California has long-standing prompt payment laws that require owners to pay contractors promptly and for contractors to pay subcontractors promptly. Under the various prompt payment laws, an owner has a specified period of time to make payments to a prime contractor and a prime contractor has a specified amount of time to make a payment to a subcontractor after the prime contractor receives payment from an owner. Failure to abide by these laws was supposed to impose stiff penalties on a violator and also provide an the claimant an award of its attorney fees against the violator. However the laws also state that an owner or prime contractor will not be found in violation for holding back from a payment 150% of an amount that is subject to a good faith dispute. While this may seem straight forward, applying the concept has taken two paths through our court systems.
Many years ago, one a California Court of Appeals had to decide a case (called Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc.) where a prime contractor had been paid its retention from a public entity owner, but did not then pay the retention that was owed to its subcontractor.
Under the Public Contract Code, a prime contractor must pay a subcontractor’s retention “within seven days from the time that all or any portion of the retention proceeds are received by the [prime] contractor… .” However, the Public Contract Code (and other prompt payment statutes) has an exception that allows the prime contractor to withhold retention from a subcontractor if a “bona fide” dispute exists between the subcontractor and the prime contractor, up to “150 percent of the estimated value of the disputed amount.”
In the Martin Brothers case, the subcontractor had made a claim for unpaid change orders, but there was no dispute as to the value of the retention that was owed to the subcontractor.
The appellate court in the Martin Brothers case decided against subcontractors finding that that a good faith dispute about any payment could be used as a reason for the prime contractor to not pay the subcontractor its retention even when the amount of retention itself is not in dispute.
As example of the result of this would be as follows:
In a project where the owner has released retention to the prime contractor, and the subcontractor and prime contractor both agree that the subcontractor is owed $100,000 in retention, the prime contractor could legally hold back the all of the subcontractor’s retention if the subcontractor had made a claim for extras for $70,000 that the prime contractor does not agree with. This is because the court in the Martin Brothers case ruled that the prime contractor could hold back up to 150% of the amount in dispute for extras against the undisputed amount owed for retention. Thus, not only would the subcontractor have to finance $70,000 in extras until that dispute is resolved, but also, the subcontractor would be out another $100,000 of undisputed retention, for a total of $170,000, just because the subcontractor made a claim for the extras. This is clearly an unjust result.
Six years after the ruling in the Martin Brothers case, a different California Court of Appeals disagreed with that ruling. In a case called East West Bank v. Rio School District, the Court of Appeals ruled that, under the prompt payment laws, a payment could only be withheld if the good faith dispute exited as to that specific payment. Thus, where the dispute concerns work unrelated to the payment that is owed, or involves disputed change orders, then those disputes cannot be used as a basis for not paying the undisputed payment.
The two opposite rulings of the Courts of Appeal prompted the California Supreme Court to review the issue of the “150% bona fide dispute” exception to the prompt payment laws. In May of 2018, in a case known as United Riggers & Erectors v. Coast Iron & Steel Co., the Supreme Court framed the issue as follows: “What we must decide is whether this exception allows withhold when there is any dispute between the parties, or only when there is a dispute directly relevant to the specific payment that would otherwise be due.”
After reviewing the history of what the Legislature recognized as “industry-wide problems” related to slow payment, and the Legislature’s wording related to bone fide disputes, the Supreme Court ruled that payment can be withheld only when the dispute is directly relevant to the payment being held. Specifically the Supreme Court listed the following as times when a prime contractor may delay payment up to 150% of the value of the dispute:
1. When the sufficiency of the subcontractor’s construction-related performance is the subject of a good faith dispute;
2. When liens or other demands from third parties expose the prime contractor to potential double payment, or
3. When payment would result in the subcontractor receiving more than the minimum amount both sides agree is due.
What a prime contractor cannot do is hold retention just because a dispute has arisen over whether the subcontractor is owed amounts over and above the retention that is owed. Also, the Supreme Court has made it clear that the payor (whether it be an owner or a contractor) “must be able to present a good faith argument for why all or part of the withheld monies themselves are no longer due.”
This means that owners and contractors should not be allowed to play games with payments – they must promptly make the payment that is due if there is no good faith dispute directly affecting that particular payment.