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A Recent Appellate Court Decision Significantly Impacts A Subcontractor's Means for Recovering California Prompt Payment Penalties
Posted by: William Last
December 28, 2009

A Recent Appellate Court Decision Significantly Impacts A Subcontractor's Means for Recovering California Prompt Payment Penalties

By

William C Last, Jr

And

Jonathan Bowne

Attorneys at Law

On December 4, 2009 the California Third District Court of Appeals published its decision in Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc. This decision will impact California's prompt payment penalty statutes becuase it allows a prime contractor to avoid prompt payment penalties by including language in its subcontract that conditions payment on the receipt of lien release and other requirements. This decision also appears to expand the ability of prime contractors to withhold retention funds without being subject to prompt payment penalties.

As most contractors are aware, California has enacted prompt payment statutes. The statutes are intended to penalize parties that fail to pay contractors within a determined period. The statutes, however, contain certain exceptions. Generally, the non-paying party can withhold up to 150% of any disputed payment.

While the prompt payment statutes may ultimately require you to institute legal action to recover the penalties, they are significant threats to non-paying parties. It is a good practice to recite the appropriate statute in any collections demand letter. The threat of a 2% penalty and attorney's fees may be sufficient to convince a non-paying party to pay the amount owed.

In this case Martin Brothers Construction ("Martin") was a subcontractor to Thompson Pacific Construction ("TPC") on a public works project. During the project Martin submitted to TPC several change requests seeking payment for disputed items. These change orders had not yet been resolved by the time Martin completed its work in March 2004. At that time Martin submitted a pay application for the change orders it was seeking and its retention. TPC and Martin agreed in their subcontracts "that payment is not due until Subcontractor has furnished all applicable administrative documentation required by the contract documents and the applicable releases pursuant to Civil Code section 3262." Martin apparently did not submit conditional lien releases for these funds along with the pay application. TPC did not pay either the change orders or retention at that time. In August 2004 the owner released retention to TPC, who continued to hold Martin's retention.

Thereafter the parties continued to negotiate the changes orders and a final payment amount. In December 2004 Martin filed a lawsuit against TPC and its bond surety. In March 2005 the parties reached an agreement whereby Martin was to submit lien and bond claim releases in exchange for an agreed amount which would constitute a final payment. Thereupon Martin submitted the conditional lien releases and received the agreed funds.

However, their dispute was not concluded at that juncture. Martin continued forward in the litigation and went to trial to seek prompt payment penalties on the basis that while payment of the progress payments and retention were eventually made (by way of the March 2005 payment), they were not timely made and the funds wrongfully withheld in violation of the prompt payment statutes.

The trial court ruled that Martin was not entitled to prompt payment penalties for the reasons discussed below, and Martin appealed. The appeals court agreed with the trial court and denied Martin prompt payment penalties. In doing so the court discussed the penalty claims relative to progress payments and retention separately. Each discussion yielded a noteworthy holding.

•1) Progress Payments: Subcontractor's may be "opting out" of the protections of prompt payment penalty statutes when they agree in subcontracts that progress payments are not due until conditional lien releases are submitted.

Martin sought penalties for the withholding of progress payments relative to its pay applications for the disputed change orders. Prompt payment penalties relative to progress payments are governed by Business and Professions Code §7108.5, which provides that a prime contractor shall pay subcontractors progress payments not later than 10 days after receipt of funds from the owner, "unless otherwise agreed in writing".

Importantly, the Court held that the language in the contract that stated "Subcontractor agrees that payment is not due until Subcontractor has furnished all applicable administrative documentation required by the contract documents and the applicable releases pursuant to Civil Code section 3262" was essentially an agreement that changed the timing for payment and thus the right to recover prompt payment penalties.

Unfortunately for Martin, it never bothered submitting conditional lien releases for the disputed amount until the March 2005 agreement for payment was reached many months after the change order disputes arose. TPC argued that no penalties should be imposed because no actual "withholding" of progress payments occurred. TPC asserted that the funds in question never actually became due until the conditional lien releases were tendered, which did not occur until the payment was made in March 2005.

In essence TPC was arguing by agreeing in the subcontract that payment was not due until conditional lien releases had been submitted Martin had "waived" its right to be paid within 10 days of TPC receiving progress payment funds as provide by Section 7108.5. TPC pointed out that Section 7108.5 appeared to allow such waiver by stating that the 10 day timeline was applicably "unless otherwise agreed in writing." TPC argued that it and Martin had effectively done so.

