California Supreme Court Addresses “Good Faith” Construction Disputes Under Prompt Payment Laws

Garret Murai | California Construction Law Blog | May 29, 2018

It’s been a rollercoaster. But the ride appears to be over.

In United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., Case No. S231549 (May 14, 2018), the California Supreme Court addressed whether a direct contractor can withhold payment from a subcontractor based on the “good faith dispute” exception of the state’s prompt payment laws if the “dispute” concerns any dispute between the parties or whether the dispute must be directly relevant to the specific payment that would otherwise be due.

California’s Prompt Payment Laws

California has a number of construction-related prompt payment laws scattered throughout the state’s Civil Code, Public Contracts Code and Business and Professions Code. Their application depends on the type of construction involved, whether public or private; the type of payment involved, whether a progress payment or retention; and who is paying, whether it’s a private owner, public entity, direct contractor, or subcontractor.

While the application of these statutes vary they are structured similarly and provide for payment by a private owner, public entity, direct contractor, or subcontractor to lower-tiered parties within certain time-frames, ranging from seven days to 45 days. The failure to comply can subject these entities to prompt payment penalties of two percent per month, which exceeds the interest rate on many credit cards. Penalties, in other words, can be substantial.

However, each of these statutes provide a “good faith” or “bona fide” dispute exception, in which a higher-tiered party can withhold from a lower-tiered party up to 150 percent of any amount disputed in “good faith” or in which there is a “bona fide” dispute, without being subject to the prompt payment statute’s credit card-like penalties for non-payment.

At issue in United Riggers, was whether the good faith withholding exception applies to any disputes between the parties or only to disputes directly related to the payment that is due. Thus, for example, can a direct contractor who is back charging a subcontractor for defective work withhold up to 150 percent from a pay application submitted by that subcontractor, or is the good faith withholding exception limited to disputes related to that specific pay application?

In United Riggers, the California Supreme Court, addressing this issue with respect to one of the state’s prompt payment statutes, Civil Code section 8814, found that the good faith withholding exception only applies if there is a “good faith” dispute as to a specific pay application.

United Riggers & Erectors, Inc. v. Coast Iron & Steel Co.

In 2010, Universal Studios, LLLP contracted with Coast Iron & Steel Co. to provide “miscellaneous metals” work for Universal Studio’s new at-the-time Transformers ride, creatively named, Transformers: The Ride, which ultimately opened in May 2012. Coast, in turn, subcontracted with United Riggers & Erectors, Inc. to perform work on The Ride.

Not atypically, Coast’s subcontract with United provided that Coast would withhold 10 percent of amounts billed by United as retention to be paid at the end of the project. At the end of the project, Coast owed United $149,602.52 in retention.

At the end of the project, Coast sent an email to United requesting that United submit its final change order log together with any outstanding change order requests. In response, United sent a letter to Coast demanding $274,158.40 as compensation for “the mismanagement and or delayed deliveries caused by Coast” as well as $78,384 in outstanding change order requests. In response, Coast sent an email to United stating, “I will see you in court!!” Apparently, the ascent to the top of the rollercoaster had been reached.

In January 2013, United filed suit against Coast seeking $446,857.42 in damages comprised of $149,602.52 in retention, $23,186.50 in unpaid change orders, and $274,068.48 in damages attributed to “missing parts, lack of communications by Coast, fabrication errors, delays in installation of steel and lack of transportation access.” United also alleged that Coast was subject to prompt payment penalties under Civil Code section 8814, which requires that direct contractors pay their subcontractors retention within 10 days after receipt of payment from the owner or be subject to prompt payment penalties of two percent per month unless there is a “good faith dispute.”     

Three weeks after the case was filed, Coast paid United two-thirds of its retention, and ten months later paid the balance of the retention. However, these payments did not moot United’s prompt payment penalty claim because Civil Code section 8814, like most but not all of the state’s prompt payment penalty statutes, permits the prevailing party to recover its reasonable attorney’s fees and costs.

