California Appellate Court Rules On Prompt Payment Statutes
Applicability to Retention
William C. Last, Jr.
Attorney at Law
On May 9, 2005, a California Appeals Court held that the prompt payment penalties for retention were not applicable if amount claimed due was not actually retention. This article will discuss the holding in that case, McAndrew v. Hazegh (Cal.App. 4 Dist., 2005) 2005 DIAR 5185.
In the case McAndrew, a general contractor, entered into a construction contract with Hazegh. After completing his work, McAndrew submitted a bill for $10,755.20. Hazegh refused to pay for the extra work, contending he had already paid in full. In turn, McAndrew recorded a mechanic's lien and then sued Hazegh. Among other causes of action the complaint included a demand for prompt payment penalties based on the failure to pay the retention (Civil Code 3260(g)).
The trial court concluded that the construction contract terms provided that McAndrew would be paid "after the completion of the job" and did not provided for installment payments or withholding of any retention. Irrespective, McAndrew billed in installments and was paid in full for the base contract work. The trial court found in favor of the contractor relative to his claims for extra work and awarded that amount plus prompt payment penalties for failure to pay for the extra work.
Hazegh appealed contending that section 3260 only applies to actions involving "retention payments" and that the extra work was not retention. The appellate court agreed. The appellate court held that before the 2 percent penalty or attorney fees may be recovered under section 3260(g), the contractor must establish that the owner being sued has actually withheld retention payments from the contractor. The court decided that Hazegh never had any retention in his possession because the contract did not provide for or contemplate that any portion of the contract price would be "retained." The court also rejected McAndrew's argument that "retention" includes any unpaid sums still owed to a contractor.
What can be learned from the McAndrew case is that it is important to base your claim for prompt payment penalties on the proper statute. The remainder of this article will set forth a brief synopsis of the prompt payment statutes.
The Prompt Payment Statutes
A. PRIVATE WORKS: PROGRESS PAYMENTS DUE PRIME CONTRACTORS: Civ. Code §3260.1 requires owners to pay prime contractors within 30 days of contractor's request for payment on contracts entered into after 1/1/92. The penalty is assessed at 2% per month on the balance owed in lieu of interest. In the event that a lawsuit is filed to recover the balance owed, attorneys' fees and costs of collection are paid by the losing party. Back charges on the disputed work may not exceed 150% of the disputed amount.
B. PRIVATE WORK: RETENTION DUE PRIME CONTRACTORS: Civil Code §3260 requires owners to pay original contractors within 45 days after completion, and original contractors to pay subcontractors within 10 days of receipt of request for payment from owner. The statute defines "Date of Completion" as issuance of the certificate of occupancy or the date indicated on a valid notice of completion. (This does not apply to retention withheld by the lender pursuant to a construction loan agreement.) If the retention payment is designated by the owner to be paid to a particular subcontractor the amount should be paid to that subcontractor. Otherwise, the retention payment should be disbursed to the subcontractors who are owed money from that payment in amount equal to their share. This statute cannot be used by suppliers, laborers and/or equipment renters. The party who owes the funds can be subject to a penalty equal to 2% per month in lieu of interest, with attorneys' fees and costs of collection to be paid by the losing party. No more than 150% of the value of the disputed work may be withheld. Within ten days after the disputed work has been completed in accordance with the terms of the contract, the person withholding the disputed amount must notify the other party of the acceptance or rejection of the disputed work. If the disputed work is accepted, the person withholding the funds must release the withheld amount.
C. PRIVATE & PUBLIC WORK: PROGRESS PAYMENTS DUE SUBCONTRACTORS: Business and Professional Code §7108.5 and Public Contract Code §10262.5 require that any prime contractor or subcontractor pay all tiers of subcontractors within 10 days of receipt of funds by contractors. Violation entitles the subcontractor to an amount equal to 2% per month on the balance owed. In the event of a lawsuit, the prevailing party is entitled to attorneys' fees and costs. Back charge for disputed work is limited to 150% of amount disputed in good faith.
D. PUBLIC WORKS (State of California & State Universities): PROGRESS PAYMENTS DUE PRIME CONTRACTORS: Public Contract Code §10261.5 requires that state agencies pay the prime contractors within thirty days after payment request or engineer submittal. Public Contract Code §10853 requires state universities to pay prime contractors within thirty-nine days of the payment request. The penalty is assessed, on the balance, at 10% per annum on the balance owed. The statutes do not require payment of the contractor's attorney's fees. Although a back charge limit on the disputed work may be inferred from the duty of good faith, there is no express back charge limit.