The Appellate Court in its decision stated: "Contrary to the argument of Martin Brothers, this language plainly reflects an intent of the parties to do more than simply follow the statutory guidelines for lien releases in Civil Code section 3262. The subcontractor language is a clear agreement to alter the timing of payments from Thompson Pacific to Martin Brothers. The language of the subcontracts that provides for monthly progress payments of "95% of labor and materials which have been placed in final position and for which the right to payment has been properly documented pursuant to the terms of this agreement" is consistent with this expressed intent to alter the timing of progress payments. The trial court correctly interpreted the language as a waiver of the payment requirements of section 7108.5."

•2) Retention: A prime contractor may withhold retention from a subcontractor in the event of any bona fide dispute, even if the dispute is unrelated to retention funds.

In addition to seeking prompt payment penalties for the withholding of progress payments, Martin sought penalties for the withholding of retention funds. Public Contract Code §7107 governs prompt payment penalties relative to retention funds on public projects. It provides that a prime contractor must pay a subcontractor retention funds within seven (7) days of receiving the same from the public entity. But, subsection (e) allows a prime contractor to withhold from retention funds up to 150% of a disputed amount in the event of a bona fide dispute. In this case TPC withheld from Martin progress payment and retention funds after the change order disputes arose.

Martin argued that it should be entitled to prompt payment penalties pursuant to Section 7107 because TPC withheld retention funds because of disputes over change orders, which it argued was unrelated to retention. Martin's argument was consistent with the customary usage of retention, which is to ensure the satisfactory completion of work. Martin was arguing that so long as its work was completed satisfactorily (as apparently it was here) that retention should be released, regardless of whether or not there were still disputes about the compensability of change orders. To wit, Martin asserted that the withholding provision in subsection (e) should only apply to disputes regarding retention funds, such as disputes over punch lists, completion of work issues, or workmanship problems. In turn, Martin asserted that a prime contractor should not be able to withhold retention when the dispute arises from only non-retention related issues, such as change orders (as was the case here).

The appeals court disagreed. It noted that while the Section 7107 itself concerned retention funds, it expressed no limit regarding the nature of a dispute which could be used justify a retention funds withholding pursuant to subsection (e). The court noted that a contrary rule would be too difficult to apply because construction disputes are often difficult to characterize. As such, the court held that a prime contractor could withhold from a subcontractor 150% of disputed amount from retention funds in the event of a dispute of any nature, regardless of whether or not the dispute was related to the retention itself.

Conclusion

The Martin decision is a significant development in the law of prompt payment penalties, although its impact is not yet certain. One thing does seem clear though: Martin decision weakens subcontractor's hands relative to prompt payment. Prime contractors (or owners) may now seek to include expanded prompt payment "opt out" provisions in their subcontracts and use these provisions to justify payment withholdings from contractors who are not diligent in submitting lien releases and/or other conditions to payment. Likewise, prime contractors may expand the practice of withholding retention funds as a matter of course whenever any disputes remain after the project has completed.

Copyright 2009, William C. Last, Jr. wrote this article. Mr. Last is an attorney who has been specializing in Construction Law for over 30 years. In addition to belonging to a number of construction trade associations, Mr. Last holds a California AA@ and AB@ license. He can be contacted at 415-764-1990 or 650-696-8350. A number of his past articles can be found on his website (lhfconstructlaw.com). This bulletin is published periodically to provide general information about current legal issues. The articles are not intended to be a substitute for the advice of an attorney as to a specific problem. If you have a specific legal question or need legal advice, you should contact an attorney.

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Actions a Contractor Can Take to Help Survive Tough Economic
Posted by: William Last
February 24, 2009

Actions a Contractor Can Take to Help Survive Tough Economic

By

William C. Last, Jr.

Attorney at Law

The construction industry is experiencing severe retraction due, in part, to financing for projects being restricted and government budgetary limitations. It has become increasingly common for a partially completed project to be halted or for payments for an ongoing project not to be paid in a timely manner. As a result, more than ever contractors must be vigilant and proactive in protecting their interests. This article will discuss some of things that can be done to minimize the risk of going unpaid on a project.

