The California legislature has enacted a comprehensive series of prompt payment statutes that are designed to ensure the prompt payment of progress payments and retention payments to downstream contractors by imposing harsh monetary penalties for any violations of the statutory scheme. Determining the applicable prompt payment statute depends on a number of factors, including the type of project (private or public), who is making the payment (owner or general contractor) and the type of payment (progress payment or retention payment). This article provides a brief overview of California’s prompt payment statutes and highlights some of the key points of the statutes that owners and contractors need to know.

Private Projects

Owner to Direct Contractors

In private projects, an owner must pay a direct contractor within 30 days after receipt of a demand for payment pursuant to the contract unless one of the following exceptions applies: (1) the parties agreed otherwise in the contract, or (2) a good faith dispute exists between the owner and direct contractor as to the progress payment due.^[1] Good faith dispute is not defined by the statutes, and courts are split on whether it is an objective test (reasonable person standard) or subjective test (owner’s individual belief). If a good faith dispute exists, the owner may withhold from the progress payment an amount not to exceed 150 percent of the amount in dispute.

An owner that fails to make timely payment faces penalties of 2 percent per month on the improperly withheld amount (instead of interest), and attorney’s fees and costs if the contractor prevails.

As for retention, if the owner has withheld retention from a direct contractor, it must pay the direct contractor within 45 days after completion of the improvement unless a good faith dispute exists as to the retention payment due.^[2] Unlike progress payments, the parties cannot modify this requirement by contract. Another exception exists if part of a work of improvement will ultimately become the property of a public entity, in which case the owner may condition payment of retention allocable to that part on acceptance of that part by the public entity.

If funds have been retained because of a dispute regarding the work and the direct contractor provides written notice that the work in dispute has been completed in accordance with the contract, the owner must respond within 10 days stating whether it accepts or rejects the disputed work.^[3] If accepted, the owner must pay the direct contractor the retention withheld relating to the disputed work within 10 days.

An owner that wrongfully withholds retention faces penalties of 2 percent per month on the improperly withheld amount (in lieu of interest), and attorney’s fees and costs if the contractor prevails.

Direct Contractors to Subcontractors

A direct contractor in a private project must pay its subcontractor within seven days of receipt of each progress payment that represents, in part, payment for the subcontractor’s work unless one of the following exceptions applies: (1) the parties agree otherwise in the contract, or (2) a good faith dispute exists between the direct contractor and subcontractor as to the progress payment due.^[4] Like with an owner, if a good faith dispute exists, the direct contractor may withhold from the progress payment an amount not to exceed 150 percent of the amount in dispute. A direct contractor that fails to make timely payment faces penalties of 2 percent per month on the improperly withheld amount (instead of interest), discipline by the California Contractors State License Board, and attorney’s fees and costs if the subcontractor prevails.

Regarding retention, a direct contractor that has withheld retention from a subcontractor (because the owner has withheld retention from the direct contractor) must pay its subcontractor the subcontractor’s portion of the retention within 10 days after receiving all or a portion of the retention, unless one of the following exceptions applies: (1) the retention was specifically designated for a particular subcontractor, or (2) a good faith dispute exists, in which case the direct contractor may withhold from the retention to the subcontractor an amount not in excess of 150 percent of the estimated value of the disputed amount.^[5] As with owners, this requirement cannot be modified by contract.  

If a subcontractor provides notice to the direct contractor that the work in dispute has been completed in accordance with the contract, the direct contractor must give notice to the subcontractor if it accepts or rejects the disputed work within 10 days. If accepted, the direct contractor must pay the subcontractor the retention withheld relating to the disputed work within 10 days.^[6]

A direct contractor faces the same penalties an owner faces if it fails to pay retention in a timely fashion.

Public Works Projects

Public Entities to Direct Contractors

The prompt payment requirements for public entities differ by entity. State and local agencies must pay a direct contractor its progress payment within 30 days after receipt of an undisputed payment request, or pay 10 percent per annum interest.^[7] California State University must pay its direct contractors within 39 days after receive of an undisputed payment request.^[8] A payment request determined not to be proper must be returned to the direct contractor with an explanation as soon as practicable, but not later than seven days after receipt.

Retention proceeds held by a public agency for a contractor on a public works project must be released within 60 days of completion of the work of improvement.^[9] If a dispute arises, the public entity may withhold from the retention up to 150 percent of the disputed amount.

If a public entity wrongfully withholds retention, it faces penalties of 2 percent per month of the improperly withheld amount (instead of interest), and attorney’s fees and costs if the contractor prevails.

Direct Contractors to Subcontractors

The rules governing the prompt payment to subcontractors are generally the same on both public and private works projects. Like with private projects, the direct contractor must pay its subcontractors within seven days after receiving a progress payment that represents, in part, payment for the subcontractor’s work unless one of the following exceptions applies: (1) the parties agree otherwise in the contract, or (2) a good faith dispute exists between the direct contractor and subcontractor as to the progress payment due.^[10] A direct contractor that fails to make timely payment faces penalties of 2 percent per month on the improperly withheld amount (instead of interest), discipline by the California Contractors State License Board, termination by the contracting agency, and attorney’s fees and costs if the subcontractor prevails.

The rules regarding retention payments on public projects differ slightly than private projects. A direct contractor in a public project that has withheld retention from a subcontractor must pay its subcontractor the subcontractor’s portion of the retention within seven days (as opposed to 10 days with private projects) after receiving all or a portion of retention, unless one of the following exceptions applies: (1) the retention was specifically designated for a particular (other) subcontractor, or (2) a bona fide dispute exists, in which case the direct contractor may withhold from the retention to the subcontractor an amount not in excess of 150 percent of the estimated value of the disputed amount.^[11] This requirement may not be modified by an agreement between the parties.

A direct contractor in a public works project faces the same penalties as a direct contractor in a private works project if it wrongfully withholds a retention payment. 

Conclusion

To avoid potentially significant penalties, those in the construction industry should familiarize themselves with California’s detailed prompt payment laws. As a general rule, owners and direct contractors should ensure that progress payments and retention are timely paid, or provide a clear and timely written notice to the direct contractor (or the subcontractor) that a good faith dispute exists as to the payment.  

Notes:

^[1] Cal. Civil Code § 8800 et seq.

^[2] Cal. Civil Code § 8812.

^[3] Cal. Civil Code § 8816.

^[4] Cal. Bus. & Prof. Code § 7108.5.

^[5] Cal. Civ. Code § 8814.

^[6] Cal. Civ. Code § 8816.

^[7] Cal. Pub. Contracts Code § 10261.5.

^[8] Cal. Pub. Contracts Code § 10853.

^[9] Cal. Pub. Contracts Code § 7107.

^[10] Cal. Bus. & Prof. Code § 7108.5; Cal. Pub. Contracts Code § 10262.

^[11] Cal. Pub. Contracts Code § 7107(d).