Despite a statutory scheme codifying a contractor’s obligations to promptly pay its subcontractors, California courts have disagreed over what types of disputes may allow a contractor to withhold subcontractor payments.  On May 14, 2018, in United Riggers & Erectors, Inc. v. Coast Iron & Steel Co. 4 Cal.5th 1082 (2018), the California Supreme clarified contractors’ prompt payment obligations, holding that a contractor can withhold payments from its subcontractor only when there is a good faith dispute concerning that specific payment.  Controversies related to other work or claims for additional payments do not excuse the delay of payment for work on which there is no dispute.

 

The statute at issue is California Civil Code Section 8814, which requires contractors on private works of improvement to make retention payments to any of its subcontractors within ten days after receiving all or a part of its retention from the project owner.  If a good faith dispute exists between the contractor and one of its subcontractors, Section 8814 allows the contractor to withhold from its subcontractor up to 150 percent of the estimated value of the disputed amount.  It is this “good faith dispute” provision that has led to disagreement among California courts.

 

The two most prominent and most recent cases demonstrating this split in authority are Martin Brothers Constr., Inc. v. Thompson Pacific Constr., Inc. 179 Cal.App.4th 1401 (2009) and East West Bank v. Rio School Dist. 235 Cal.App.4th 742 (2015).  In Martin Brothers, the appellate court held that any bona fide dispute between the contractor and subcontractor would support the withholding of retention.  However, the East West Bank court disagreed, restricting the right to withhold payment to only those disputes that related to that payment.

 

In 2010, Universal Studios entered into agreements for the construction of its new Transformers movie roller coaster ride.  Universal selected Coast Iron & Steel to design, furnish and install the metal work.  Coast Iron & Steel retained United Riggers to install the metal work.  The subcontract price upon execution was $722,742 but would increase to approximately $1.5 million after change orders.  United Riggers completed its work to Coast Iron & Steel’s satisfaction.  However, United Riggers demanded an additional $274,158 because of alleged project mismanagement and outstanding change order requests.  Coast Iron & Steel refused to pay the additional amount demanded, and in turn withheld retention from United Riggers, citing United Riggers’ additional demands.

 

The dispute went to a bench trial, where the trial court found entirely in favor of Coast Iron & Steel.   On United Riggers’ appeal, the appellate court affirmed all but the trial court’s decision on whether prompt payment penalties were owing to United Riggers as a result of Coast Iron & Steel’s withholding.  The appellate court disagreed with the trial court and held that Coast Iron & Steel could not use the parties’ dispute over mismanagement and unresolved change order requests to justify withholding otherwise due and owing retention.  United Riggers appealed to the California Supreme Court, which considered only the claim for prompt payment penalties.

The California Supreme Court reviewed each of the state’s prompt payment statutes, which included those related to public works of improvement as well as progress payments.  It determined that the prompt payment statutory scheme was remedial in nature – to ensure contractors are not at the mercy of those upon whom they depend for payment.  Consistent with this purpose, the court held that a direct contractor could delay payment when the sufficiency of the subcontractor’s construction-related performance is the subject of a good faith dispute, “when liens or other demands from third parties expose the direct contractor to potential double payment, or when payment would result in the subcontractor receiving more than the minimum amount both sides agree is due.”  United Riggers, 4 Cal.5th at 1097.  The court further clarified that a contractor could not withhold retention because a dispute has arisen related to whether additional amounts may be due and owing.   “In effect, the payor must be able to present a good faith argument for why all or a part of the withheld monies themselves are no longer due.”  Id.

 

Applied to United Riggers’ claim against Coast Iron & Steel, the court found that Coast Iron & Steel did not dispute that United Riggers’ retention was due – the work was satisfactory.  The only basis for withholding retention was that United Riggers demanded additional funds above and beyond the earned contract price.  The court viewed Coast Iron & Steel’s withholding as a punishment and not valid grounds for withholding the duly earned retention.  In so doing, the court disapproved of the Martin Brothers ruling, thus setting a clear rule that a timely payment may be excused only when the contractor has a good faith basis for contesting the subcontractor’s right to receive the specific payment that is withheld.

 

Coast Iron & Steel’s withholding of retention from United Riggers to counter United Riggers’ demands for additional money was not some novel tactic, nor was it expressly illegal.  Since at least 2009, contractors have been using the Martin Brothers ruling to shield them from prompt payment penalties while leveraging against or defending themselves from subcontractor claims. Those days are now over.  The decision in United Riggers strengthens the prompt payment penalties under Civil Code section 8814, and further reminds contractors of the protections afforded to subcontractors under California law.