First and foremost, contractors must be diligent in looking for the signs that a project maybe in trouble. Those signs include: (1) slow and delayed progress payments; (2) scheduling deadline slippage due to subcontractors who are not performing; (3) predecessor subcontractors and suppliers who are decreasing their manpower and slowing deliveries; (4) future phases and releases of the project being terminated; (5) the project lender being taken over or going out of business; (6) other projects that are being developed by the owner being terminated; (7) project subcontractors or suppliers going out of business; (8) the project lender starting the foreclosure process; (8) if part of the project is completed, the completed units are not being sold or rented; and.(9) if it is a public project, the public entity has had the funding for the project stopped or delayed.

If you detect any of the warning signs you must take immediate action to protect your interests. Such actions should include, but not be limited to:

1. Review the status of your preliminary lien notices: Mechanic's liens, stop notices and payment bond claims are unique remedies that are available to contractor to ensure that he or she will be paid. But to be effective, the contractor must comply with all of the applicable statutory prerequisites for recording and foreclosure of the lien. There are three prerequisites for enforcing such remedies. These are the timely service of a Preliminary 20-Day Lien Notice; the timely recordation and/or service of the lien, stop notice and/or bond claim; and the timely filing of a lawsuit to perfect such remedies. If you have yet to serve a 20-Day Lien Notice and you are obligated to do so, you should serve one if your work is not completed. By doing so, you can use the aforementioned remedies for the goods and services provided up to 20 days before the notice was served as well as for the period after the service.

Under Civil Code §3097(o), if a 20-Day Lien Notice is properly filed with the County Recorder, that Recorder has the good faith duty to notify the filing party within five (5) days following recording of a Notice of Completion or a Notice of Cessation. This extra step of filing the Preliminary 20-Day Lien Notice with the Recorder in the county where the property is located, will aid you in determining when a Notice of Completion is filed. However, the system is not fool-proof since the Country Recorder has no liability should it fail to notify the contractor that a Notice of Completion has been filed.

Also, you must ensure that the 20-Day Lien Notice includes the proper names and address of the relevant parties. If the notice does not include the correct project owner name then the notice will be ineffective. If you are a subcontractor or supplier do not necessarily rely on information given to you by a general contractor, as it may be incorrect. Themost reliable source for property owner information is at the recorder's office in the county where the project is located.

2. Monitor the project status and make ongoing inquiries: When you are working on the project keep in contact with other subcontractors and suppliers to discuss the status of their payments. Many counties have websites that allow you to access legal filings. Such filings can indicate if a contractor and/or owner is being sued by subcontractors for non-payment. Those filings are listed by party name. They can show when lawsuits were filed and the parties.

If any of the following occurs, discuss the impact of the event with competent construction law counsel: (1) the project owner or the project general contractor changes; (2) work on the whole project is stopped for more than 20 days; and/or (3) a bankruptcy filing by the owner, general and/or your subcontractors and suppliers. Any of the foregoing events may necessitate you to take prompt legal action to protect your rights.

3. Review Contract Notification and Dispute Provisions: If a project is stopped you should consider how the delay will impact your future performance. For example, you may be forced to remove your equipment from the site and then bring it back, or your jobsite overhead costs may increase as the time it takes to complete the project is extended. If that occurs you maybe entitled to additional compensation. However, you must give notice to the other party. Many construction subcontract clauses require the subcontractors to give notice of change orders, delay/disruption claims and other disputed items. Those types of clauses typically condition the subcontractor's right to recovery on timely notification, followed with a timely, detailed, and documented claim.

Most contracts also have dispute resolution clauses. They may require the parties to mediate a dispute before an arbitration demand or a lawsuit is filed. You should immediately consult with competent legal counsel if those requirements will interfere with fulfilling the requirements for recording and filing an action on a lien, serving and taking legal action on stop notices and payment bond claims.

4. If payments are being delayed consider how best to respond: If the project owner or the project general contractor changes, or the owner or surety takes over the project, be sure to discuss with a competent construction law attorney how to protect your lien rights. The same holds true if there is a bankruptcy filing by the owner, general and/or your subcontractors and suppliers.

The time limits within which all liens must be recorded, payment bond claims made and/or stop notices must be served are based on when the project is completed, or work on the project stops short of actual completion. The specific time limitation for recording a lien, serving a payment bond claim and/or serving a stop notice is based on: (a) whether actual completion occurs, or there is an equivalent to completion; and (b) whether or not the owner shortened the recording deadlines by recording a Notice of Completion or Notice of Cessation. After you leave the project monitor the project to ascertain if there were any short term work stoppages. Also monitor the project to determine when substantial completion was obtained or if a Notice of Completion was recorded.

