California Supreme Court Clarifies “Good Faith Dispute” Under California’s Prompt Payment Law

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In recent case of United Riggers and Erectors, Inc. v. Coast Iron and Steel Company ___ Cal. 4th ___ (May 14, 2018 Case No. S231549), the California Supreme Court addressed whether a direct contractor can withhold payment from a subcontractor based on the “good faith dispute” exception pursuant to the state’s prompt payment laws.

The issue in United Riggers was whether the good faith withholding exception applies to any dispute between the parties or only disputes directly related to the specific payment that would otherwise be due. The court held that the dispute must be directly relevant to the specific payment that would otherwise be due. United Riggers resolved the split of authority between two other California cases, Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc. (2009) 179 Cal. App. 4th 1401, which held that any bona fide dispute can justify withholding of retention, and East West Bank v. Rio School District (2015) 235 Cal. App. 4th 742, which held that only disputes related to the retention security functions can justify withholding payment. It should be noted, that while United Riggers concerned the dispute over the correct interpretation of California Civil Code section 8014 (withholding of retention), the breadth of the Supreme Court’s ruling appears to put an end to similar interpretation issues under other prompt payment statutes in California. Thus, for contractors who occasionally use as leverage or otherwise the “good faith” withholding provision to justifying nonpayment to a lower tiered party or contractor, it now appears that this will be contrary to California’s prompt payment laws, at least when it comes to a dispute that is not directly related to the specific payment that would otherwise be due.

In United Riggers, the owner contracted with Coast Iron to provide “miscellaneous metals” for work to construct an amusement ride at Universal Studios. Coast Iron, in turn, subcontracted with United Riggers to perform certain work. As is typical, the subcontract executed by United Riggers provided that Coast Iron would withhold 10 percent of amounts billed by United Riggers as retention to be paid at the end of the project. At the end of the project, Coast Iron requested that United Riggers submit its final change orders together with any outstanding change order requests. In response, United Riggers sent a letter to Coast Iron demanding $274,150.40 as compensation for “the mismanagement and/or delay deliveries caused by Coast Iron, as well as $70,384 in an outstanding change order request.” Coast Iron’s response was a rejection of the claim. United Riggers sought to recover all these sums as well as prompt payment penalties. Following a bench trial, the court issued a statement of decision denying relief to United Riggers on all its claims, finding that United Riggers had failed to follow the subcontract’s procedures with respect to many change orders and that United Riggers had failed to show that Coast Iron was responsible for the actual expenses incurred by United Riggers. The trial court further found that prompt payment penalties were not appropriate because “there was a good faith dispute between Coast Iron and United Riggers… that entitled Coast Iron to withhold payment of retention.” At the Court of Appeal, the Court affirmed as to United Riggers common law claims but reversed as to United Riggers’ statutory claim on the prompt payment statute, finding that the good faith withholding exception to disputes must specifically relate to the specific payment at issue and that this interpretation was more in line with what the state legislator had contemplated when enacting the prompt payment statute. Accordingly, the appellate court determined that Coast Iron could not use the parties’ dispute over mismanagement of the project as the basis for good faith withholding of United Riggers’ retention. This appellate decision contributed to the split of already existing authority which has now ultimately been resolved by the California Supreme Court. This case should remind those in current disputes which involve the withholding of retention to review their current positions and the consequences thereof given the clarification of the law.

While the United Riggers case resolved a split of authority as to what a bona fide dispute has to relate to in order to justify withholding retention, it is important to note that some California prompt payment statutes, other than those related to retention, are waivable in writing. Therefore, this case may remind parties to review their contracts to determine whether and where prompt payment can be waived in order to manage risk.

Lastly, this case seems to clarify that when deciding to withhold a payment subject to prompt payment penalties a direct contractor may 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 such payment would result in the subcontractor receiving more than the minimum amount both sides agree is due. In effect, the payor must be able to present a good faith argument for why all or part of the withheld monies themselves are no longer due. Moreover, this case seems to clarify that what a direct contractor may not do is withhold a retention that is an undisputed amount, because a dispute has arisen over whether additional amounts over and above the retention might also be owed.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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