Contractors Beware: Your Prompt Payment Rights May Not Be As Strong As You Think After

Taylor v. Van-Catlin Construction (2005) 130 Cal.App.4th 1061.

A recent decision suggests for the first time that an owner may recover its

attorney's fees from a contractor who sues the owner for breach of contract and also requests the statutory 2 percent penalty and attorney's fees under Civ. Code § 3260 for improperly withheld retention funds.

In Taylor v. Van-Catlin Construction, issued June 29, 2005, homeowners hired a contractor to remodel their home under an agreement that contained an arbitration clause but no attorney's fees clause. When the homeowners refused to pay the full amount, the contractor initiated arbitration, in which it sought recovery of the contract balance, plus the 2 percent penalty and attorney's fees under Civ. Code § 3260. The contractor claimed that the homeowner had wrongfully withheld the retention payment. The arbitrator found the contractor's work to be "materially substandard" and entered an award for the homeowner that included the homeowners' attorney's fees.

On the contractor's challenge of the arbitration award, the trial court deleted the award of the homeowners' attorney's fees on grounds that the arbitrator had exceeded his jurisdiction and that such fees were not recoverable under Civ. Code § 3260(g) because there existed a "bona fide" dispute between the parties.

On appeal, Taylor held that the trial court should not have disturbed the award of the arbitrator who enjoyed broad discretion to fashion any relief that is "fair and just under the circumstances" and not expressly prohibited by the parties' contract. However, instead of stopping at that point, the Taylor court went on, in what is arguably dicta (i.e., extraneous discussion that is not necessary to the decision and not binding law) and held that the provision in Civ. Code § 3260(g) for recovery of attorney's fees by the "prevailing party" means that either the contractor or the homeowner may recover its attorney's fees.

Disagreement over the meaning of Civ. Code § 3260(g) and who may recover attorney's fees stems from the language of the statute which is hardly a model of clarity. The statute reads as follows:

"In the event that retention payments are not made within the time periods required by this section, the owner or original contractor withholding the unpaid amounts shall be subject to a charge of 2 percent per month on the improperly withheld amount, in lieu of any interest otherwise due. Additionally, in any action for the collection of funds wrongfully withheld, the prevailing party shall be entitled to his or her attorney's fees and costs."

In 2001, another court in Darling v. Controlled Environments Constr., interpreted Section 3260(g) to mean that attorney's fees are recoverable only when the 2 percent penalty is recoverable, i.e., only when no bona fide dispute exists between the parties. Darling reasoned that "[i]t would seem that if the Legislature had intended to provide for an award of attorney's fees to the prevailing party in every action for collection of retention funds, the provision would have been placed in a separate paragraph." Thus, "[t]he 2 percent penalty and the attorney's fees provision are directed at the more egregious situation in which a contractor withholds payment of retention proceeds beyond specified time periods and without cause."

In reaching the opposite conclusion, Taylor disagreed with what it perceived to be Darling's "broad language," which effectively resulted in recovery of attorney's fees by the contractor only, since the owner would never be in the position of seeking the 2 percent penalty under Civ. Code § 3260(g). Taylor reasoned that "[i]f the Legislature had intended only the successful demanding party to receive attorney's fees, it would have so stated instead of permitting an award to the 'prevailing party.' There is simply no logical reason to punish the party who was not at fault-who justifiably retained payment in good faith- by denying that party attorney's fees for successfully defending against the other party's action for payment."

In holding that either party may recover its attorney's fees under Civ. Code § 3260(g), Taylor overlooks the fact that the attorney's fees provision was included in the 2 percent penalty section instead of a separate section, which is consistent with the intent of the Legislature in enacting Civ. Code § 3260 to compensate contractors who are forced to litigate wrongfully withheld retention funds. Although the discussion of attorney's fees in Taylor is arguably nonbinding dicta, it still provides ammunition for the attorney representing an owner/general contractor who prevails on a "prompt payment" claim to argue that the recovery of attorney's fees is a two-way street.

Before Taylor, a contractor did not risk exposure to the owner's attorney's fees simply by asking for, but failing to recover, the 2 percent penalty. Under Taylor, a contractor could recover its retention due under the contract, but now be liable for the owner's attorney's fees where the contractor asserts, yet fails to establish, its right to recover the 2 percent penalty. Thus, after first paying its own attorney to recover the retention funds and then having to pay the owner's attorney's fees as well, the contractor may very well end up with a negative net recovery.

A more in-depth analysis of this issue will appear in November 2005 Value Added.

- James E. Sell

- Francis D. Conway