When a general contractor subcontracts work in California, it is standard practice that payment is made by the general contractor to the subcontractor on a monthly basis. The contractor is allowed to withhold a certain amount of the payment due as a retention in order to ensure that the subcontractor continues to uphold their end of the bargain at the expected level of quality. The payment of these retention funds is dictated by Civil Code § 8800 et. seq, and in particular § 8814 subdivision (a) which mandates that the payment of the retention must be made by the direct contractor to the subcontractor within ten days of the direct contractor receiving all or part of the retention payment. Failure to make the payment can result in two financial penalties for the direct contractor: a two percent penalty per month of the amount withheld as well as any fees resulting from the litigation brought by the subcontractor to collect the funds. Subdivision (c) allows for one general circumstance when the retention payment may be withheld, stating “If 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.” (See Cal. Civ. Code, § 8814, subd. (c) (Section 8814(c)).)
The statute does not define what qualifies as a good-faith dispute, and until recently, the question as to what qualified remained unanswered. The California Supreme Court put the question to rest in May of 2018, when it decided in favor of the Court of Appeal ruling in United Riggers & Erectors v. Coast Iron & Steel, Case No. S231549 (United Riggers). In agreeing with the Appeal ruling, the California Supreme Court stated,
“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.” (Id. at p. 1).
The United Riggers Case
In 2010, Coast Iron & Steel Co. (Coast Iron) was selected by Universal City Studios LLLP (Universal) to design, furnish, and install metal work for Transformers: The Ride, agreeing to pay a monthly fee, minus a ten percent retention withholding. Coast Iron subsequently subcontracted United Riggers & Erectors, Inc. (United Riggers) to install the metal work supplied by Coast Iron. While the original agreement would have paid United Riggers $722,742 for the work, the cost rose to about $1.5 million without dispute. In 2012, Coast Iron received the final bill from United Riggers which amounted to $1.85 million, a $274,158.40 increase as a result of mismanagement and an additional $78,384 for outstanding change order requests. Coast Iron refused to pay the final $149.602.52 when they received their retention payment from Universal.
The Court of Appeals Decision
While the trial courts sided with Coast Iron, the Court of Appeals disagreed, choosing to follow a narrower application of the good faith dispute provision. The Court of Appeal reached the conclusion through the reasoning that failure to hold Coast Iron accountable for the payment, or simply an overly broad interpretation of what qualified as a good faith disagreement, would apply an undue burden upon subcontractors, who would be discouraged from bringing suits against direct contractors to recover the full amount owed for their services for fear of delaying the retention payment United Riggers & Erectors v. Coast Iron & Steel (2015), 243 Cal.App.4th 151. The Court of Appeal explained that purpose of the statutes outlining these retention payments would be bastardized by a ruling allowing the direct contractors wide discretion to withhold the payments. (Id.)
The Supreme Court of California Decision
Oral arguments began in the Supreme Court of California (The Court) on March 6, 2018. Coast Iron began by comparing Civil Code § 8814 to § 8812, which outlines payments between owners and direct contractors. Unlike § 8814 (c), §8812 expressly states that only a good faith dispute about the retention payment may allow the owner to withhold the payment. Coast Iron’s argument was predicated on the point that if the Legislature intended to limit the situations when payment could be withheld, it would have applied equally strict wording to § 8814 as it did to § 8812. The Court pushed back against this interpretation, with Justice Kruger warning that such a reading could lead to the retention payment being withheld for any reason, even unrelated projects. United Riggers argued that § 8814 contained an implicit restriction because the very subject of the section is the timeliness of retention payments.
In its decision, The Court recognized the purpose of the statutes was to alleviate the slow payments that were riddling the industry. Previously, owners and direct contractors could withhold payments as a way of effectively granting themselves interest free loans. The Court first considered the three subsections of § 8814, noting that each intrinsically dealt with the topic of retention payments. Then, it cited Doe v. City of Los Angeles which stated that the “words [of a statute] must, of course, be read in the context of the provisions as a whole” (Doe v. City of Los Angeles (2007) 42 Cal.4th 531, 546).
While acknowledging that if the omission of such explicit text as is found in § 8812 was unique to § 8814, then a broad ruling in favor of direct contractors could be reasonable, The Court found that no such pattern exists across the Civil Code or other codes which govern the timing of progress payments such as the Business and Professions Code or the Public Contract Code. In lieu of any such pattern, the text of the section will suffice to provide meaning to the intentions of the Legislature. Additionally, The Court pointed out that a reading of the section that allowed for the withholding of payment under any circumstance would make the entire section moot, as its purpose was to ensure prompt payment. The Court further addressed the Legislative history, noting that the language of § 8812 was meant to clarify existing law, and “the lack of any corresponding addition to section 8814 is not significant.” (United Riggers, at p. 15). Finally, in regard to Coast Iron’s argument that the Legislature made the language omission in response to a concurrent ruling favorable to direct contractors, The Court pointed out that the draft legislation was made prior to the ruling, and therefore the two were unrelated.
When considering the scope of a good faith argument in a construction default case, The Court has made clear that a variety of sources should be used. In the event of ambiguous language in the governing subsection, the language in other subsections should be used to provide relevant context as to the intended scope of the section as a whole. Additionally, other related sections should be considered to determine whether an omission of specificity is irregular or a standard practice of the Legislature. Furthermore, the legislative history should be considered to determine if changes were made to the Civil Code to specifically omit language, or if it was simply a contextual oversight resulting from changes to other sections, as it seems to have happened in this instance. Finally, the fundamental intentions of the section should be considered, particularly in regard to the ill the Legislature sought to cure. In United Riggers¸ The Court used this process to determine that ambiguous language can still be read narrowly in order to implement the purpose of the guiding legislation, effectively limiting when direct contractors may withhold retention payments from their subcontractors.