This article originally appeared in ABA Construction on December 6, 2023. Reprinted with permission.
Prompt payment laws continue to disrupt the construction industry, eliminating past practices by requiring timely payments for contractors, subcontractors, and suppliers. Prompt payment laws vary across states, with each jurisdiction establishing its own framework to ensure timely compensation in the construction industry. However, there has been a discernible shift in recent years as state legislatures actively revise these laws to provide stronger protections for claimants. This shift reflects a growing desire to protect the rights and interests of construction participants. This article explores this trend, highlighting specific legislative and judicial examples from various states in the last few years, and examines a recent Massachusetts case outlining the requirements for rejecting payment applications in good faith to avoid their deemed acceptance.
Continuation of a Multi-State Trend, Not a New Trend
California’s prompt payment laws are designed to ensure that contractors, subcontractors, and suppliers involved in construction projects are paid promptly and fairly for their services and materials. California law mandates that owners and contractors must make progress payments to contractors and subcontractors within specific timeframes. Non-compliance with California’s prompt payment laws can result in significant penalties, including the payment of interest penalties on overdue amounts and attorney’s fees. Repeated violations can also lead to the suspension or revocation of a contractor’s license. In the case of a dispute, the owner or contractor may withhold 150% of the disputed amount. However, until 2018, the issue of whether funds could be withheld based on any dispute or a specific dispute regarding the payment itself was uncertain. Often the upstream party used the 150% threshold liberally to withhold funds from claimants, especially retainage.
In 2018, after a split of authority between two districts of the California Court of Appeal, the California Supreme Court took up the question in United Riggers & Erectors, Inc. v. Coast Iron & Steel Co., 4 Cal. 5th 1082 (2018): may a contractor withhold retention payments when there is a good faith dispute of any kind between the contractor and a subcontractor, or only when the dispute relates to the retention itself? After a review of the history of California prompt payment statutes, the underlying purpose of the prompt payment laws, and discussion of inconsistency of the wording in the related but differently worded provisions in the relevant statutes, the California Supreme Court narrowly interpreted the good faith dispute provision and held that the “dispute” must relate to the specific payment due. As a result of the decision, upstream parties in California must be careful when withholding payments to lower-tier claimants and ensure withholding is directly related to a dispute tied to the withheld payment or face the sharp teeth of California’s prompt payment penalties.
In addition to courts clarifying and strengthening claimants’ rights to prompt payment, multiple state legislatures have enacted changes to their prompt payment laws. For example, in 2018, Pennsylvania made changes to its Contractor and Subcontractor Payment Act focused on the protection of downstream claimants. Some of the key changes included: (1) clarifying that the protections of the statute could not be waived by the parties: (2) authorizing contractors and subcontractors to suspend performance in the event of non-payment, following the provision of statutorily required notice; (3) specifying that the failure to provide timely notice—within 14 days of receiving an invoice—containing a good faith basis for withholding waives the payor’s right to withhold and requires payment in full; (4) requiring payment for undisputed items in an invoice, even if others are disputed; and (5) allowing a subcontractor (or contractor) to facilitate the early release of retention by posting a maintenance bond for 120 percent of the retainage held at substantial completion instead of waiting for payment after final acceptance of the work.
Similar changes were enacted to Tennessee’s Prompt Payment Act in 2020. The highlights of the changes included: (1) permitting parties not timely paid to send a notice to the payor and if the payor fails to respond in 10 days with “adequate legal reasons” for nonpayment, the unpaid party can seek injunctive relief; (2) specifying that failure to provide “adequate legal reasons” for nonpayment also entitles a claimant to stop work and receive an extension of the contract schedule; (3) mandating a default 18% per annum interest rate for late payment if the contract does not specify an interest rate; and (4) removing the requirement for notice to owners on commercial projects for lien rights to attach.
Most recently, Virginia updated its Prompt Payment Law effective January 1, 2023. The changes broadened the reach of the law by expanding the enumerated parties and expanding the contracts that it covers. The changes also specifically set forth procedures on private projects for owners and contractors intending to withhold payments for contractual “noncompliance” to send written notice within 45 days (owners) and 50 days (contractors) specifically identifying the contractual noncompliance and the amount being withheld. On public projects, contractors—in direct contract with the state agency—are required to pay lower-tier parties within 60 days of receiving an invoice, regardless of whether they have received payment from the state agency.
These types of statutory changes will require upstream parties to be more vigilant about taking prompt action on payment applications to ensure they are not inadvertently waiving the right to withhold payments for deficiencies. Relatedly, downstream parties who want to ensure prompt payment must also provide timely notifications to qualify for the types of protection provided by these amendments. While these changes impact all parties in the payment pipeline, the benefits to claimants are noteworthy.
Application of Prompt Payment Laws, a Warning to Owners and Upstream Parties
To ensure the effectiveness of prompt payment laws, states have incorporated withholding and good faith rejection requirements. These provisions are designed to prevent the abuse of rejection rights and protect claimants from arbitrary denial of rightful compensation. By mandating clear and justifiable reasons for payment rejections, states promote transparency and accountability in the payment process. As a result, prompt attention must be given to pay applications routinely exchanged on construction projects.
On June 7, the Appeals Court in Tocci Bldg. Corp. v. IRIV Partners, LLC, 101 Mass. App. Ct. 133 (2022), issued the first appellate decision interpreting the Massachusetts Prompt Payment Act, which was passed in 2010. Tocci was retained as general contractor to construct a building in Boston and sued the project owner for breach of contract relating to seven unpaid payment applications, valued at more than $4.6 million. Tocci moved for summary judgment on its breach of contract claim, arguing payment was wrongfully withheld under the act 1 and, therefore, was in breach of the parties’ contract. The trial court found the defendants failed to properly reject Tocci’s payment applications under the act, and the payment applications must be treated as approved. Thus, Tocci was entitled to receive full payment as demanded.
The Appeals Court agreed and affirmed the trial court decision. In doing so, the court examined the circumstances surrounding each application for payment and succinctly concluded that the defendants never issued an effective rejection because they did not certify the facts and deficiencies in the pay application. Accordingly, each was “deemed approved by operation of law on the date payment was due, and each became due and payable.” The court held that a project owner’s failure to issue certified and timely pay application rejections resulted in the applications being deemed approved under the act. Anything short of strict statutory compliance will not meet legal requirements when rejecting applications for payment in Massachusetts.
The decision has far-reaching consequences and will mean common forms of rejection of pay applications, if not coupled with detailed reasoning and a certification of good faith, will be considered approvals. While the Appeals Court decision in Tocci is certainly a cautionary tale for project owners, it is instructive for all parties to private construction contracts in Massachusetts that are subject to the act, as well as projects in other states governed by similar prompt pay statutes.
Key Takeaways for Project Participants
The national trend of construction-related state prompt payment laws embracing claimant-friendly measures highlights a shift towards protecting the rights and interests of contractors, subcontractors, and suppliers. Through revisions to statutory and legal precedents, states like California, Pennsylvania, Tennessee, Virginia, and Massachusetts have actively prioritized fair treatment and timely compensation for construction participants.
Moreover, the inclusion of good faith rejection requirements in some of these laws ensures transparency, and accountability, and prevents arbitrary denials of rightful compensation. By demanding clear and justifiable reasons for payment rejections, states uphold the principles of fairness and equity in payment disputes.
As the construction industry continues to evolve, staying informed about the evolving landscape of prompt payment laws is crucial for all stakeholders. By understanding the national trend toward claimant-friendly laws and the significance of good faith rejection requirements, construction participants can navigate payment disputes with confidence, secure their rights, and foster an equitable and efficient payment process in the construction industry.
