Tennessee Supreme Court Clarifies Application of the Prompt Pay Act

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On June 30, the Supreme Court of Tennessee issued an opinion interpreting the retainage provisions in Tennessee’s Prompt Pay Act (the Act). The opinion has significant implications for construction projects across Tennessee. Under the Act, a party withholding retainage from payments made to a contractor for construction work is required to deposit the withheld retainage into a separate, interest-bearing, escrow account with a third-party. Failing to follow this requirement is a Class A misdemeanor, subject to a $3,000 fine and, at the time the project in question began, a separate $300 civil “penalty,” for each day retainage is not properly held.

Background

Holladay Construction Group, LLC, acting as the general contractor for a construction project in Nashville, entered into a subcontract with Snake Steel, Inc., under which Snake Steel was to provide structural and other steel for the project. The subcontract allowed Holladay to withhold 5% retainage from the amounts due to Snake Steel until Snake Steel had substantially completed its work. Snake Steel completed its work and submitted an application for payment of its retainage in February 2016. Holladay refused to release Snake Steel’s retainage and Snake Steel filed a lawsuit in Davidson County Chancery Court in September 2017. As part of the lawsuit, Snake Steel alleged that Holladay had violated the Prompt Pay Act by failing to properly escrow retainage and sought payment of the $300 per day penalty.

Holladay did not dispute that Snake Steel’s retainage was never properly escrowed. Instead, Holladay argued that Snake Steel’s claim for penalties was barred by Tennessee’s one-year statute of limitations on claims for statutory penalties because Snake Steel had failed to file its lawsuit within one-year of when it submitted its application for payment of retainage. Snake Steel argued that under Tennessee’s “discovery rule,” the applicable statute of limitations was tolled until Holladay’s failure to properly escrow Snake Steel’s retainage was known or reasonably should have been known to Snake Steel. Snake Steel also argued that even if the one-year statute of limitations applied, it was still entitled to recover penalties for the one-year period before it filed its lawsuit.

Summary of the Tennessee Supreme Court’s Decision

The court began by noting that cases applying Tennessee’s discovery rule have only applied it to claims of compensation for injury or harm and not claims for penalties. In any event, the court held that Holladay’s failure to properly escrow Snake Steel’s retainage was discoverable because Tennessee’s Prompt Pay Act is a matter of public knowledge that was available to both parties, and nothing indicated Snake Steel had ever asked Holladay if its retainage funds were being properly held. Consequently, the court found the one-year statute of limitations applied to Snake Steel’s claim for penalties.

Giving the words of the Prompt Pay Act their natural and ordinary meaning, the court noted that the provision of the Act requiring retainage to be placed in an interest-bearing escrow account was designed to protect contractors in the event release of their retainage was delayed. Further, the provision providing for payment of statutory penalties was intended “[t]o put teeth into the escrow requirement.” As such, the court held that Snake Steel was entitled to recover statutory penalties of $300 per day for each of the 365 days prior to when Snake Steel filed its lawsuit. Holladay was ordered to pay to $109,500 in penalties to Snake Steel despite the fact that the total amount of retainage withheld from Snake Steel was only $18,270.58.

How Does this Decision Affect Construction Projects in Tennessee?

This decision affirms the statutory interpretation that a contractor or subcontractor is entitled to statutory penalties of $300 for each and every day that retainage is not held in an interest-bearing escrow account, but that such penalties are subject to a shorter statute of limitations than most other types of claims that can arise in the construction context. As highlighted by the court’s decision, this can result in harsh consequences, especially in light of the proportionally small amount of retainage that can be withheld under Tennessee law (no more than 5% of the contract price).

This opinion is also significant in light of recent amendments to the Prompt Pay Act. Beginning July 1, 2020, the Act was revised to reclassify the $300 per day from a penalty to an award of civil damages that “accrue from the date retained funds were first withheld,” meaning the one-year statute of limitations applied by the court will no longer apply. Instead, claims for failure to properly escrow retainage are likely now governed by the three-year statute of limitations for actions for the detention of personal property. In any event, the Tennessee Supreme Court’s decision and the recent amendments to Tennessee’s Prompt Pay Act have reaffirmed the detrimental consequences of failure to properly escrow retainage and have substantially increased the potential financial impacts that can accompany such a failure.

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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