Following a bench trial, the trial court issued a statement of decision denying relief to United on all of its claims, finding that United had failed to follow the subcontractor’s procedures for submitting change orders and that United had failed to show that Coast was responsible for the extra expenses incurred by United. The trial court further found that prompt payment penalties were not appropriate because “there was a good faith dispute between Coast and United . . . that entitled Coast to withhold the payment of retention.”

On appeal, the Second District Court of Appeal affirmed as to United’s common law claims but reversed as to United’s statutory claim under the prompt payment statute, finding that limiting the good faith withholding exception to disputes specifically related to the specific payment at issue was more consonant with what the state legislature had contemplated when enacting the prompt payment statute. Thus, Coast could not use the parties’ dispute over mismanagement of the project as the basis for a good faith withholding of United’s retention. The Second District’s decision contributed to an already existing split of authority between appellate courts over interpretation of the good faith withholding exception of the state’s prompt payment penalty statutes.

The Supreme Court Decision

Describing the payment provisions contained in nearly all construction contracts, whereby, as a project reaches various stages of completion, “progress payments” are made by higher-tiered parties to lower tiered parties, with “retention” withheld from a portion of the progress payment until completion of the project, the California Supreme Court explained that progress payments provide contractors with the necessary cash flow to keep a project moving forward while retention provides higher-tiered parties with some protection from the risk of non-performance and is an incentive for lower-tiered parties to complete a project.

But, explained the Supreme Court, while contract and common law historically governed the details of progress payments and retention on construction projects, contractors would sometimes face challenges when negotiating payment terms that ensured prompt payment to them, particularly during tough economic times when higher-tiered parties have more leverage. As such, explained the Supreme Court, the State Legislature enacted a series of prompt payment statutes beginning in 1990 to discourage owners and higher-tiered contractors from withholding payments from lower-tiered parties as a way of granting themselves what were essentially interest-free loans.

But while the prompt payment statutes were designed to facilitate prompt payment to lower-tiered parties, the right to prompt payment is not unconditional, and a higher-tiered party can withhold payment from a lower-tiered party if there is a good faith or bona fide dispute. Some of these statutes, explained the Supreme Court, clearly provide that the good faith or bona fide dispute must concern a dispute relevant to the specific payment itself. In other words, the dispute must concern the work underlying the specific pay application for which payment is sought.

However, the prompt payment statute at issue, Civil Code section 8814, merely states that in cases of a “good faith dispute” the direct contactor may withhold up to “150% of the estimated value of the disputed amount,” without reference to whether the good faith dispute must concern the work underlying the specific payment sought or whether the good faith dispute could involve any dispute between the parties.

Looking at other similar prompt payment statutes, the underlying purpose of the prompt payment laws, and the legislative history of the various prompt payment statues including Civil Code section 8814, the Supreme Court held that in order for a direct contractor to withhold payment under the good faith withholding exception of Section 8814 the good faith dispute must concern a dispute relevant to the specific payment that would otherwise be due.

While the language of Civil Code section 8814 is prone to competing constructions, stated the Supreme Court, “statutes relating to the same class of things, and sharing the same purpose or object, should be harmonized and construed similarly.” And, here, explained the Supreme Court, when drafting the good faith withholding exception in other similar prompt payment laws, “[t]he Legislature drafted the dispute exception in these statutes using language that plainly limits withholding to circumstances in which the dispute relates to the specific amount or payment at issue.”

Moreover, stated the Supreme Court, looking at the underlying purpose of Civil Code section 8814, “reading the statute in light of its broader purpose, as we must, supports the conclusion that only withholding for disputes over the retention payment itself is allowed” since the underlying aim of the statue is “to ensure that parties who supply work or materials on projects, and who otherwise might lack leverage, are timely paid, and to provide them recourse in the event that they are not.”

Furthermore, explained the Supreme Court, were Civil Code section 8814 be interpreted to allow a direct contractor to withhold 150% of a disputed amount for “any” dispute, it could create a windfall for the direct contractor. Using the United’s claim of $274,158.40 for Coast’s alleged mismanagement on the project as an example, the Supreme Court explained that if Coast’s withholding of 150% of this amount or $411,237.60 were a proper good faith withholding, United would be unable to recover both the $274,158.40 it was claiming and Coast would able to keep $411,237.60 in retention that it never disputed was owed.

