Breach of Contract: Part 3 – Prompt Payment Statutes

1. Unjust enrichment

It would seem to be self-evident that a person cannot be bound to a contract unless it consents to be bound.  This is really just another way of saying that a contract requires a manifestation of mutual assent.

However, consider this situation.  A prime contractor, under contract with the owner, is creating an industrial building.  The contract price is $200,000.  The prime contractor expects to pay $50,000 for the “mechanical package” on the building including plumbing, heating, air conditioning, and the fire sprinkler system.  The contractor awards a $50,000 subcontract to S-1 for the complete mechanical package.  S-1 in turn subcontracts the heating, ventilating and air conditioning (but not the plumbing or fire sprinkler) to S-2 at a contract price of $25,000.  S-2 is a sub-subcontractor.  There is no contractual relationship between S-2 and the prime.

Now suppose that all the mechanical work has been finished and S-1 has been paid $25,000, all of which it has retained for its own work.  S-2 has been paid nothing.  At this point, S-1 leaves the state on an extended vacation.  S-2 for some reason, fails to enforce its mechanic’s lien and stop notice rights.

S-2 finds it impossible to collect is $25,000 from S-1, because S-1 cannot be found. But suppose the owner has paid the prime the full contract price of $200,000.  Since the prime contractor has paid only $25,000 for the mechanical package, and since S-1 has left the state and is not seeking the balance of the $25,000 due on the mechanical package subcontract, the prime contractor has only paid $25,000 for the mechanical package, though it agree to pay $50,000 for the package.

What is the puzzling legal problem the owner has paid the full contract price of $200,000.  Therefore, the prime has been paid the $50,000 for the mechanical package, $25,000 of which was intended to go to S-2 for the heating, ventilating and air conditioning system.  However, because S-1 has left the jurisdiction, S-2 has been paid nothing.  Therefore, the prime received a gratuitous bonus of a $25,000 gift profit.  Which it never expected to receive and S-2 has performed $25,000 worth of work for which it has not been paid.  Since the prime received the benefit of the work, S-2 should be paid rather than go unpaid while the prime enjoys an unearned bonus.

What legal theory will require the prime to pay the $25,000 to S-2 there is no contract between the prime and S-2 the prime has committed no fraud nor has it been negligent nor failed to discharge a duty to S-2.  However, why should the prime be enriched?

On case held that the sub-sub has no agreement with the general and therefore the general owes nothing, regardless of nonpayment by S-2’s immediate employer, S-1.

The court in effect said that there is no privity of contract between the prime and sub-sub.

However, one case held that a prime was obliged to pay a sub-sub on a theory known as quasi contract or contract implied in law.

The implied contract theory states that when a person accepts and retains the benefits of a transaction under circumstances making it inequitable for the benefits to be retained without payment of their reasonable value, the law will imply that there is a contract obliging the recipient of the benefits to pay their reasonable value to the party who furnished them—this is a contract implied by the law–regardless of whether the parties ever actually entered into a contract.

2 Prompt payment requirements

In recent years the legislatures has enacted a confusing and inconsistent series of statutes requiring prompt payment of progress payments and retentions by owners, contractors and subs and design professionals on public and private projects.  Failure to make prompt payments is penalized in two ways: (1) monthly interest rates and penalties are imposed, and (2) the prevailing party in a prompt payment dispute is entitled to recover reasonable attorney’s fees from the losing party.  However the parties to a construction contract can waive prompt payment rights under business and professions code 7108.5

Here is an outline of the laws:

A. Requirement that prime or sub remit the amount it received in respect of a subcontractor’s work to the subcontractor. The requirement of prompt payment applies only to monies that have actually been received by the prime contractor or sub–not to monies that either should have received.

1. Penalty for failure to may prompt payment is 2% per month in addition to interest (in the case of retentions, the penalty is 2% per month in lieu of interest)

2. In addition, the prevailing party in action for the collection of funds wrongly withheld is entitled to attorney’s fees

3. 150% of an amount in dispute in good faith may be withheld.

Within 10 days of receipt of written notice that disputed work has been completed the contractor shall advise the subcontractor of acceptance or rejection of the disputed work.  Within 10 days after acceptance, the retained portion of retention shall be disbursed.

4. On public utility contracts, prime contractor must pay subcontractor within 15 days from receipt of payment.

B. Progress payments from prime to sub on federal projects–31 usc 3905–prime K is required to insert in their sub-K a provision that sub-Ks will receive their progress payments within 7 days from the time prime K receives payment from the government.  Interest penalty is at the rate specified by the sec of treasury.

C. Payment of retention by owner to direct K on a private project civil code section 8810-et sq

1. Payable within 45 days of completion.  Completion is defined as certificate of occupancy, date indicated on a valid record notice of completion or completion as defined in the mechanic’s lien law.  Civil code section 8100-private project or 9200 public work

  1. Penalty is 2% per month in lieu of interest, attorney’s fees and costs to prevailing party–non-waivable.

D.  Payment of retention by public entity to direct contractor–public contract code section 7107

1. 60 days after date of completion.  Completion means occupation, beneficial use, and acceptance by the public agency, or a cessation of labor for a continuous period for 100 days.

2. 2% per month in lieu of interest, attorney’s fees and costs to prevailing party- non-waivable.

E. State agencies are required to pay undisputed amounts due to creditors by the 31st day after the agency received notice than an undisputed payment is due, after which interest accrues at the rate equal to interest accruing in the pooled money investment account minus 1%, and the court shall award costs and reasonable attorney’s fees to the plaintiff.

F. Progress payments from public agencies to prime contractors.

1. State agency to contractor (public contract code 10261.5)  State agency must make payment within 30 days after payment request for undisputed item or pay 10% annual interest. Any payment request determined not to be proper shall be returned as soon as practicable, not later than 7 days after receipt, specifying the reason the payment request is not proper.

2. Cal state university must make progress payments to prime contractor within 39 days after payment request (public contract code section 10853) late payments accumulate 10% annual interest.  If payment request is determined not be a proper request, it is to be returned to the contractor as provided above.

3. Local agencies are required to pay prime contractors their progress payments 30 days after payment request. (public contract code section 20104.50) otherwise they pay interest at the rate of 10% per annum.  Payment requests that are determined to be improper are handled as above.

G. Payments to architects, engineers and land surveyors civil code sections 3320-3321.

1. Agency progress payments and retentions are to be paid within 30 and 45 days respectively after receiving written demand or the agency must pay 1 1/25 per month in lieu of interest, with attorney’s fees and costs to the prevailing party.  The agency may withhold 150% of disputed amounts.

2. Prime design professionals are required to pay their consultants within 15 days after receipt of payment from the agency or pay 1 ½ % per month in lieu of interest, with attorney’s fees and costs to the prevailing party(public works only) the payor may withhold 150% of disputed amounts.

Sureties on payment bonds are liable for prompt payment penalties.  While a mechanic’s lien claim is limited to the reasonable value of work or materials furnished or the price agreed to by the claimant whichever is less, in contrast, a payment bond secures payment of the claim of the claimant.  Public contract code section 10223.  A subcontractor’s claim for payment includes the 2% per month penalty and the statutory provisions are incorporated into the bond.

 

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