PENALTIES FOR
FAILURE TO PAY SUBCONTRACTORS
INTRODUCTION:
Most construction
projects involve an owner or financial entity paying the general
contractor in progress payments that are usually based on stages of
completion confirmed by inspection by the owner’s agents such as the
architect or engineers. Those payments, in turn, result in required
payments to the subcontractors and material men who have performed labor
or provided materials to the job.
Usually, the owner
or bank will require
mechanics lien releases from the
contractors and material men to be delivered by them or the general
contractor before the payment can be made. Typically, the lien releases
are delivered in a packet, along with other paperwork providing for
proof of performance, and the money is released.
While our office
normally suggest strongly that only conditional lien releases should be
provided (releases that are only valid after the check for payment is
cashed) too often subcontractors or material men will succumb to
pressure of the general or owner to provide simple releases relying on
the promise that payment will soon be received.
And too often,
usually based on cash flow, the owner or general contractor will delay
or deny payment to the subcontractors, suddenly coming up with
“problems” with the work performed or material supplied and, instead,
keep the money for their own cash needs.
And the
subcontractor is in the position of having waived the most powerful tool
to enforce immediate payment…the lien…and often facing an angry material
man who will cut off access to needed materials thus making it
impossible for the subcontractor to finish the project who is then
attacked by the owner for failure to perform and can face being thrown
off the job.
The subcontractor
can always threaten the contractor with suit for breach of
contract
and if there is an
arbitration clause,
the decision may only take months and not years. But, while that is
progressing, the subcontractor faces attorneys fees and costs, has its
credit with the material man ruined, and is off the job.
But there is perhaps
another tool at hand that may make the contractor rethink its position.
That tool is penalties available under California law that apply
precisely to this situation and are the topic of this article.
LEGAL REQUIREMENT TO
PAY SUBCONTRACTORS:
California has
passed specific statutes to protect the subcontractors from failure of
the general contractor…or other subcontractors…to pay out monies they
have received from the owner for work completed and materials installed
by the contractor.
APPLICABLE STATUTE:
CA Business &
Professions Code
§ 7108.5 Prime
building contractors and subcontractors; payment to subcontractors;
withholding payments; violation; penalty
A prime contractor
or subcontract shall pay to any subcontractor, not later than 10 days of
receipt of each progress payment, unless otherwise agreed to in writing,
the respective amounts allowed the contractor on account of the work
performed by the subcontractors, to the extent of each subcontractor’s
interest therein. In the event that there is a good faith dispute over
all or any portion of the amount due on a progress payment from the
prime contractor or subcontractor to a subcontractor, then the prime
contractor or subcontractor may withhold no more than 150 percent of the
disputed amount.
Any violation of
this section shall constitute a cause for disciplinary action and
shall subject 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. In any action for the collection of
funds wrongfully withheld, the prevailing party shall be entitled to
his or her attorney's fees and costs.
The sanctions authorized under this section shall be separate from,
and in addition to, all other remedies either civil, administrative,
or criminal.
EXCEPTIONS:
SEQ CHAPTER \h \r 1There
are two exceptions where Statute 7108.5 might not be applicable.
1.
According to Sections 4106 and 4107 of the Fair Practices Act, if a
contractor or subcontractor assigns work without the city’s consent,
to a subcontractor who was not identified in the bid for the prime
contract, the sub subcontractor never "listed" has no statutory
right to perform job and may not recover damages under the Act.
SEQ
CHAPTER \h \r 1
2.
Statute 7108.5 applies to all private works of improvement and to
all public works of improvement, except where
Section 10262
of the Public Contract Code applies.
