On January 27, 2015, the Court of Appeal, Second Appellate District, affirmed, in part, a hefty trial judgment against the Rio School District for improperly withholding retention funds in the case of FTR International, Inc. v. Rio School District, case B238618. Under Public Contract Code §7107, a public entity may withhold retention funds in the event of a good faith dispute. So what’s a “good faith dispute?” Under Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc. (2009) 179 Cal.App.4th 1401, the answer is “almost anything.” The Rio School District found out that common sense still prevails when looking at the words “good faith.”
Rio School District hired FTR International (“FTR”) to build a school. The District withheld 10% from FTR’s progress payments, resulting in a retention of $676,436 at the end of the project. The District withheld the retention because of stop notices, but when the stop notices were released, it still refused to release the retention because FTR claimed it was due additional compensation because of pending change orders.
FTR sued the District and the result was nearly $10 million judgment in favor of FTR consisting of damages for extra work performed, prompt payment penalties under §7107, and attorneys’ fees. The District appealed. The Court of Appeal upheld the trial court’s assessment of penalties against the District under §7107, but sent the case back to the trial court to recalculate the attorneys’ fees award.
In pertinent part, §7107(c) states: “Within 60 days after the date of completion of the work of improvement, the retention withheld by the public entity shall be released. In the event of a dispute between the public entity and the original contractor, the public entity may withhold from the final payment an amount not to exceed 150 percent of the disputed amount.” §7107(f) provides for a penalty of two percent per month on any amount improperly held, plus attorneys’ fees and costs. Both of these provisions are subject to an exception in §7107(e) where there is a “a bona fide dispute between the subcontractor and original contractor.”
The purpose of retention funds is to provide security and to insure that a contractor completes work properly. The Court of Appeal stated: “Here, after the stop notices were cleared, District points to nothing for which security was required. The dispute on which District relies, FTR’s claim against District, does not require District to retain FTR’s funds as security. But District argues there is no language in section 7107 limiting the term ‘dispute’ to disputes relating to the legitimate purposes for the retention.”
Citing Martin Brothers, the District argued any dispute – regardless of whether it related to the retention or not – would allow withholding. This interpretation of §7107 went too far for the Court of Appeal, which stated: “Section 7107’s purpose of ensuring the prompt release of retention funds would not be served if any dispute justified retaining the funds. There is no reason to allow a public entity to retain the funds once their purpose of providing security against mechanics liens and deficiencies in the contractor’s performance has been served. Unless the dispute relates to one of those purposes, the public entity will not be protected from the statutory penalty. FTR’s action against District is not such a dispute.”
The takeaway from this case is simply this: If a public entity is going to withhold retention funds, it must look at whether those funds are necessary to protect it from claims or damages. It cannot retain retention funds simply because it disputes the contractor is entitled to compensation above the contract price. The wild card here is that the Martin Brothers‘ opinion was authored by Justice Cantil-Sakauye, who is now Chief Justice of the California Supreme Court. Will this be enough reason for the District to file a Petition to Review at the Supreme Court?
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