Eric J. Rollins | Newmeyer & Dillion LLP | June 27, 2016
It is common in California for the owners of a project to make monthly payments to a contractor for work as it is completed, but withhold a certain percentage as a guarantee of future satisfactory performance. Contractors almost always pass these withholdings on to their subcontractors. Unsurprisingly, disputes can arise regarding when the withheld retentions must be paid.
Civil Code section 8814, subdivision (a), states that a direct contractor must pay each subcontractor its share of a retention payment within ten days after receiving all or part of a retention payment. However, an exception exists — a direct contractor may withhold from the retention paid to a subcontractor an amount not in excess of 150 percent of the estimated value of the disputed amount, whenever a “good faith dispute exists between the direct contractor and a subcontractor.” (See Cal. Civ. Code, § 8814, subd. (c).) The problem with the statute is that it offers no help in defining a“good faith dispute,” and the California courts have historically not provided much guidance either. Can a “good faith dispute” be any dispute between the contracting parties, e.g., a dispute regarding change orders, mismanagement, etc.? Or must the dispute relate specifically to the retention? Unfortunately for California litigants, the answer may depend on the appellate district in which the parties find themselves.
In United Riggers & Erectors, Inc. v. Coast Iron & Steel Co. (2015) 243 Cal.App.4th 151, a contractor confronted this issue and was forced to decide whether it could legally withhold a portion of a retention payment from a subcontractor with whom the contractor had a dispute. In this recent case decided by the Second District Court of Appeal, Universal City Studios LLLP (“Universal”) contracted with Coast Iron & Steel Co. (“Coast”) to provide metal work in the construction of the new Transformers ride at Universal Studios. United Riggers & Erectors, Inc. (“United Riggers”) signed a purchase order with Coast and served as a subcontractor to Coast. Universal paid Coast on a monthly basis, but retained approximately ten percent of the total amount due under the contract pending final completion of the work. When the project completed, Universal paid Coast the retentions. At that time, Coast owed United Riggers approximately $150,000 for its share of the retentions. Shortly after the job was completed and before Coast paid United Riggers its final amount, United Riggers wrote a demand letter to Coast seeking an additional $352,542 in unpaid change orders and compensation due to mismanagement. In response, Coast refused to release United Riggers’ portion of the retention, presumably believing that Coast’s letter was a sufficient “good faith dispute” to allow it to ignore the ten-day payment mandate of Civil Code section 8814, subdivision (a).
United Riggers filed an action challenging Coast’s failure to pay out its portion of the retention. The trial court ruled in favor of Coast based upon the prevailing authority on the issue at the time, Martin Brothers Construction, Inc. v. Thompson Pacific Construction,Inc. (2009) 179 Cal.App.4th 1401, in which a Third District Court of Appeal held that nearly any dispute between contracting parties was sufficient to withhold a retention payment because the statute contains no limiting language except that the dispute must be “bona fide.” United Riggers appealed, and while its appeal was pending, a Second District Court of Appeal in East West Bank v. Rio School Dist. (2015) 235 Cal.App.4th 742, rejected the rationale of Martin Brothers and held that withholding a retention in the public works context is justified only when the purported“good faith dispute” is about the retention itself.
The United Riggers court followed East West Bank and reversed the trial court. In doing so, the court criticized Martin Brothers for neglecting the public policy and intent of the statute, which was to protect contractors by allowing them to insist on satisfactory performance from subcontractors prior to final payment, but also to protect subcontractors by ensuring prompt payment. The court noted that“[t]o excuse Coast in this case from paying United the retention payments would unduly increase the leverage of owners and primary contractors over smaller contractors and subcontractors by discouraging subcontractors from making legitimate claims for fear of delaying the retention payment.”
In summary, the law in California regarding withholding of retention payments is currently in flux. Two decisions from the Second District Court of Appeal have held that retention payments can only be withheld if the dispute relates to the retention, while the Martin Brothers decision from the Third District Court of Appeal is still good law and holds that any“good faith” dispute provides adequate support for withholding a retention payment. Until the California Supreme Court considers the issue, withholding of retentions must be carefully considered. Making the wrong decision can subject the offending party to penalties, attorney fees, and court costs.