WHEN YOU CAN AND CAN’T WITHHOLD RETENTION IN CALIFORNIA AND OTHER THOUGHTS BY THE CALIFORNIA SUPREME COURT
By Laurence P. Lubka
Lubka & White LLP
The California Supreme Court only infrequently rules on construction issues. It did so this week. In United Riggers and Erectors, Inc. v. Coast Iron and Steel, United Riggers was a subcontractor to Coast Iron. United Riggers had completed its work on a project and that work had been accepted. United Riggers was owed $149,602.52 in retention. Coast Iron withheld payment of that retention when United riggers filed a claim of approximately $350,000 against Coast Iron based on change order requests and “expenses attributed to Coast Iron’s mismanagement”. Coast Iron would later pay the retention, but only after the prompt payment deadline had passed. United Riggers would lose it claim for $350,000.
United Riggers pressed its claim for prompt payment penalties based on the late paid retention. The issue was whether Coast Iron could withhold the retention based on any dispute or if it could only do so if the dispute involved the retention itself. There was historic caselaw support for both positions. The Supreme Court held in the United Riggers case that the retention withholding must involve a dispute regarding retention and that the Coast Iron withholding did meet that standard. Coast Iron was held to be subject to prompt payment penalties.
In reaching this decision, the Supreme Court made several comments in its decision that will be useful in future non-prompt payment cases.
- To withhold money that is owed is not proper since that “would create a windfall. Coast Iron would be able to secure for itself an interest-free loan of the additionally withheld ”
- [T]he prompt payment statutes are best understood uniformly, as requiring that all monies not themselves in dispute be paid over in a timely
- [T]he Legislature understood the importance of timely payment to contractors’ cash
- [C]ash flow … would be impaired if any dispute between two contractors on one project could forestall payment on another, unrelated
- [The] East West Bank [case] emphasized the underlying purpose of the prompt payment statute: to ensure timely payment of the retention as soon as its narrow justifications have been
- From this provision it reasons that the Legislature was willing to allow withholding of amounts not in dispute.
- Yet the most reasonable understanding of the 150 percent clause is also the most straightforward –– by allowing withholding up to 150 percent, the statute provides a margin for error for managing the run-of-the-mill disputes about construction that lie at the heartland of the statute’s purpose, given the likelihood of uncertainty about the precise cost of incomplete or inadequate work. The resulting leeway insulates payors from statutory penalties and prevailing party fees in the event a judge or jury later takes a marginally different view of the amount genuinely in dispute. (Ed: This adds quite a bit to the understanding of the purpose and application of the 150% withhold standard.)
- This interpretation comports more closely with the prompt payment statutes’ underlying remedial purpose: to ensure timely payment of undisputed amounts to contractors, without impairing the ability of payors to withhold amounts as security when the obligation to pay those specific monies is in doubt.
- Consistent with this rule, a direct contractor may delay payment when the sufficiency of the subcontractor’s construction-related performance is the subject of a good faith dispute, when liens or other demands from third parties expose the direct contractor to potential double payment, or when payment would result in the subcontractor receiving more than the minimum amount both sides agree is due. What a direct contractor may not do is withhold a retention that is simply part of that undisputed minimum amount, because a dispute has arisen over whether additional amounts over and above the retention might also be owed. In effect, the payor must be able to present a good faith argument for why all or a part of the withheld monies themselves are no longer due.
The last section above, Item 9, is both a summary of the court’s description of when there can be withholding and a warning that the party withholding funds should, at the time of the withhold, be able to document the basis for the withholding. Otherwise, the withholding party is potentially subject to prompt payment penalties, attorney’s fees and sometimes, interest.
The California Supreme Court has clarified what has been a sticky question, but a careful reading of the case may provide some clues for future disputes in California’s construction business.