Finally, explained the Supreme Court, Civil Code section 8814 was modeled after former Civil Code section 3260, and legislative bill analyses reveal that the various iterations of former Section 3260 were designed to require timely payment of all “amounts due about which there is no good faith dispute” and, further, that when read in connection with Civil Code section 8816 which provides that when a contractor gives notice that work in dispute has been completed in accordance with the contract, the owner or direct contractor, upon acceptance of the disputed work, shall pay the portion of the retention relating to the disputed work, it is clear that “the good faith disputes that justify withholding are those that relate to the work for which the retention is payment.”

Conclusion

United Riggers resolves the split of authority between Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc. (2009) 179 Cal.App.4th 1401which held that any bona fide dispute can justify withholding of retention, and East West Bank v. Rio School Dist. (2015) 235 Cal.App.4th 742, which held that only disputes related to the retention’s security functions can justify withholding payment. Furthermore, while United Riggersconcerned a dispute over the correct interpretation of Civil Code section 8814, the breadth of the Supreme Court’s ruling would appear to put an end to similar interpretation issues under other prompt payment statutes. For higher-tiered parties who occasionally pull out the “good faith” witholding ticket when justifying non-payment to lower-tiered parties, it appears to be the end of that ride, at least when it comes to a dispute that is not directly related to the specific payment that is otherwise due. Here’s a secret though: some prompt payment statutes are waivable in writing.

Type 1 Differing Site Conditions Claim is not Easy to Prove

David Adelstein | Florida Construction Legal Updates | May 19, 2018

A differing site condition claim will almost universally result in both a cost and time impact.    There will be additional, unanticipated costs incurred.  And there will likely be a delay requiring additional time to perform.

 

A Type I differing site condition claim is when the contractor encounters conditions at the site different than those indicated in the contract documents.  That seems easy enough to prove, right.  Nope.  And, I mean nope!  If you don’t believe me, consider the recent decision in Meridian Engineering Co. v. U.S., 885 F.3d 1351 (Fed.Cir. 2018).

 

To prevail on a Type I DSC claim, a contractor must prove that: (1) a reasonable contractor reading the contract documents as a whole would interpret them as making a representation as to the site conditions; (2) the actual site conditions were not reasonably foreseeable to the contractor, with the information available to the particular contractor outside the contract documents (i.e., reasonable foreseeability); (3) the particular contractor in fact relied on the contract representation; and (4) the conditions differed materially from those represented and … the contractor suffered damages as a result. 

Meridian Engineering Co., 885 F.3d at 1356 (internal quotations and citation omitted).

 

In this case, the contractor entered into a contract with the government to build flood control structures.  During construction, the contractor encountered subsurface unsuitable saturated soils.  The contractor notified the government and modifications were issued as a result of the unsuitable soils.  However, the government eventually suspended the work following structural failures and then terminated the project.

 

An issue pertained to the contractor’s Type I differing site conditions claim that the subsurface unsuitable saturated soil caused delays and increased costs.  The trial court found that the existence of the subsurface saturated soils was reasonably foreseeable.  (If the site conditions were reasonably foreseeable, there is not a Type I differing site conditions claim.)

 

First, the specifications stated “[w]ater in varying quantities may be flowing in natural washes throughout the length of the project,” and “[t]he work site may be inundated because of [water] runoff.”  Meridian Engineering Co., 885 F.3d at 1357.  Based on these specifications, the court found that a reasonable contractor would interpret the specifications as a representation of water as a site condition.  Remember, the very first element in a Type I differing site conditions claim requires a reasonable contractor interpreting the contract as a whole would interpret them as making a representation about the site conditions. This kills the Type I differing site conditions claim.

 

Next, the original drawings showed the potential presence of saturated soil and the job was on a floodplain.  Based on this, a reasonable contractor would have performed a site inspection which, in turn, would have informed the contractor of the subsurface saturated soil conditions.