E. PUBLIC WORKS ( Local Government Agencies) : PROGRESS PAYMENTS DUE PRIME CONTRACTORS: Public Contract Code §20104.50 requires that local government agencies pay contractors no more than thirty days after receipt of contractor's request for payment. The penalty is assessed, on the balance, owed at 10% per annum. The statute does not provide for the recovery of attorney's fees. Although a back charge limit may be inferred from the duty of good faith, there is no express back charge limit.
F. PUBLIC WORKS ( State or Local Agency): PROGRESS AND RETENTION PAYMENTS DUE DESIGN PROFESSIONALS: Civil Code §3320 requires that any public entity pay design professionals within thirty days of their demand if it is progress payment, and within forty-five days if retention is due. Civil Code §3321 requires that a design professional must pay both progress and retention payments to its sub-consultants within fifteen days after receipt from the public agency. A penalty of 1½ % per month in lieu of interest plus attorneys' accrue to the prevailing party. Back charge is limited to no more than 150% of disputed amount.
G. PUBLIC WORKS; RETENTION DUE PRIME AND SUBCONTRACTORS: Public Contract Code §7107 provides that any public entity must pay original contractor within sixty days after the date of completion, and that any original contractor must pay subcontractors within 7 days from their receipt of funds from any public entity. The penalty for failing to comply with the statutes is the assessment of 2% per month on the balance owed in lieu of interest. In the event a lawsuit is filed, the prevailing party is entitled to attorneys' fees and costs. Back charges are limited to no more than 150% of disputed amount.
H. DIVERSION OF FUNDS: Penal Code § 484b makes it a crime for any person who receives money for the purpose of obtaining or paying for services, labor, materials or equipment and willfully fails to apply such money for such purpose by either willfully failing to complete the improvements for which funds were provided or willfully failing to pay for services, labor, materials or equipment provided incident to such construction, and wrongfully diverts the funds to a use other than that for which the funds were received.
I. FEDERAL PUBLIC WORKS PROJECTS; PAYMENTS DUE SUBCONTRACTORS: The United States Codes, at 31 USC 3905 provides that the prime contractor is required to include in each subcontract for property or services entered into by the prime contractor and a subcontractor (including a material supplier): (1) a payment clause which obligates the prime contractor to pay the subcontractor for satisfactory performance under its subcontract within 7 days out of such amounts as are paid to the prime contractor by the agency under such contract; and (2) an interest penalty clause which obligates the prime contractor to pay to the subcontractor an interest penalty on amounts due in the case of each payment not made in accordance with the payment clause included in the subcontract. The period for computing the interest payment is the period beginning on the day after the required payment becomes due and ending on the date on which payment of the amount due is made. The interest is computed at the rate specified by section 31 USC § 3902(a).
The Prompt Payment statutes are valuable collection tools. However, the effectiveness of the statutes are, at times, limited by the right of the paying party to withhold sums if there is a dispute between the parties. It is common practice of owners and prime contractors to withhold funds from the other party to prod that party into completing the disputed work. However, some owners and prime contractors create baseless disputes to avoid paying balances legitimately owed. In that event, the party demanding payment should notify the non-paying party, in writing, when the disputed work is completed. Such a notice maybe the basis for a later court determination that the continued withholding of the funds was not undertaken in good faith.
While the prompt payment statutes may ultimately require you to institute legal action to recover the penalties, they are significant threats to non-paying parties. It is a good practice to recite the appropriate statute in any letter that demands payment of past due amounts. In the event, the contract does not provide for the payment of attorney's fees the prompt payment statutes may allow the prevailing party to recover that collection expense. The threat of a 2% penalty and attorneys fees may be sufficient to convince a non-paying party to pay the amount owed.
This article, 8 2005, was written by William C. Last, Jr. of Last & Faoro. Mr. Last is an attorney who has been specializing in Construction Law for over eighteen years. Mr. Last also holds a California A&B contractors license. If you have any questions Mr. Last can be contacted at 415-764-1990 or 650-425-7679. He has other articles on his web site: lhfconstructlaw.com. This bulletin is published periodically to provide general information about current legal issues. If you have a specific legal question or need legal advice, you should contact an attorney.