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California Court Limits Ability of Public Owner to Withhold Contract Funds

In a major victory for both general contractors and their subcontractors, a California appellate court has ruled that a public entity cannot withhold contract funds from a general contractor simply due to a dispute over the original price of the contract work.

In FTR International v. Rio School District (2015) 182 Cal.Rptr.3d 865 the Second District Court of Appeal affirmed a trial court’s award of $9,356,124.00 in damages, prompt payment penalties, interest and attorney’s fees to general contractor FTR International stemming from a decade long dispute over the construction of a school project in Northern California. FTR sued the District after the District refused to pay FTR progress billings and retention, citing a dispute over the original contract price. The original amount in dispute was $676,436.00.

The key issue on appeal was whether the District could be held liable for statutory prompt payment penalties for the District’s wrongful withholding of FTR’s retention and progress billings. California’s Prompt Payment Act requires public owners to timely pay their general contractors’ progress billings and retention. The Act permits a general contractor to pursue a public owner for 2% penalties per month (and attorney’s fees) for untimely payment unless there is a good faith dispute over the work performed.

In this case, the District claimed that there was a bona fide dispute regarding the project work. Specifically, the District argued that there was an ongoing dispute with FTR over the amount of 150 pending change orders. Although stop notices had been filed on the project, those stop notices were ultimately released. Regardless, the District refused to pay FTR its progress billings and retention due to the dispute over the amount of the change orders.

The Court of Appeal flatly rejected the District’s argument that a dispute over the amount of change orders created a bona fide dispute sufficient to withhold all of FTR’s money. The Court went out of its way to criticize an earlier legal opinion, Martin Brothers Construction Inc. v. Thompson Pacific Construction, Inc.(2009) 179 Cal.App.4th 1401, which had given public owners wide latitude to hold-up general contractors’ progress billings and retention under the guise of “bona fide dispute.”

FTR International is significant victory for contractors for several reasons. First, it marks the first time the California Courts have actually put some teeth into the Prompt Payment Act. In the past, public owners would often hold-up a general contractor’s progress billing and retention for all sorts of insignificant reasons. This case holds that unless there is a real risk to the public owner (i.e. stop notices, claims, etc.) the owner must timely pay its general contractor or risk incurring 2% penalties on those amounts.

Equally as important, this decision has a beneficial impact to subcontractors on public works projects. Oftentimes, when the general contractor is not paid, the subcontractors do not get paid. By forcing the owner to free-up these critical dollars, the benefit will be felt down-stream. Subcontractors, sub-subcontractors and material suppliers can now be paid. By freeing-up contract dollars, projects can be completed faster and contractors and subcontractors can be paid in a timely manner.

A final important impact from this case is that the Court expressly undermined the Martin Brothers decision. Public owners will no longer be able to use that opinion to justify holding up contract money that should otherwise be paid. By correcting that loop-hole, the owners now face significant increased risk if they do not pay their contractors on time. In this case, the public owner’s refusal to pay $676,436.00 in contract money resulted in a $9,356,124.00 hit! Once again, public projects may be completed quicker and result in less claims if the contract money is paid in a more timely manner.

Unfortunately, the case is not over. The public owner has requested a re-hearing of the case and an appeal to the California Supreme Court is possible. Stay tuned.