 

Moreover, boring logs that accompanied the contract stated that variations may exist between boring locations.  Certain geotechnical information did indicate there would be hard unyielding material in excavation areas.  “[E]ven though the Contract indicated ‘hard unyielding material’ found at parts of the site, a reasonable and prudent contractor would not have understood the [C]ontract documents as providing an affirmative indication of the subsurface conditions to be nonsaturated at the site.  Meridian Engineering Co., 885 F.3d at 1357 (internal citations omitted).  Had the contractor undertaken a pre-bid site inspection, it reasonably would have foreseen a saturated soil condition.

 

This case demonstrates that Type I differing site conditions claims are not simple to prove. If the site conditions were reasonably foreseeable, perhaps with a pre-bid site visit, then there goes the claim.  And, presumably, the contract and accompanying geotechnical information will warrant a reasonable contractor to undertake a pre-bid site inspection (according to the Meridian court’s reasoning).

Strategy for Enforcement of Dispute Resolution Rights

Whitney Judson | Smith Currie | May 21, 2018

Arbitration and litigation each offer their own benefits and drawbacks to litigants looking to resolve a construction dispute. A careful analysis of these benefits and drawbacks may be helpful in determining whether to avoid or pursue either dispute resolution process. Arbitration is oftentimes regarded as the more economically feasible dispute resolution option and is therefore attractive to many construction dispute litigants. Although arbitration may prove to be less expensive than litigation in the long run, some litigants may prefer to file a case in court because the upfront filing fees in litigation are less expensive than the filing fees of arbitration.

Litigants may also prefer the decision makers of one process for dispute resolution over another. Arbitrators in a construction dispute oftentimes have a background in the construction industry, whereas a judge or jury may not. Strategy may dictate whether the preferable decision maker should have experience within the construction industry or be free of any construction industry knowledge and possible biases. The finality of decisions may also be a reason to strategically choose one dispute resolution process over another. Arbitration decisions are overturned only under very narrow and specific circumstances. The losing party in litigation however, has a right to appeal decisions to a higher court and has more options for recourse when the findings of the court are not supported by the evidence or the law.

Jurisdiction and the Enforcement of Agreements to Arbitrate

Construction contracts oftentimes contain arbitration clauses where the signatories agree to resolve certain disputes through arbitration proceedings. Parties may disagree, however, on whether any given dispute falls within the scope of the arbitration clause. They may further disagree as to whether a judge or an arbitrator should have the power to rule on this issue. When one of these disputes presents itself, at least one party may insist that the issue of jurisdiction be decided before any arbitration proceedings can begin. The first step in either enforcing or avoiding an arbitration agreement may therefore be answering the preliminary question of who should rightfully decide whether claims in dispute belong in litigation or arbitration.

The United States Supreme Court has held that, in general, courts have the sole power to decide whether claims fall within the scope of an arbitration agreement, unless the parties have clearly and unambiguously decided to submit such questions to an arbitrator. The rationale behind this general rule is that an arbitration cannot be forced upon any party who has not agreed to participate. Parties that have not agreed to arbitrate are entitled to resolve their disputes in court. If a party prefers to participate in arbitration and have arbitrators decide issues of jurisdiction, it is important to clearly and unambiguously express these preferences within the contract. Additionally, parties that contractually elect to be governed by the American Arbitration Association Rules have agreed to empower arbitrators to decide issues of jurisdiction. The AAA Rules state: “The arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope, or validity of the arbitration agreement or to the arbitrability of any claim.” Rule R-7, AAA Commercial Rules.

Incorporation and Waiver

Construction contracts, in particular, oftentimes incorporate other documents. For example, a subcontract may not contain any agreement to arbitrate, but it may incorporate a prime contract that contains an arbitration clause. The arbitration clause that is referenced or incorporated from the prime contract may be enforceable against the subcontractor, even if the parties to the subcontract have not signed an agreement to arbitrate. Enforceable incorporation language in a contract will work to the advantage of a party that prefers arbitration and seeks to enforce an arbitration agreement. While this is the general rule, a minority of courts have held that broad language of incorporation may not be sufficient to incorporate an arbitration agreement.

