Prompt Payment Statutes Revisited: A Valuable Collection Tool

By William C. Last, Jr. & Patrick J. Whitehorn

As most contractors are aware, California has enacted prompt payment statutes. The statutes are intended to penalize parties that fail to pay contractors, within a determined period, after they have been paid.

The statutes, however, contain certain exceptions. Generally, the party who owes the funds can retain a certain percentage of the amount owed in the event there is a good faith dispute between the two parties. Each statute sets forth the percentage amount that can be withheld (back charged) in the event there is a dispute. The statutes also vary as to time for payment and the amount of the penalty.

The following is a brief synopsis of the statutes:

The Statutes

A. PRIVATE WORKS: PROGRESS PAYMENTS DUE PRIME CONTRACTORS: Civ. Code §8800 requires owners to pay prime contractors within 30 days of contractor's request for payment on contracts. The penalty for wrongfully withholding payment 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. If there is good faith dispute as to a progress payment due, the owner may withhold from the progress payment an amount not exceed 150% of the disputed amount.

B. PRIVATE WORK: RETENTION DUE PRIME CONTRACTORS: Civil Code §8812 requires owners to pay direct contractors within 45 days after completion. Civil Code §8180 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.) The penalty for wrongfully withholding payment is assessed at 2% per month on the balance owed in lieu of interest (Civil Code §8818). 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. If there is good faith dispute as to a retention payment due, the owner may withhold from the retention payment an amount not exceed 150% of the disputed amount. If a direct contractor gives notice to the owner that the work in dispute has been completed in accordance with the contract, the owner shall within 10 days either accept or reject the disputed work. Within 10 days of acceptance of the disputed work, the owner must pay the direct contractor the retention relating to the disputed work (Civ. Code §8816).

C. PRIVATE WORK: PROGRESS PAYMENTS DUE SUBCONTRACTORS: Business and Professional Code §7108.5 requires that any prime contractor or subcontractor pay all tiers of subcontractors within 7 days of receipt of funds by contractors. The penalty for wrongfully withholding payment is assessed at 2% per month on the balance owed. In the event of a lawsuit the prevailing party is entitled to attorneys' fees and costs. If there is good faith dispute as to a progress payment due, the contractor may withhold from the progress payment an amount not exceed 150% of disputed amount.

D. PRIVATE WORK: RETENTION DUE SUBCONTRACTORS: Civil Code §8814 requires direct contractors who have withheld retention from one or more subcontractors to pay each subcontractor their share of the retention within 10 days of the direct contractor receiving all or part of the retention withheld by the owner. If the retention received by the direct contractor from the owner is specifically designated for a particular subcontractor, the retention shall be paid to the designated subcontractor if consistent with the terms of the subcontract. The penalty for wrongfully withholding payment is assessed at 2% per month on the balance owed in lieu of interest (Civil Code §8818). 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. If there is good faith dispute as to a retention payment due, the direct contractor may withhold from the retention payment an amount not exceed 150% of the disputed amount. If a subcontractor gives notice to the direct contractor that the work in dispute has been completed in accordance with the contract, the direct contractor shall within 10 days either accept or reject the disputed work. Within 10 days of acceptance of the disputed work, the direct contractor must pay the subcontractor the retention relating to the disputed work (Civ. Code §8816).

E. 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 30 days after payment request or engineer submittal. Public Contract Code §10853 requires state universities 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 contractors 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.

F. 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 30 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.

G. PUBLIC WORK: PROGRESS PAYMENTS DUE SUBCONTRACTORS: Public Contract Code §10262.5 requires that any prime contractor or subcontractor pay all tiers of subcontractors within 10 days of receipt of funds by the contractor. A prevailing party is entitled 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. If there is good faith dispute as to a progress payment due, the contractor may withhold from the progress payment an amount not exceed 150% of the disputed amount.

H. PUBLIC WORKS; RETENTION DUE PRIME AND SUBCONTRACTORS: Public Contract Code §7107 provides that any public entity must pay original contractor within 60 days after the date of completion, and that any direct contractor must pay subcontractors within 10 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. If there is good faith dispute as to a retention payment due, the direct contractor may withhold from the retention payment an amount not exceed 150% of the disputed amount.

I. 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 30 days of their demand if it is progress payment, and within 45 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' fees accrue to the prevailing party. If there is good faith dispute as to an amount due, the local agency may withhold from the retention payment an amount not exceed 150% of the disputed amount.

J. 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.

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).

RECENT DEVELOPMENTS

The Prompt Payment statutes are valuable collection tools. However, the effectiveness of these statutes is, at times, limited by the right of the paying party to withhold 150% of amounts due if there is a dispute between the parties. It is common practice of owners and prime contractors to withhold funds from other parties to prod that party into completing the disputed work. While the right to withhold 150% of the disputed amount is predicated on a good faith dispute, 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 may be the basis for a later court determination that the continued withholding of the funds was not undertaken in good faith.

In addition, until recently it had been the rule that a prime contractor or owner, could withhold from a direct contractor or subcontractor 150% of a disputed amount from progress payment or retention funds in the event of a dispute of any nature, regardless of whether or not the dispute was related to the retention itself (Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc. (2009) 179 Cal.App.4th 1401.) The California Supreme Court in United Riggers & Erectors, Inc. v. Coast Iron & Steel Co. (2018) 4 Cal.5th 1082 specifically disapproved Martin Brothers and held that the exception to the requirement of prompt payment of retention payments in the event of a good faith dispute, allowing a direct contractor to withhold 150% of the disputed amount, applies only when there is a dispute directly relevant to the specific payment that would otherwise be due. The execution applies only when the good faith dispute exists over a statutory or contractual precondition to that payment, such as the adequacy of the construction work for which the payment is consideration. Controversies concerning unrelated work or additional payments above the amount both sides agree is owed will not excuse delay. If the dispute is not related to the payment of the retention itself, the retention cannot be withheld. While the United Riggers case applies only to retention payments owed by a direct contractor to a subcontractor and interprets only Civil Code §8814, the reasoning in this case will likely be applied to all of the prompt payment statutes listed above that contain the good faith dispute exception.

CONCLUSION

While the prompt payment statutes may ultimately require you to institute legal action to recover the penalties, they are a significant threat 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% per month penalty and attorney's fees may be sufficient to convince a non-paying party to pay the amount owed, without the need for litigation.