Section 10262 of the Public Contract Code states:
The
contractor shall pay to his or her subcontractors, within 10 days of
receipt of each progress payment, the respective amounts allowed the
contractor on account of the work performed by his or her
subcontractors, to the extent of each subcontractor's interest
therein. The payments to subcontractors shall be based on estimates
made pursuant to Section 10261. Any diversion by the contractor of
payments received for prosecution of a contract, or failure to
reasonably account for the application or use of the payments
constitutes ground for actions proscribed in Section 10253 in
addition to disciplinary action by the Contractors' State License
Board. The subcontractor shall notify, in writing, the Contractors'
State License Board and the department of any payment less than the
amount or percentage approved for the class or item of work as set
forth Section 10261.
"The
provisions of this act shall apply only with respect to contracts
entered into on or after January 1, 1999."
FEDERAL
PROJECT APPLICATIONS (MILLER BOND)
Statute 7108.5
has been applied in case law decided by California courts but the
following case indicates that if pled correctly, such relief may be
available in Federal Projects.
Didomenico v. North American Constr. Corp., C.A.9 (Cal.) 2004, 94
Fed.Appx. 598, 2004 WL 759550, Unreported. United States
(67) 12
In the above referenced case, the Subcontractor brought action to
recover under prime contractor's Miller Act payment bond. The United
States District Court for the Northern District of California, James
Ware, J., dismissed the complaint, and subcontractor appealed. The
Court of Appeals held that subcontractor could not recover attorney
fees or penalties as "sums justly due" under Miller Act.
Affirmed.
The Provision of
Prompt Payment Act, allowing supplemental state law claims against
contractor did not incorporate state remedies as “sums justly due”
under Miller Act, and thus subcontractor could not recover attorney
fees or penalties as “sums justly due” under Miller Act, even though
fees and penalties were allowed under state law where contract did
not provide for fees or penalties.
Didomenico
argued that the district court erred in holding that penalties and
attorneys' fees allowed in
California Business and Professionals Code 7108.5
are not "sums justly due" under the Miller Act. However, federal
law, not state law, determines the remedies under the Miller Act.
Because the contract in this case did not provide for fees or
penalties, Didomenico was not entitled to attorneys' fees or
penalties as "sums justly due" under the Miller Act.
Didomenico argues
that Section
3905 (i)
of the Prompt
Payment Act, 31 U.S.C. 3905i incorporates state remedies as "sums justly
due" under the Miller Act but that claim failed. The plain language of
3905 (i) of the Prompt Payment Act allows supplemental state law claims
against contractor. It does not incorporate state law remedies into the
Prompt Payment Act or Miller Act as Miller Act remedies that can be
recovered from the surety or Miller Act *600
bond. Although supplemental state claims may be asserted against a
subcontractor, Didomenico did not assert supplemental state law claims
against the contractor in district court. Thus, the district court did
not abuse its discretion in treating all of the claims in this case as
Miller Act claims.
PENALTY:
According to CA Jur.
3d Building and Construction Contracts, Section 178, a licensee may be
disciplined for willful or deliberate failure by the licensee or an
agent or officer thereof to pay any moneys, when due for any materials
or services rendered in connection with operations as a contractor, when
the licensee has the capacity to pay or has received sufficient funds
therefore as payment for the particular construction work, project, or
operation for which the services or materials were rendered or
purchased. A licensee, agent, or officer, may also be disciplined for
false denial of any such amount due or the validity of the claim thereof
with intent to secure for the licensee, the licensee's employer, or
other person, any discount on such indebtedness or with intent to
hinder, delay, or defraud the person to whom such indebtedness is due.
Violating Statute §
7108.5 constitutes a cause for disciplinary action. A contractor
who has been paid for a project and refuses to pay a subcontractor shall
as a penalty, pay 2 percent of the amount due per month every month
that the payment is not made. In addition, the prevailing party
shall be entitled to his attorney’s fees and costs.
1. The Two Percent Penalty
The two percent
penalty against a contractor for violation of statutory requirements for
paying subcontractors is recoverable by the subcontractor in a civil
action or a disciplinary proceeding before the Contractors State License
Board (CSLB).
