Retention clauses are almost always included in California construction contracts and permit an Owner to withhold a portion of what is owed to the General Contractor as security to ensure the proper completion of the work. General Contractors pass the withholding of retention down to the subcontractors. Thus, if the subcontractor fails to complete its work, or fails to correct deficiencies, the Owner/General Contractor can use the retention to pay the costs of completing or correcting the subcontractor’s work.
The contractor must release any retention it receives from the owner within ten days unless a “good faith dispute exists between the direct contractor and the subcontractor.” (Civil Code section 8814.) Where there is a good faith dispute, the contractor “may withhold from the retention to the subcontractor an amount not in excess of 150 percent of the estimated value of the disputed amount.” (Civil Code section 8814(c).) If the contractor wrongfully withholds retention, it must not only pay the retention but must also pay the subcontractor “a penalty of 2 percent per month on the amount wrongfully withheld.” The contractor must also pay the subcontractor’s costs and reasonable attorney’s fees incurred in collecting the retention. (Civil Code section 8818.)
Ironically, even though retention clauses are found in virtually all construction contracts, there is little judicial guidance on what constitutes a “good faith dispute” permiting the contractor on a private construction project to withhold retention. Does Section 8814(c) cover any dispute between the parties, or only disputes related to the work which the retention is securing? The case of Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc. (2009) 179 Cal.App.4th 1401seemed to indicate that just about anything could qualify as a “good faith dispute.” But Martin Brothers is clearly in disfavor, as shown by United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., et al. (B258860, LASC VC062679) (“United”) where the Court of Appeal for the Second District held a contractor may only withhold retention when the “good faith dispute” relates to the work secured by the retention.
In United, a contractor, Coast Iron & Steel Co. (“Coast”), hired United Riggers & Erectors, Inc. (“United”) to work on the new “Transformers” ride at the Universal Studios theme park. After the work was completed, Coast refused to pay United for disputed change orders and withheld payment of the retention it received from Universal Studios to pay for the original work. While conceding the retention was unrelated to the work covered by the disputed change orders, it contended it was allowed to hold on to the retention under the good faith exception of Section 8814(c). United subsequently sued Coast seeking payment of the change orders, the withheld retention, penalties for wrongfully withholding retention, and additional damages it claimed it incurred as a result of delays on the project. During the pendency of the case, Coast paid United all of the retention that was owed.
After a bench trial, the trial court ruled in favor of Coast on all causes of action. The court found United was not entitled to payment for the disputed change orders and was also not entitled to delay damages. It also found the parties’ dispute over the contested change orders was “a good faith dispute between Coast and United . . . that entitled Coast to withhold the payment of retention.” It therefore rejected United’s claim for penalties under Section 8818. Significantly, because it found Coast had a “good faith” reason to hold the retention, the trial court found Coast to be the prevailing party pursuant to Section 8818, and awarded Coast $150,000 in attorney’s fees.
United appealed. In addition to arguing the trial court erred in finding it was not entitled to the delay damages and the disputed change orders, United argued that because there was no dispute relating to the retention payment itself, Coast was not entitled to withhold the retention.
The Court of Appeal rejected United’s arguments regarding the change orders and delay damages. However, it agreed with United regarding the retention issue. The Court of Appeal held a contractor working on a private construction job may withhold retention only when there is a good faith dispute regarding whether the subcontractor is entitled to the full amount of the retention payment. The court writes:
“In this case, Coast did not deny that it owed United the full $149,602.52 retention that it withheld. The only dispute was over whether United was also entitled to other payments it claimed. To excuse Coast in this case from paying United the retention payments would unduly increase the leverage of owners and primary contractors over smaller contractors and subcontractors by discouraging subcontractors from making legitimate claims for fear of delaying the retention payment.”
The Court concluded under Section 8814(c), “a contractor is entitled to withhold a retention payment only when there is a good faith dispute regarding whether the subcontractor is entitled to the full amount of the retention payment.”
The Court also determined United, not Coast was the “prevailing party” under Section 8818, and reversed the trial court’s award of $150,000 in attorney’s fees to Coast. It ordered the trial court to award “attorney’s fees to United, including attorney’s fees for this appeal as it relates to the retention claim.”
In its analysis of Section 8814(c)’s scope, the Court of Appeal adopted the reasoning of another recent case, East West Bank v. Rio School District (2015) 235 Cal.App.4th 742. In East West, the Court of Appeal (again for the Second Circuit), held in public works contracts, withholding retention is justified only if the dispute is about the work secured by the retention itself. (Click here for Haight’s alert on the East West case.) Both the United Riggers and East West cases distinguished and declined to follow Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc. (2009) 179 Cal.App.4th 1401, which held that under a public works contract a disagreement unrelated to retention constituted a “good faith dispute” allowing the contractor to withhold retention.
The holdings of United Riggers and East West should make all contractors, whether working on public or private jobs, carefully consider whether withholding retention is directly tied to their dispute with subcontractors. Both cases interpret the retention statutes to prohibit a contractor from holding on to retention unless the dispute involves the work for which the security is held.
It should be noted, however, that while Martin Brothers is on-the-ropes, it is still citable but directly contrary to United Riggers and East West. Given the split created by the United, East West Bank, and Martin decisions, it is possible the issue of when retention can be withheld on both public and private projects, will eventually be decided by the California Supreme Court.
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