The time limits within which all liens must be recorded on private works are based on when the project is completed, or work on the project stops short of actual completion. When actual completion has not been obtained, California law defines what constitutes completion so that the contractor will know when time for recording a lien commences to run.

Specifically, Civil Code §3086 states: "Completion" means, in the case of any work of improvement other than a public work, actual completion of the work of improvement. Any of the following shall be deemed equivalent to a completion: (a)The occupation or use of a work of improvement by the owner, or his agent, accompanied by cessation of labor thereon; (b) The acceptance by the owner, or his agent, of the work of improvement; (c) After the commencement of a work of improvement, a cessation of labor thereon for a continuous period of 60 days, or a cessation of labor thereon for a continuous period of 30 days or more if the owner files for record a notice of cessation.

The general rule is that when all the work on the project actually has been completed all possible lien claimants must record their liens within ninety (90) days from the date of actual completion. (Civil Code §§ 3115-3116).

If the project is not completed, but all work on the project stops for a specific period, California law deems the work complete after a certain period of time passes. If there is a cessation of labor for a continuous period of sixty (60) days, California law declares that such cessation is deemed to be an equivalent to the completion of the work. After that sixty (60) day period elapses, all possible lien claimants must record their liens within ninety (90) days from that date. (Civil Code §3092).

For example, if the owner runs out of money and cannot complete the original agreed-upon scope of work and, as a result, all work stops before the project is complete, the contractor has one hundred and fifty (150) days from the total and complete stoppage of all work to record a mechanic's lien so long as no Notice of Cessation was recorded.

If, however, during the first fifty-nine (59) days of the work stoppage, the original agreed-upon scope of work recommences, the time for recording a mechanic's lien will be restarted and subject to the same rules relative to: (a) whether actual completion occurs, or there is an equivalent to completion; (b) whether or not the owner shortened the deadlines by recording a Notice of Completion or Notice of Cessation; and (c) whether or not the contractor has a direct contract with the owner of the project.

The deadlines when a Notice of Completion or a Notice of Cessation have been recorded are:

•· Notice of Completion: When an owner records a valid Notice of Completion (i.e. 10 days after actual completion of work on the project) (Civil Code §3093): (a) Prime contractor in direct contract with the owner must record his or her lien within sixty (60) days of the recording of the Notice of Completion (Civil Code §§ 3115-3116); (b) All others must record their liens within thirty (30) days of the date the Notice of Completion is recorded. (Civil Code §3116).

•· Notice of Cessation: When an owner, after thirty (30) days of continuous cessation of labor, records a valid Notice of Cessation (this is the equivalent of recording a Notice of Completion). (Civil Code §3092): (a) Prime contractor in direct contract with the owner must record his or her lien within sixty (60) days of the recording of the Notice of Cessation; (b) All others must record their liens within thirty (30) days of the date the Notice of Cessation is recorded. (Civil Code §§ 3115, 3116).

In addition to recording a mechanics lien a contractor can also serve a bond stop notice on a private works lender. On a public works project, a contractor can serve a stop notice and also pursue the payment bond surety. These remedies are cumulative. When the economy turns down it is always to pursue every available remedy.

Conclusion

In the current construction environment it is increasingly common for a contractor to learn that a project is going to be stopped or that the owner doesn't have the funds to pay for the work that has been performed. In such an event it the contractor must determine how the stoppage will impact there ability to collect for the work performed and how it can impact the overall cost of the project. It becomes important to document when the project was stopped so that key dates for recording liens, serving stop notices and/or bond claims can be calendared and subsequently acted on.

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2008 Update SB 1691: The Mechanics Lien Law That Is Before the Legislature
Posted by: William Last
May 08, 2008

Over the past several years, the California Law Review Commission has been reviewing the existing mechanics lien laws and considering changes to those laws. Proposed changes to the existing mechanics lien laws will affect both public and private mechanics liens, stop notices, and payment bonds. The bill includes substantive and nonsubstantive changes to the existing laws.. As part of the California Law Review Commission process, the Commission received comments from members of the construction industry.

During February of 2008, Senate Bill 1691 was introduced. The bill is currently undergoing review by the California Senate. California Law Review Commission 2008-11 (April 2008) memorandum indicates that due to the large size of the bill and the various construction industry members who could be affected by the bill it is doubtful that all their proposed changes will be enact in one legislative session. The Commission is suggesting that the substantive aspects of the legislation be deferred until next year

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