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.
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.
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.
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.
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).
Morton Engineering & Const., Inc. v. Patscheck (App. 5 Dist. 2001) 104 Cal.Rptr.2d 815, 87
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.
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.