By: Micaela L. Neal

United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., No. S231549, 2018 WL 2188916 (Cal. May 14, 2018)

The pressure on California contractors to make “prompt payment” to their subcontractors – or else face penalties – has increased following the California Supreme Court’s recent decision narrowing the meaning of “good faith dispute.”

Civil Code Section 8814 provides that where a direct contractor withholds retention from a subcontractor, the direct contractor must, within 10 days after receiving all or part of a retention payment, pay to the subcontractor its share of the payment.  If payment is not made in the time required, the contractor is liable for a penalty of two (2) percent per month on the amount wrongfully withheld. (Civil Code Section 8818.)  Moreover, if the subcontractor brings a legal action to collect the amount wrongfully withheld, the prevailing party is entitled to costs and attorneys’ fees.

However, Section 8814 also provides an exception: “If a good faith dispute exists between the direct contractor and a subcontractor, the direct contactor may withhold from the retention to the subcontractor an amount not in excess of 150 percent of the estimated value of the disputed amount.” This portion of the statute has long been relied on by contractors as justification to withhold payment from subcontractors when anydispute related to the project arises.  The term “good faith dispute” has been applied broadly, and has enabled contractors to avoid paying penalties, attorneys’ fees and costs, so long as they could argue that some sort of dispute existed justifying the withholding. This broad construction has had the effect of protecting contractors, and providing them negotiation leverage in disputes with their trades.

The California Supreme Court dealt a blow to this practice by holding that the exception to prompt payment only applies where there is a good faith dispute directly relevant to the specific payment that would otherwise be due – notwhen there is anydispute between the contractor and subcontractor.

The Court’s narrow construction of the term “good faith dispute” means that a contractor may only withhold payment where there is a dispute regarding a statutory or contractual precondition for the specific payment being withheld – for example, if the specific construction work for which that payment is due was not done, was done inadequately, when payment would result in the subcontractor receiving more than the minimum amount agreed upon, or where third party liens or demands raise the risk of potential double payment. In contrast, the payment may not be withheld if the controversy between the contractor and subcontractor relates to different work or where the dispute relates to extra work or additional payments beyond that already agreed as owed.  For example, in the Coast Ironcase, the Court held that the contractor could not withhold payment of retention to the subcontractor due to a dispute related to extra work claims by the subcontractor due to mismanagement of the project.

The Court reasoned that a narrow construction of “good faith” is consistent with the what the Legislature intended by enacting the prompt payment statute, and noted that “timely payments are essential to enable direct contractors and subcontractors to maintain an adequate cash flow and make payments to the subcontractors, suppliers, and workers they owe.”  The Court also noted that the prompt payment statutes are “intended to discourage owners and direct contractors from withholding monies owed as a way of granting themselves interest-free loans,” while still allowing contractors to “withhold amounts as security when the obligation to pay those specific monies is in doubt.”

The Court’s decision brings the “prompt payment” law applicable to contractor payments to subcontractors in line with that applicable to owner payments to direct contractors.  Unlike Section 8814, Section 8812, pertaining to prompt payment by an owner to a direct contractor, already requires that the “good faith dispute” between the owner and direct contractor be “as to a retention payment due.”

The take-away from this case for owners and direct contractors alike is that “good faith disputes” will be scrutinized more closely going forward, and retention payments should only be withheld where the dispute is specific to the payment in question.  Whether withholding is appropriate must be determined on a case-by-case basis, and both project owners and direct contractors are encouraged to seek legal counsel prior to withholding payment.

Micaela Neal is an attorney with Wanger Jones Helsley PC and practices in Fresno and Sacramento.  She regularly represents owners, prime contractors, and subcontractors in disputes over public and private works of improvement.  This article is intended to notify our clients and friends of changes and updates to the law and provide general information. It is not intended, nor should it be used, as legal advice, and it does not create an attorney-client relationship between the author and the reader.