California Supreme Court Holds That Contractors May Not Unreasonably Withhold Retention Payments

Until recently, there has been a split in the courts of appeal in California regarding the extent to which contractors are excused from the prompt payment requirement for retentions. One rule permitted contractors to withhold retention payments to subcontractors if there was any good faith dispute between them, whether or not the dispute was directly related to the work for which the retention was given. The other rule limited a contractor’s ability to withhold retention payments to good faith disputes which specifically involved the work for which the retention was held.

At the heart of the issue was the interpretation of California Civil Code Section 8814. The statute states:

(a) If a direct contractor has withheld a retention from one or more subcontractors, the direct contractor shall, within 10 days after receiving all or part of a retention payment, pay to each subcontractor from whom retention has been withheld that subcontractor's share of the payment.

(b) If a retention received by the direct contractor is specifically designated for a particular subcontractor, the direct contractor shall pay the retention payment to the designated subcontractor, if consistent with the terms of the subcontract.

(c) If a good faith dispute exists between the direct contractor and a subcontractor, the direct 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.

The case before the California Supreme Court, United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., involved work for Universal Studios in Los Angeles. Contractor Coast Iron and Steel Co. (Coast) entered into an agreement with Universal. Coast subcontracted some of the work to United Riggers and Erectors (United). Subcontractor United’s invoices to contractor Coast included charges not specifically envisioned in the agreement between the parties. The additional charges arose out of change orders and added costs due to to Coast’s alleged mismanagement of the project. Coast accepted United’s work under the parties’ agreement, but disputed the additional charges. On that basis, Coast withheld the entire final payment due to United, including the retention associated with the accepted work. United sued Coast, alleging that Coast failed to make a prompt payment of the retention, as required by Section 8814, which was owed under the terms of the subcontract. 

Coast argued that the Supreme Court should adopt the view held by some courts, that any good faith dispute between the parties justified withholding of the retention. United argued that the viewpoint adopted by other courts was appropriate, and that the withholding of a retention payment is only justified when the underlying dispute relates to the security purpose of the retention. 

In its decision, the Supreme Court analyzed the legislative history of Civil Code Section 8814. Based on that history and its perceived intent of the California Legislature in enacting the statute, the court held that the statute’s goal of promoting timely payment of undisputed retentions to subcontractors while preserving the underlying purpose of the security provided by the retention would be best served by allowing contractors to withhold retention payments only when the dispute relates directly to the work for which the retention was given. 

The court determined that a retention may be withheld when there is a good faith dispute which relates to the subcontractor’s performance of the work, when liens or other third party demands potentially expose the contractor to double payment, or when the payment would result in a windfall to the subcontractor. In sum, the Supreme Court held that retention payments may not be withheld when the dispute between the contractor and subcontractor arises out of charges which are allegedly owed for matters outside of the retention, such as change orders. The decision is a victory for subcontractors, who may now obtain prompt payment of retentions, where the work for which the retention was given is deemed acceptable.

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