Show Me the Money: The Good Faith Dispute Exception to Prompt Payment Penalties | California Construction Law Blog

California has a number of prompt payment penalty statutes on the books. Among them is Civil Code section 8800 which requires project owners on private works projects to pay progress payments to direct contractors within 30 days after demand for payment pursuant to contract or be subject to prompt payment penalties of two percent (2%) per month on the amount wrongfully withheld. Like California’s other prompt payment penalty statutes, however, there is an important  carve out: If there is a good faith dispute between the project owner and the direct contractor the project owner may withhold up to 150% of the dispute amount and not be subject to prompt payment penalties. And that, my friends, is a higher-tiered party’s “get out of jail free” card.

In a case of first impression, the 1st District Court of Appeals, in Vought Construction Inc. v. Stock (2022) 84 Cal.App.5th 622, examined whether a project owner’s claim for liquidated damages constitutes a good faith dispute under Civil Code section 8800.

The Vought Construction Case

In September 2019, Vought Construction, Inc. entered into a construction contract with Jay Stock for a home renovation project. The contract required Vought to complete its work by January 13, 2020 and included a liquidated damage provision providing that Vought would be liable in the amount of $300 per day for each day Vought did not complete construction within the time agreed upon. During the course of the project several change orders were approved which extended the completion date from January 13, 2020 to February 11, 2020.

Toward the end of the project an issue arose regarding the installation of exterior railing. The exterior railing was supposed to match the interior railing and both Vought and Stock, according to their testimony, were under the impression that the exterior railing could be ordered and installed without a set of architectural drawings. Turns out that was no the case. Three weeks before the date set for project completion, Vought informed Stock that architectural drawings would be needed to fabricate the railing. Further, due to the onset of the COVID-19 pandemic, Vought was unable to install the railings until August 2020. Work on the remaining portions of the house, however, were completed in May 2020.

In April 2020, Vought sent an invoice to Stock for $73,000, and when this was not paid, sent another invoice to Stock in May 2020, which was also unpaid. In June 2020, Vought sent a proposed change order to Stock for $50,000 for the exterior railing. Stock rejected the change order and continued to refuse to make payment on the early invoices. In July 2020, Vought recorded a mechanics lien for $78,000 and in August 2020 sent a proposed change order to Stock for $10,000 in “legal costs” and interests on unpaid progress payments. In response, Stock claimed that he was entitled to liquidated damages of $53,000, and in December 2020 paid Vought $20,000, or roughly the difference between Vought’s invoice for $73,000 and Stock’s liquidated damage claim of $53,000. The parties decided to litigate.

In November 2021, following a four-day bench trial, the trial court found that Vought was entitled to $59,000 in unpaid invoices (the difference between the total contract price and amounts paid by Stock including the $20,000 paid by Stock in December 2020) plus $31,000 in additional compensation for the exterior railing, and that Stock was entitled to an offset of $29,000 for liquidated damages, for a total award in favor of Vought of $61,000 plus prejudgment interest in the amount of $17,000.

The trial court further ruled that neither party was the prevailing party and that Vought was not entitled to prompt payment penalties of 2% per month under Civil Code section 8000 because “there was . . . a good faith dispute between the parties as to what needed to be paid.”

Vought appealed.

The Appeal

On appeal, Vought argued that: (1) Stock violated Civil Code section 8000 as a matter of law; (2) that it (Vought) was the prevailing party as a matter of law and, therefore, entitled to recover its attorneys’ fees under Section 8000;  (3) that Stock’s liquidated damage claim was barred due to his bad-faith actions; and (4) that the trial court erred in failing to order foreclosure of its mechanics lien.

As to Vought’s Civil Code section 8000 contention, the Court of Appeal held that the progress payments withheld by Stock on account of liquidated damages was a “good faith dispute” under Section 8000. Under Section 8000, explained the Court of Appeal, a project owner is entitled to withhold payment “[i]f there is a good faith dispute between the owner and direct contractor as to a progress payment due,” and here, parties’ contract specifically allowed Stock to “withhold [payment] in whole or in part to such extent as may be necessary . . . to protect the Owner from loss . . . because of . . . reasonable evidence that the Work will not be completed within the Contract Time, and that the unpaid balance would not be adequate to cover actual or liquidated damages for the anticipated delay . . .” The Court also distinguished the case from United Riggers & Erectors, Inc. v. Coast Iron & Steel Co. (2018) 4 Cal.5th 1082, a case we wrote about earlier, on the ground that United Riggers involved a dispute over change orders that would have increased amounts then due rather than liquidated damages that would have decreased amounts then due.

As to Vought’s prevailing party contention, the Court of Appeal held that the trial court was within its discretion to find that neither party was the prevailing party under Civil Code section 8000 which provides that the prevailing party is entitled to the recovery of reasonable attorneys’ fees. However, the Court of Appeals held that because Vought obtained a net monetary recovery against Stock, that under Code of Civil Procedure section 1032, Vought was the prevailing party and entitled to recovery of its costs although not attorneys’ fees.

As to Vought’s liquidated damage claim, while acknowledging that existing case law allowed a contractor to challenge liquidated damages in cases where delay “was caused by matters beyond [a contractor]’s control and was entirely excusable,” the Court of Appeal held that the trial court “correctly held that Vought was not relieved of the obligation to pay liquidated damages for the delay that it caused even though it was not responsible for the entire delay.”

Finally, the Court of Appeal found that Vought had satisfied the elements of its foreclosure of mechanics lien and remanded the case back to the trial court for an order allowing Vought to foreclose on its mechanics lien.

Conclusion

This is a very interesting case both generally and because I’m currently litigating a case involving prompt payment penalties. And, while the case involved a specific prompt payment penalty statute, Civil Code section 8000, the case, I believe, has applicability to all of the prompt payment penalty statutes. Further, the case is interesting in that the Court of Appeals based its decision on both the prompt payment penalty statute as well as the underlying contract between the parties, but makes no distinction as to whether either alone was sufficient to support its decision. While liquidated damages are a product of contract, would the Court of Appeal have reached the same conclusion if the parties’ contract did not expressly provide that payment may be withheld to cover liquidated damages and, instead, merely stated, as most liquidated damage provisions do, that liquidated damages are owed if a project is not timely completed but with no reference to the project owner being able to use liquidated damages as an offset to monies owed?