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Notice, Good Faith Issues Clarified in California Prompt Payment Case
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February 19, 2007
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Thelen Reid Brown Raysman & Steiner LLP
California Business and Professions Code §7108.5 and Civil Code §3260 require that contractors pay their subcontractors within 10 days of receiving progress payments or retention payments unless otherwise agreed to in writing. If there is a good faith (or bona fide) dispute over all or any portion of the amount due to a subcontractor, then the prime contactor may withhold up to 150 percent of the disputed amount.
A violation of the prompt payment statutes is cause for disciplinary action and subjects the licensee to a penalty, payable to the subcontractor, of 2 percent of the amount due per month for every month that payment is not made. The prevailing party in an action under the prompt payment statutes also is entitled to attorney fees and costs. The prompt payment statutes apply to owners as well to as contractors.
Alpha Mechanical, Heating & Air Conditioning, Inc. entered into a subcontract with RAS Builders, Inc. for plumbing and mechanical work in connection with the construction of a new hotel. Travelers Casualty & Surety Co. of America issued a payment bond to RAS for the project. A dispute arose when RAS withheld payment of $199,000 from Alpha because Alpha allegedly caused damage to other trades' work. Alpha sued RAS and Travelers.
RAS filed a cross-complaint against Alpha for breach of contract, which was dismissed with prejudice before trial pursuant to a settlement between Alpha and RAS.
At trial of its claims, Alpha argued that RAS failed to comply with the prompt payment statutes because they required RAS to give timely notice of its good faith disputes with Alpha. Alpha asserted that it was not notified within 10 days of discovery of any good faith disputes.
Travelers countered that prompt payment penalties could not be awarded because there was a good faith dispute that was not resolved until trial. The trial court permitted RAS to make an offer of proof to contest the imposition of penalties, and RAS' regional vice president testified that RAS had notified Alpha of every backcharge.
Even so, the trial court awarded Alpha $70,268.04 in penalty interest under the prompt payment statutes in addition to the principal sum of $199,164.44, prejudgment interest, attorney fees and costs.
On appeal, the award of prompt payment penalties was reversed. Alpha Mechanical, Heating & Air Conditioning, Inc. v. Travelers Casualty & Surety Co. of America,133 Cal.App.4th 1319 (2005).
Travelers argued on appeal that: (1) Alpha's complaint did not mention the prompt payment statutes and Travelers was not given adequate notice; (2) the evidence was insufficient to support an award of penalties; (3) the trial court erred by imposing a notice requirement on RAS as a condition to avoiding prompt payment penalties; and (4) there was a good faith dispute that entitled RAS to withhold payment.
The appeals court held that while Alpha did not seek prompt payment relief in its complaint, Alpha raised entitlement in its trial brief, and Travelers failed to respond or object.
The appellate court held that there was not substantial evidence to support the trial court's finding of no good faith dispute. While noting that it was unable to find authority expressly interpreting the good faith dispute standard in the prompt payment statutes, the court stated that the phrase "good faith" does have a distinct meaning and purpose in the law. It cited other cases in which good faith " 'suggests a moral quality; its absence is equated with dishonesty, deceit or unfaithfulness to duty.' " The court cited another case stating that good faith involves a factual inquiry into the plaintiff's subjective state of mind.
The court explained that it was unable to find evidence in the record demonstrating RAS' lack of good faith in withholding payment. Rather, the trial court acknowledged that the parties "did have a dispute over the retraxit issue...," which the appellate court interpreted to refer to a dispute involving RAS' dismissed cross-complaint and whether RAS owed Alpha more money. At trial, Travelers' witnesses testified that RAS paid $280,000 to other subcontractors to repair work that Alpha damaged, and the resolution of that dispute resulted in a settlement payment of $162,000 from Alpha to RAS.
The appellate court further noted that the sole evidence on the good faith dispute issue was provided by RAS' regional vice president, who testified that RAS believed it had overpaid Alpha and withheld payment under a contract provision permitting it to deduct the cost of correcting Alpha's defaults.
There was no evidence that RAS subjectively believed its claim had no merit, the appeals court noted. Based on that evidence, the appellate court concluded that it could not infer a finding that RAS and Alpha did not have a good faith dispute over the balance owed Alpha.
The appellate court also rejected Alpha's contention that the prompt payment statutes require a contractor to notify its subcontractor that a good faith dispute exists within 10 days of payment by the owner because there is no such express requirement in the statute. The court refused to imply such a requirement based on California Civil Code §3260 (f), which includes a 10-day written notice requirement related to the acceptance of disputed work. The court noted that the Legislature could have imposed a notice requirement in the prompt payment statutes if it wanted to do so.
The judgment was otherwise affirmed, with a subcontract provision supporting the award of attorney fees.
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For more information about the issues covered in this report, please contact Paul Berning in our San Francisco office at 415-369-7229 or at pwberning@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©2007 Thelen Reid Brown Raysman & Steiner LLP
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