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California Court's Ruling Turns Prompt Pay 'Hammer' Into Child's Plastic Toy
Construction Practices Newsletter
Background: California's Prompt Pay Act
Subcontractors have viewed California's prompt payment statutes as a hammer to hold over the head of general contractors to ensure timely payment of undisputed money. These statutes, set forth in California Civil Code § 3260, et seq., and California Public Contract Code § 7107, et seq., establish specific time periods within which prime contractors must pay their subcontractors progress payments and release withheld retentions. Failure to comply with these strict time frames subjects the non-paying entity to a 2 percent penalty on the amount due per month for every month that payment is not made. A contractor who brings a successful action to recover the 2 percent penalty is also entitled to recover attorney fees and costs. There are similar statutes for contractor pay applications to owners.
Armed with this statutory weapon, claimants have been assured of receiving quick payments upon the completion of projects. California courts traditionally viewed these statutes as serving a "remedial purpose to encourage general contractors to pay timely their subcontractors and to provide the subcontractor with a remedy in the event that the contractor violates the statute." See, Morton Engineering & Construction, Inc. v. Patscheck (2001) 87 Cal.App.4th 712, 720. But recently, a California court has taken this remedial statute and turned it on its head.
The Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc., 2009 DJDAR 17066, Decision
The subcontractor, Martin Brothers, entered into two subcontracts with Thompson Pacific to perform site clearing, grading and paving work on a public works school project. The subcontracts provided Thompson Pacific would make monthly progress payments of 95 percent of the labor and materials "placed in final position and for which the right to payment has been properly documented." Martin Brothers further agreed "payment is not due until Subcontractor has furnished all applicable administrative documentation required by the Contract Documents and applicable releases." This documentation included, among other things, lien releases, certified payroll, union letters regarding payment of prevailing wages, and proof of insurance.
As the work progressed, Martin Brothers submitted requests for additional compensation for extra work it alleged Thompson Pacific directed or that the project's conditions required. Thompson Pacific approved some changes, but disputed others.
Martin Brothers substantially completed its work in late 2003, and its punch list work in February 2004. Thompson Pacific made its last progress payment to Martin Brothers in March 2004, at which time Martin Brothers had several disputed claims for additional work. After failed attempts to resolve these claims, Martin Brothers filed a stop notice in June 2004, and suit in December 2004 seeking damages in the amount of $938,183.40 including interest, penalties and attorney fees. In March 2005, the parties met and negotiated a payment of $632,792.36, provided Martin Brothers submitted the required release documents—which it failed to do. Nonetheless, Thompson Brothers paid Martin Brothers $632,792.36 over a series of three installment payments in 2005. At trial, Martin Brothers sought recovery of the statutory prompt payment penalties, interest and attorney fees. The trial court denied Martin Brothers the requested relief, and an appeal followed.
The Appellate Court's Ruling
On appeal, the court focused on the exception to prompt payment penalties found in Public Contract Code §7107(e). Subdivision (e) provides: "The original contractor may withhold from a subcontractor its portion of the retention proceeds if a bona fide dispute exists between the subcontractor and the original contractor. The amount withheld from the retention payment shall not exceed 150 percent of the estimated value of the disputed amount." The court found that section 7107(e) allows a general contractor who has received retention proceeds from a public entity owner to nonetheless withhold all or a portion of such retentions from a subcontractor if a bona fide dispute exists between them. The court found that the existence of a dispute between Martin Brothers and Thompson Pacific regarding change orders rose to the level of a bona fide dispute so as to warrant a withholding of the earned retention, as 150 percent of the disputed amounts exceeded the amounts the parties agreed were due. Even though this "bona fide" dispute existed only as to the change orders (i.e. extra amounts), the court found Thompson Pacific was not bound to release the undisputed retention, and was not liable for the 2 percent penalty.
The court further found that Martin Brothers failed to provide all of the required contractual closeout documents, which negated Thompson Pacific's obligation to pay Martin Brothers the final payment, and thus Thompson Pacific was not liable for any violations of the prompt payment statutes.
Potentially Broad Impact
In interpreting "bona fide dispute" in a vacuum and including extra work claims under the prompt payment penalty analysis, the court in Martin Brothers effectively eradicated a claimant's ability to pressure the payor with the threat of a 2 percent per month penalty whenever any dispute exists with a value over the claimed amount. The Martin Brothers ruling swings the balance of power in the prompt payment statutes to those holding the money, who can now arguably insist all claims be dropped before facing the risk of prompt payment penalties even if large amounts are otherwise undisputed. By implication, Martin Brothers may embolden owners to hold undisputed money when claims arise on contracts under similar owner/contractor prompt-pay statutes. In short, if Martin Brothers stands, query whether the prompt-pay statute "hammer" has been transformed in to a child's plastic toy.
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