Appeals reversed, citing East West Bank, holding that allowing Coast Iron to withhold retention when there was no dispute that it was owed (under the contract) would “unduly increase the leverage of owners and primary contractors over smaller contractors and subcontractors by discouraging subcontractors from making legitimate claims for fear of delaying the retention payment.”

In March of last year, the California Supreme Court granted Coast Iron’s petition for review. Brief were submitted July 2016.

The take-away – The law, as it stands right now is: On private projects, a good faith dispute means contract price disputes and change order disputes, on public projects it only means contract price disputes. Of course, that may change once the Supreme Court rules on United Rigger. Stay tuned!

Filed under Good Faith Dispute, Prompt Payment Laws

California Prompt Payment Laws and the Non-Retroactivity of Retention Reduction

By on June 30, 2016
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Introduction

California’s prompt payment laws serve the important function of encouraging timely and orderly payment for work on construction projects. They impose statutory deadlines by which project owners must pay general contractors (who in turn must pay subcontractors and so on) or face exorbitant penalties. However, they have become increasingly confusing. Prompt payment statutes span the Business and Professions Code, Public Contracts Code, and Civil Code and their applicability varies depending on the type of project, the type of payment (i.e. progress payment or retention), and the identity of the payor (owner, public entity, direct contractor, etc.). As such, any opinions offering clarity to the interpretation of these statutes are welcomed with open arms.

Blois Construction, Inc. v. FCI/Fluor/Parsons (245 Cal.App.4th 1091) offers, albeit in a limited way, such clarity, particularly regarding retention payments. The decision is timely in an age where sophisticated commercial contractors negotiate for terms that reduce or eliminate retention amounts as projects near completion (the argument being that since costs decrease as completion approaches, and since owners can rely on the accumulation of previous retentions, additional security is unnecessary). Even the California State Legislature followed this retention-reduction trend by instituting a 5% cap on retention for public works projects.

Brief Summary of Public Contract Code §7107

Section 7107 of the Public Contract Code requires public entities to release retention proceeds to contractors within 60 days of completion of a project. Pub. Contract Code §7107(c). The original contractor must pay its subcontractor(s) their share of the retention received within seven days of receipt, or face penalties of 2% per month of the improperly withheld amount. Pub. Contract Code §7107(d) and (f).

Blois Construction Summary

In 2006, the Exposition Metro line Construction Authority (“Metro” or “owner”) contracted with defendant FCI/Fluor/Parsons (“FCI” or “general contractor”) to serve as general contractor of Metro’s light rail line (the “Project”). Id.at 1094. FCI contracted with plaintiff Blois Construction, Inc. (“BCI” or “sub-contractor”) to perform underground work. Id. Both the primary contract (between Metro and FCI) and the subcontract (between FCI and BCI) contained provisions allowing retention of 10% of payments owed to FCI and BCI respectively. Id. An additional provision in the primary contract allowed Metro to elect not to take further retentions from remaining progress payments after 50% of the work on the project had been completed, and if it determines that FCI’s work was satisfactory. Id.

Pursuant to FCI’s request, Expo stopped retaining portions of progress payments beginning in December 7, 2009. However, Expo held the retention funds that accumulated from prior progress payments. Id.

Over the course of the Project FCI withheld over $500,000 in retention. Id. BCI sued FCI, alleging non-payment for 1) extra work performed on the Project, and 2) withheld retentions. Id. FCI agreed to pay the full amount of withheld retentions, but disputed BCI’s entitlement to late payment penalties under Public Contract Code §7107(f). Id.at 1095.

The appellate court ruled that Metro’s decision to stop withholding future retentions did not equate to payments of past retentions under §7107. Id. Therefore, since FCI did not receive retention proceeds from Metro until 2014, months after paying BCI its retention amounts in full, BCI was not entitled to penalties under §7107(f). Id.at 1096.

The court reasoned that BCI wrongly interpreted “retention proceeds” to include any amount that Metro could withhold from FCI, regardless of whether it actually did so. Id. Such an interpretation contradicts the statutory language of §7107, which applies only to withheld payment amounts. Id. Since Metro stopped withholding retention from progress payments in late 2009 onward, §7107 did not apply to those payments. Id.

BCI argued that the court’s conclusion contradicted the statute’s purpose of ensuring timely payment by general contractors to subcontractors. Id. The court stated that §7107 and other prompt payment statutes merely ensure that subcontractors do not wait significantly longer than general contractors for their share of the proceeds. Id.at 1097. An interpretation supporting earlier payment would unfairly prejudice general contractors, who often wait years before receiving withheld retentions from owners. Id. When Metro ceased withholding retention, FCI began paying BCI the full amount to which it was entitled from each progress payment, without retaining any funds. At no point did FCI receive payments without distributing BCI’s share of the proceeds. Id. Since FCI’s payments were timely, BCI could not succeed on its claims for additional penalty amounts. Id.

Conclusion

The court’s ruling falls in line with the prompt payment laws’ intent to ensure orderly and time-appropriate payment, and applies its interpretation broadly, offering clarity to all prompt payment statutes. The judgment obviously favors all “upstream” contractors, and will likely stoke the trend towards retention-reduction. What then, is to be gleaned from this case? Namely, if general contractors (or other upstream contractors) seek to modify retention withholdings, they should clearly identify and record their payments as non-retention progress payments to avoid confusion and dispute.

Filed under Prompt Payment Laws, Public Contract Code § 7107