Even when an agreement to arbitrate exists, a party may avoid its enforcement by arguing that the opposing party has waived its right to arbitration. When one party behaves in a manner that is inconsistent with its known arbitration rights—especially when this inconsistent behavior causes prejudice to the opposing party—arbitration rights may be waived. Actions that are inconsistent with arbitration rights include, but are not limited to, filing motions in court, conducting discovery in court, delays in filing motions to compel or stay arbitration, or otherwise substantially invoking rights and powers in litigation prior to filing an arbitration demand.

Motions to Compel Arbitration

If litigation has been initiated by one party in court, a party opposing litigation and seeking to enforce its arbitration rights may choose to file a motion to compel arbitration. A motion to compel arbitration uses the litigation process to require a party to arbitrate claims in accordance with the arbitration agreement. A party that has not agreed to arbitrate, however, cannot be compelled to do so.

A motion to compel works as a shield to parties who wish to avoid litigation because if a motion to compel is granted, the parties must seek legal remedies through arbitration. A grant of a motion to compel can either be accompanied by a dismissal of the court case, or a stay of the court case. If the case is dismissed, the court’s decision is immediately appealable to a higher court, as it is a final decision on the merits. If any party chooses to appeal a final decision on the merits with respect to a motion to compel, both parties will then be required to invest additional time and expense in litigation in a higher court. This can be especially frustrating for a party wishing to pursue its rights to arbitration and avoid litigation.

If a motion to compel is granted and the case is stayed, the decision is not appealable, as it is not a final decision on the merits. Under these circumstances, the parties are required to take the dispute to arbitration, and the litigation of the case in court is effectively paused pending the outcome of arbitration. In terms of filing a motion to compel, a stay of the court case is the most desired outcome for a party seeking to enforce its arbitration rights. Such a party may even be more direct in its enforcement of arbitration rights by filing a motion to stay litigation pending arbitration.

Conclusion

Parties must balance the benefits and drawbacks of various options for dispute resolution. Despite an agreement to arbitrate, parties may initiate litigation in court based upon reasonable arguments of waiver, that a particular dispute falls outside the scope of any arbitration agreement, or that the arbitration agreement itself is unenforceable against a particular party. Parties who believe they have a legitimate right to arbitration however, are able to enforce their rights through motions to compel arbitration, motions to stay legal proceedings pending arbitration, and by ensuring that the contract designates that an arbitrator is to decide any issues of jurisdiction.

California Supreme Court Provides Clarity to California’s Prompt Payment Exception

Timothy L. Pierce and Heather L. Frisch | K&L Gates | May 23, 2018

The California Supreme Court issued an opinion on May 14, 2018 in United Riggers & Erectors, Inc. v. Coast Iron & Steel Co. that resolves a split in authority regarding whether Civil Code Section 8814 excuses prompt payment of retention by an owner or prime contractor if a good faith dispute of any kind exists between the parties or only when there is a dispute over the work for which the retention is due. The Court held that a contractor is only entitled to withhold retention when there is a dispute arising out of the work on which the retention is based.

In United Riggers, the prime contractor, Coast Iron & Steel Co. (Coast Iron), entered into a contract with the owner, Universal Studios, and in turn subcontracted a portion of the work to United Riggers & Erectors (United Riggers). United Riggers submitted its final bill that included additional costs for increased expenses due to Coast Iron’s alleged mismanagement and outstanding change order requests. Coast Iron accepted the work completed by United Riggers, but disputed the additional costs. Coast Iron then used this dispute as justification to withhold the entire final payment, including the retention payment for the accepted work.

United Riggers filed suit against Coast Iron for, among other things, its failure to make prompt payment of the retention monies it had received from Universal according to California Civil Code Section 8814. Notably, by the time the bench trial took place, Coast Iron had paid the outstanding retention to United Riggers. This action did not moot the statutory claim because violation of the prompt payment statute can result in a monetary penalty and payment of attorney’s fees under Civil Code Section 8818.

