In the typical construction contract arrangement, the Owner hires a prime contractor who, in turn, hires subcontractors to perform specified work and they, in turn, often hire sub subcontractors and all purchase materials from various suppliers. The law in California has created a complex set of legal rights and forms of security and the reader should review our articles on Contracts as well as Mechanics Liens on this website.
As noted in those two articles, relief is available depending on whether the contractor or subcontractor or material man adhered to the strict time limits of the various lien, stop notice and bond actions and, additionally, subject to the terms of the construction contract.
There is additional very powerful relief available to the claimant, however, if the contractor or a subcontractor higher on the payment ladder failed to pay if that contractor had received payment from the owner or someone higher on the payment ladder which was meant to pay for work performed. Attorneys fees, interest and penalties may be assessed in favor of the claimant and the contractor can face significant problems with the licensing board.
This article shall discuss the basic law and suggested tactics for the claimant in such a situation.
The law is found in the Business and Professions Code of the State of California and applies to any job that occurs within the State.
CA Business & Professions Code
§ 7108.5 Prime building contractors and subcontractors; payment to subcontractors; withholding payments; violation; penalty
A prime contractor or subcontractor shall pay to any subcontractor, not later then 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.
There 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 not "listed" has no statutory right to perform job and may not recover damages under the Act.
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 in Section 10261.
"The provisions of this act shall apply only with respect to contracts entered into on or after January 1, 1999."
The above provisions radically alter the cost benefit analysis available to the parties in any such dispute. First, with attorneys fees awarded to the prevailing party as allowed under the statute, even a small claim may be worth pursuing for the subcontractor. Secondly, the 24% per annum increase in the amount of the claim is payable to the subcontractor in addition to the sums rightfully due. Lastly, the contractor faces disciplinary costs and fines in addition to any private civil action commenced by the subcontractor.
In short, the use of the subcontractor’s money by the prime contractor may be the most expensive decision the prime contractor could have made.
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.
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).
The above procedure is illustrated in the following case::
Morton Engineering & Const., Inc. v. Patscheck
(App. 5 Dist. 2001) 104 Cal.Rptr.2d 815, 87;Cal.App.4th 712.
HOLDING OF COURT
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 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 the same sum of money. Penalties pursuant to Section 7108.5 and Public Contract Code section 7107 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.
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.
ISSUES TO BE CONFRONTED:
A key defense is, of course, whether payment was rightfully due and whether payment was for the work undertaken by the subcontractor. Note, however, that the Legislature anticipated that defense and limited the amount that could be held back to one hundred and fifty percent of the disputed amount and requires the contractor to pay the rest to the subcontractor.
Terms of the contract may also alter the duties hereunder. Many contracts do not require payment to the subcontractor unless the contractor is paid and this writer knows of at least one contractor who simply did not request payment due on a particular portion of the project knowing that the bulk of the payment would go to the subcontractor. The contractor hoped the subcontractor, starved for money, would simply close its doors and it took a letter threatening legal action for intentional interference with a contractual relationship to force the contractor to relent and abide by the spirit as well as the wording of the contract.
The point to be made, however, is that the above statutes make all the difference in a dispute in which a contractor is using the subcontractor’s money to fund its own cash flow. The risk is great and the penalties significant. This office routinely advises its contractor clients that such risks do not allow such unauthorized retention of monies due the subcontractor and that the costs of the defense before the License Board, not to mention the civil suit, must exceed whatever benefit the short term access to monies would give the contractor.
Most contractors facing that issue, however, are already desperate and short of money and ready to take any risks. As one contractor advised the writer, “I’m in bankruptcy if this project is delayed by my lack of funds anyway. What do I have to risk?
But what he was risking was not only the loss of his license but penalties being imposed that might very well not be discharged in bankruptcy. The reader should read the web article on bankruptcy on this website. Like using money that should be paid in taxes, it would seem to be a move taken by desperate business people that simply makes a bad situation much worse.
The Claimant should note the notice requirements to the public agency required and should seek legal advice before threatening action since it may be extortion to threaten to report someone to the authorities if he or she does not pay you money. The demand must be carefully structured; but know that relief is certainly available.