Subcontractor Rights, The Lack Of Remedies, & The Short End Of The Stick
John P. McGill
As every contractor knows, or should know, California does not allow pay if paid conditions in contracts. The California Supreme Court determined that those clauses are void as a matter of public policy. And for good reason. If they were allowed, then a subcontractor might not be able to file a Mechanics Lien and exercise its constitutional right to be paid for work performed. Mechanics Liens need to be filed within a specific time after completion of a project and then a lawsuit needs to follow within 90 days of recording the lien. If the subcontract agreement says you get paid if I get paid, then payment might not be made until after the Lien period expires and/or your right to file a lien might not be available until it is too late.
Similar, but not exactly the same, is the pay when paid clause. This clause is not void as a matter of public policy provided it is worded in particular way. The key language to validate these provisions is the “reasonable time” condition. These payment provisions usually provide that the subcontractor will be paid when the contractor is paid, and the time for the contractor to be paid is a reasonable time; i.e.- the time needed to resolve disputes with the Owner. There is an implied expectation that those disputes will be resolved fairly quickly, but more often than not that is just wishful thinking and disputes can drag on for years.
Under California Prompt Payment statutes, if the Owner does not pay the General within 30 days of the progress payment being submitted, and if there is no good faith dispute for not making the payment, then the Owner can be subject to statutory penalties of 2% per month and attorney fees. Retention is a little different. Retention is supposed to be released on public works projects 60 days after the notice of acceptance. If not, and if there is no good faith reason for the withhold, then statutory penalties apply: 2% per month and attorney fees. On private works it is much the same, retention must be released within a certain period following completion otherwise penalties can attach.
For subcontractors, if retention is released but not paid or if a progress payment is received but not paid to the subcontractor within seven days after receipt, and assuming there is no good faith reason not to make the payment, the subcontractor is entitled to penalties of 2% per month and attorney fees.
But there is an anomaly in the law and there are a couple of pitfalls that contractors should be aware of, especially subcontractors.
First, recall a pay if paid clause is void as a matter of law, although pay when paid is possible if it is conditioned with the reasonable time language. You probably anticipate the issue: what is reasonable time? Pay when paid makes sense if you are a subcontractor and the dispute with the Owner relates to some part of your work. What happens though if the dispute does not involve your work? Arguably, payment is being delayed to you even though you did nothing wrong. What is your remedy in that case?
For one thing, the contract requires that you wait a reasonable time, which you will do, but when does that reasonable time become unreasonable? If a lawsuit is filed by the Owner or the General, and unless the General will pay you off, your payment will be held up by that litigation- the reasonable time- and that could be a long time.
A subcontractor may need to file suit for breach of contract against the General if there is no issue that involves the sub in the Owner-General dispute. If the subcontractor can show that 1- they did nothing wrong, 2- they are owed the money, and 3- the delay in making payment is no longer reasonable, they may prevail. If the subcontract had an attorney fee provision, then perhaps fees will be awarded. This litigation will likely finish about the same time as the Owner-General lawsuit concludes, so the subcontractor will not gain much, except to maybe get its money a little sooner.
You may be wondering about the 2% per month penalty; can you get that? Subcontractors don’t get penalties unless the General has been paid but does not pay the subcontractor. If the General has not been paid, then the subcontractor is not entitled to prompt payment penalties even if the court decides the time waited was not reasonable, there was no good faith reason to hold the money, and the sub is entitled to all the money demanded. Subcontractors cannot get attorney fees either unless there is an attorney fee provision in the contract. If there isn’t, tough luck; you just pay the attorney out of your recovery. Subcontractors can recover costs and statutory prejudgment interest, but that is not likely going to cover the attorney fees.
There is an important further consideration for any contractor that includes a cause of action for wrongful withhold penalties. If that claim is not proved, because the other side establishes there was a good faith basis for not making payment, then the other side may be awarded their attorney fees. There is a strategy to employ here and it needs to be well thought out before you make this claim.
The prompt payment statutes sound good and are intended to encourage payment. For subcontractors however, the good intentions won’t always make them whole. The General has an important remedy if the Owner withholds payment; they get penalties and fees. Subcontractors don’t have that same remedy for unreasonable delay in payment. The subcontractor has to wait, sometimes a very long time, and then only gets what it is owed in the first place. The sub can sue for breach but that may be throwing good money after bad; kind of the short end of the stick.
Bio: John P. McGill is an attorney representing contractors and suppliers throughout the Bay Area and Northern California in both private and public work disputes, employment, transactional, and administrative matters. He received his JD with distinction from the University of the Pacific, McGeorge School of Law, and is a member of the Traynor Honor Society. He is the author of California Contractor’s DESKTOP GENERAL COUNSEL What You Need To Know About California Construction Law. Contact: Work - 925-952 5403 or Cell- 707 337 1932.
johnmcgill310@gmail.com; jmcgill@archernorris.com