Coast Iron argued that the Court should adopt the broad view of the statute held in Martin Brothers Construction, Inc. v. Thompson Pacific Construction (2009) that held any bona fide dispute between the parties can justify the withholding of retention. In particular, Coast Iron pointed out the lack of any express limit on the nature of the dispute contained in the Section 8814 exception. On the other hand, United Riggers argued for the narrow interpretation of Section 8814 held in East West Bank v. Rio School District (2015) which restricts justification for withholding retention payments to disputes related to the security purpose of retention. East West Bank highlighted the underlying purpose of the prompt payment statutes was “to ensure timely payment of the retention as soon as its narrow justifications have been served.”

The Court considered the legislative history of Section 8814 and held that its narrow interpretation of the prompt payment statute aligns with the statute’s underlying purpose to ensure timely payment of undisputed amounts to contractors while still allowing the retention to fulfill its security purpose. Retention may be withheld when: (1) the subcontractor’s construction-related performance is the subject of a good faith dispute, (2) the liens or other demands from third parties expose the direct contractor to double payment, or (3) when payment would result in the subcontractor receiving more than the minimum amount both sides agree is due. Under United Riggers, withholding retention is not justified because of a dispute whether additional amounts beyond the retention might be owed such as pending requests for change orders.

5 Key Takeaways from a Defense Verdict in a 15-Year MLB Stadium Case

John Bergin | Kilpatrick Townsend | May 24, 2018

Kilpatrick Townsend recently won a long and hard-fought battle resulting from the construction of a MLB stadium and wanted to share some practice pointers for how to prevail in a lengthy, nasty, and highly-complex construction dispute resulting from a high-profile project such as a stadium for a professional sports team.

In December 2017, Pennsylvania’s intermediate appellate court affirmed a defense verdict, obtained by my team at Kilpatrick Townsend, for the design/construction manager of a major league baseball stadium (PNC Park in Pittsburgh). The court issued its ruling following extensive discovery and motions practice, a 6-week bench trial in 2010, and two defense verdicts (directed verdict on a limitations issue of first impression and on the merits). The case began in 2002 when a subcontractor sued the project’s design/construction manager and its joint-venture members, municipal owner, and the Pittsburgh Pirates. More specifically, the subcontractor filed three separate multi-count complaints (with contractual, statutory, and tort counts) seeking more than $20 million in compensatory damages plus unspecified punitive damages and substantial interest. Our five key takeaways for complex, multiparty cases follow:

1.      Identify the Key Claim(s)/Issue(a) at the Outset: While the plaintiff subcontractor filed three complaints with more than 15 counts, all of them relied on the subcontractor’s allegation that the project’s design/construction manager had conspired with the owner and the Pirates to improperly issue a default notice so that they could access the subcontractor’s performance bond to pay for cost overruns and delays. Refuting that allegation was the central focus from the beginning to the end of the case.

2.     Narrow the Case Before Discovery: Since we represented five clients defending more than 15 counts, we had to narrow the case as early as possible. We did our due diligence and then convinced the judge to dismiss the far-fetched and legally-defective claims against the municipal owner and the Pirates. Similarly, we significantly narrowed the claims against the design/construction manager.

3.     Know the Facts: Though voluminous, we identified the key facts for all aspects of the project – bidding, award, project preparation, project performance issues and eventual default notice, post-default notice performance, and post-project issues. This includes the relevant project documents and the project executives. Credible fact witnesses and experts who teach (rather than preach) to the judge and/or jury are absolutely critical to success.

4.     Simplify/Support Your Primary Arguments: Judges and juries must be able to understand your primary arguments before they can agree with them and rule for your client. The strongest defenses focus only on the most important arguments, present those arguments in a simple and easy to follow manner, and rely on credible facts provided through first-hand documents and testimony. Judges and juries rarely care about mere opinions. Even the most complicated construction disputes can be distilled into one or a few fundamental arguments that a judge and/or jury can follow – and use to rule for your clients.

5.     Convince the Fact Finder that Your Client Acted Appropriately. At trial – whether bench or jury – you must clearly establish that your client did the right thing under the circumstances and must be made whole. In short, this means establishing that your client was wronged and that the judge/jury must right that wrong by awarding damages (monetary or otherwise) or render a defense verdict.