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Avoiding Prompt Payment Penalties Just Got A Little Harder

April 18, 2016

by Wahid Guirguis

Typically, the law treats the failure to pay as a straight-forward breach of contract. But to prevent contractors and subcontractors from becoming the unwitting financiers of construction projects, California enacted a series of laws known as the Prompt Payment Statutes. The Prompt Payment Statutes allow contractors and subcontractors to recover monetary penalties for untimely payments. To counterbalance any inequity, the Prompt Payment Statutes provide a safe harbor for owners or contractors to avoid prompt payment penalties where there is a good faith dispute by allowing them to withhold 150 percent of the “disputed” amount.

Until recently, the controlling case law interpreted the safe harbor provision to allow an owner or contractor with a good faith dispute to withhold payments without regard to the nature of the payment dispute. In short, so long as the payment dispute was made in good faith and the withholding did not exceed 150 percent of the disputed amount, it did not matter whether the dispute related to a progress payment or retention or both or neither. As such, contractors and subcontractors often would not be paid amounts indisputably owed to them while pursuing their other rights.

Recently, however, the court of appeal in United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., 243 Cal. App. 4th 151 (2015), followed a growing trend to narrow this safe harbor exception. In United Riggers, United, a subcontractor, sued the general contractor, Coast, seeking payment for unpaid change orders, impact and delay damages, and prompt payment penalty interest and attorneys’ fees on a private construction project. Coast did not dispute the retention moneys were owed and eventually paid United the retention in full before trial without interest or attorneys’ fees.

The court of appeal found that Coast’s withholding was a prompt payment violation. The court held that an owner or contractor could only withhold retention proceeds without penalty where there is a dispute over the payment of the retention funds. The court disallowed the owner from using unrelated payment disputes (the disputed change orders and contractor delay claims) as the basis for a refusal to release retention proceeds that are not in dispute. The failure to release retention proceeds in such circumstances warrants the assessment of the prompt payment penalties. To hold otherwise, according to the United Riggers court, “would unduly increase the leverage of owners and primary contractors over smaller contractors or subcontractors by discouraging subcontractors from making legitimate claims for fear of delaying the retention payment.”

The United Riggers decision is a victory for contractors and subcontractors and reinforces the remedial purpose of the Prompt Payment Statutes.

Wahid Guirguis is a Shareholder with Hunt Ortmann, a leader in California construction law. If you have any questions about this bulletin or stop notices and mechanic’s liens, please contact him at guirguis@huntortmann.com.

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