On May 14, 2018, the California Supreme Court issued its opinion in United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., No. S231549, slip. op. (Cal. Sup. Ct. May 14, 2018). In it, the Court narrowly construed the “good faith” exception to the general rule that a direct contractor must make retention payments to its subcontractors within 10 days of receiving any retention payment. The exception provides that “[i]f a good faith dispute exists between the direct contractor and a subcontractor, the direct contractor may withhold from the retention to the subcontractor an amount not in excess of 150 percent of the estimated value of the disputed amount.” Cal. Civ. Code section 8814(c).

Despite the broad language of Section 8814(c), the Court held that it excuses payment:

[O]nly 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 may not . . . . 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.

By way of background, the critical facts in United Riggers were not in dispute.^[1] The general contractor, Coast Iron & Steel Co. admitted that (1) it did not pay its subcontractor United Riggers & Erectors in a timely manner the retention it received from the project owner, and (2) United Riggers’ performance for which Coast had received retention payments was adequate. Instead, the parties’ disagreement concerned United Riggers’ demand for additional monies it claimed it was owed for the increased expenses it incurred as a result of Coast’s mismanagement of the project. Coast withheld United Riggers’ retention payments on the basis of this dispute, citing Section 8814(c), after which United Riggers’ sued Coast for the alleged increased expenses and prompt payment penalties. The resolution of the disagreement thus turned on whether Section 8814(c)’s exception to timely payment of retention applied to any good faith dispute or only a dispute that was directly relevant to the retention payment.

The Court chose the latter interpretation after applying several principles of statutory interpretation. The Court first explained that it was required to read Section 8814 in the context of “the provision as a whole” and “the statutory scheme as a whole.” Reading the statute in context, the Court explained that “Section 8814 is one of a series of provisions meant to ensure timely payment to contractors and subcontractors.” Looking at those prompt payment provisions and their corresponding exceptions, the Court noted that some were drafted “using language that plainly limits withholding to circumstances in which the dispute relates to the specific payment amount or payment at issue[,]” but that the Legislature was inconsistent in its statutory language. Id. at 9-10 (citing Bus. & Prof. Code § 7108.5(a); Civ. Code §§ 8800(b), 8802(b), 8812(c); Pub. Contract Code § 10262.5(a)). In light of this inconsistency, the Court determined that the statute was textually ambiguous, therefore and turned to the statute’s broader purpose to guide its interpretation. Given the remedial purpose of the statute to protect the right to fair compensation for contractors, laborers, and suppliers, the Court determined that it must construe Section 8814(c) narrowly. To do otherwise, the Court cautioned, would run the risk of contractors potentially withholding retention payments to gain unfair leverage against their subcontractors.

Although this case involved a private work of improvement, the Court also resolved a split in authority regarding the good faith exception for withholding retention payments in public works of improvement. Compare Martin Brothers Construction, Inc. v. Thompson Pacific 4 Construction, Inc., 179 Cal. App. 4th 1401 (2009) (construing Pub. Contract Code § 7107(e), and holding any bona fide dispute can justify withholding retention payment), with East West Bank v. Rio School Dist., 235 Cal. App. 4th 742 (2015) (only disputes related to the retention’s security functions can justify withholding payment). The Court disapproved Martin Brothers to the extent it was inconsistent with its foregoing opinion, and cited with approval East West Bank, indicating that its decision in United Riggers applies with equal force in the public contract context.

There are two key takeaways from this opinion. First, direct contractors should immediately review any currently withheld retention payments to determine whether they pass muster under United Riggers, and take steps as necessary to minimize exposure to claims for prompt payment penalties and attorney fees. Second, going forward, direct contractors will need to be cautious when withholding retention payments from subcontractors and ensure that retention is only withheld where the adequacy of the work is at issue or to otherwise ensure performance of work to which the retention relates.

[1] This is the second post in a two-post series. Our first post provides additional background information about the case as well as the statutory scheme at issue. It can be found here.