Applicable Case:
Morton Engineering & Const., Inc. v. Patscheck (App. 5 Dist. 2001) 104
Cal.Rptr.2d 815, 87
Cal.App.4th 712.
In the above
reference case, Respondent Morton Engineering & Construction, Inc.
(Morton), was hired by appellant Stanley Douglas Patscheck (Patscheck),
as a subcontractor in a public works project. Patscheck failed to pay
Morton for its work. Morton obtained a judgment that included penalties
for a failure to pay progress payments and retention proceeds within the
time required by Bus. & Prof. Code Section 7108.5 and Public Contract
Code Section 7107.
FACTS OF CASE:
El Tejon Unified
School District (School District) contracted with Patscheck for what
appears to be the construction of a gymnasium and football stadium
(Prime Contract). Patscheck hired various subcontractors including Raul
Gonzales (Gonzales). Gonzales, who was to provide the concrete and
structural steel for the project, apparently breached the subcontract
and was overpaid, causing Patscheck financial problems on the project.
After Gonzales abandoned the project, Patscheck entered into an oral
agreement with plaintiff to complete the concrete work for the sum of
$112,800. Morton completed the work in accordance with the plans and
specifications. By September 1996, Patscheck received payment for the
entire contract amount from the School District, less the 10 percent
retention. Patscheck failed to pay Morton $31,520 admittedly due under
the contract. The reason given by Patscheck was the financial problems
caused by Gonzales. Morton filed a complaint in February 1998 containing
five causes of action including breach of contract and various common
counts to recover *715
the same sum of money. Penalties pursuant to 7108.5 were requested.
Patscheck timely filed an answer asserting various affirmative defenses.
Patscheck was paid all retention proceeds by July 1998. When Patscheck
received the retention proceeds from the School District, he apparently
offered Morton $42,800 as full and final settlement of all claims
arising. This was the amount Patscheck admitted was due Morton under the
contract, but excluded the extra work, interest and penalties. Morton
rejected the offer.
RESULTS
A one-half-day court
trial resulted in judgment for Morton in the amount of $111, 316.73
which included all sums due under the contract plus the extra work,
interest, penalties, attorney fees and costs. Neither side requested a
statement of decision.
Note that actual
workers on the jobsite have their own protection under the California
Labor Code Sections 1771-3, requiring payment at the prevailing wage.
CONCLUSION and
PRACTICALITIES:
A
prime
contractor or subcontractor must pay to any subcontractor, not later
than within 10 days of receipt of each progress payment, unless
otherwise agreed to in writing, the respective amounts allowed the
contractor on account of the work performed by the subcontractors, to
the extent of each subcontractor's interest therein. If there is a
good-faith dispute over all or any portion of the amount due on a
progress payment from the prime contractor or subcontractor to a
subcontractor, then the prime contractor or subcontractor may withhold
no more than 150 percent of the disputed amount. These requirements
apply to all private works of improvement and to all public works of
improvement, unless the provision of the Public Contract Code applicable
to payments to subcontractors on certain public improvements applies.
Any prime (general)
contractor considering withholding such sums has to face the danger of
twenty four percent interest payable to the injured contractor plus
license problems as well as having to eventually pay the attorney’s fees
and costs incurred by the injured subcontractor. The entire purpose of
this statute is to make it less palatable for the general contractor to
use the subcontractor as its bank.
The problem we have
encountered is that most generals in this situation are either predatory
(they often destroy subcontractors in projects and assume the sub will
go out of business before the matter is tried) or so desperate for money
that any “loan”, even one at 24% interest, is worthwhile.
In either case, the
subcontractor may eventually recover, but will be in for months if not
years of expensive struggle. Clearly the remedies available under the
mechanics lien laws
are faster and more effective and we always urge our clients to hesitate
long and hard before surrendering them or letting their strict time
limits expire.
But, this tool is
one of substance and when added to the arsenal of litigation, gives the
subcontractor wronged a few more bullets in his or her gun. |
