California Supreme Court Limits a Direct Contractor’s Ability to Withhold Money from Subcontractors

The California Supreme Court recently provided a significant win for subcontractor prompt payment rights.  The court unanimously held in the case of United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., that the direct contractor may only delay payment to its subcontractors when there is a good faith dispute regarding the sufficiency of the subcontractor’s performance of the work that is directly related to the monies that are being held. Specifically, the case clarified what constitutes a good faith dispute that allows an owner or direct contractor to withhold payment under prompt payment laws.

Under most prompt payment statutes, the party who is supposed to make payment may withhold 150% of any amount in dispute from the sums that the party otherwise would be required to pay.  Over the past decade, there were two conflicting lines of appellate cases with regard to what constitutes the type of dispute for which funds may be withheld.

One line of cases, including Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc., interpreted the withholding language very broadly and held that any dispute, of any kind, would justify withholding of payment.  Under these cases, even an affirmative claim (such as a request for a change order) by the party seeking payment could justify withholding of payment of undisputed amounts.

The second line of cases interpreted the withholding language more narrowly.  Under this line of cases, which included East West Bank v. Rio School Dist., the courts held that withholding retention is only justified by disputes related to the retention’s security function.

The California Supreme Court ruling in United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., resolved the conflict between these two lines of cases.  The Supreme Court decided to follow the line of cases that more narrowly interpreted the statutory withholding language and disapproved Martin Brothers.

The facts of the case were straightforward.  On a project for Universal Studios, Coast Iron subcontracted to United Riggers the installation of the fabricated metalwork.  The work was done to everyone’s satisfaction.

Universal Studios paid retention to Coast Iron, but Coast Iron failed to pay United Riggers retention that had been withheld from its progress payments.  Coast Iron had continued to withhold retention from United Riggers because Coast Iron was aware of substantial claims that United Riggers had against Coast Iron relating to other aspects of the job.  United Riggers demanded the balance of its original contract, increased expenses which it attributed to Coast Iron’s mismanagement, and another sum for outstanding change order requests.

United Riggers argued that because the base contract work was completed satisfactorily, Coast Iron was obligated, at a minimum, to pay the uncontested base contract balance, including the retention.  The Supreme Court agreed and determined that Coast Iron had wrongfully withheld payment and held that United Riggers was entitled to recover interest, prompt payment penalties, and attorney’s fees, stating that:

The dispute exception excuses payment only when a good faith dispute exists over a statutory or contractual precondition to that payment, such as the adequacy of the construction work for which the payment is consideration. Controversies concerning unrelated work or additional payments above the amount both sides agree is owed will not excuse delay; a direct contractor cannot withhold payment where the underlying obligation to pay those specific monies is undisputed. 

In other words, the court stated that base contract progress payments and retention can only be withheld if the dispute deals with work in the original contract or the retention itself.

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