Public Agencies Cannot Withhold Retention Over Contract Price Dispute

In FTR International, Inc. v. Rio School District, case number B238618, the Court of Appeal, Second Appellate District, affirmed, in part, a trial judgment against Rio School District (“District”) for improperly withholding retention funds due to a dispute between the contract price resulting from approximately 150 proposed change orders by FTR International, Inc. (“FTR”). The Court of Appeal held that a dispute over the contract price does not entitle a public entity to withhold its retention funds under California Public Contracts Code section 7107.

In 1999, the District contracted with FTR for the construction of a school. During the construction, FTR submitted approximately 150 proposed change orders. The District denied most of the change orders on the grounds that the work was covered under the contract. The construction was completed in June 2001 and a notice of completion was filed on August 7, 2001. Pursuant to the contract, the District withheld 10% from FTR’s progress payments, resulting in the retention of $676,436.49 at the end of the project. The District withheld the retention because of stop notices, but when the stop notices were released, the District still refused to release the retention because of the contract price dispute over the change orders.

Under Public Contracts Code section 7107(c), “[w]ithin 60 days after the date of completion of the work of improvement, the retention withheld by the public entity shall be released. In the event of a dispute between the public entity and the original contractor, the public entity may withhold from the final payment an amount not to exceed 150 percent of the disputed amount.” The Court of Appeal disagreed with the District’s argument that a public entity may withhold the retention funds if there is any “good faith dispute.” In rejecting this argument, the Court of Appeal also declined to follow Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc. (2009) 179 Cal.App.4th 1401, which held that Section 7107(e) applied to “any good faith dispute between a general contractor and subcontractor.” The Court of Appeal held that Martin Brothers Construction was not consistent with the purpose of Section 7107.

The Court of Appeal stated that “Section 7107’s purpose of ensuring the prompt release of retention funds would not be served if any dispute justified retaining the funds. There is no reason to allow a public entity to retain the funds once their purpose of providing security against mechanics liens and deficiencies in the contractor’s performance has been served. Unless the dispute relates to one of those purposes, the public entity will not be protected from the statutory penalty. FTR’s action against the District is not such as dispute.”

The Court of Appeal upheld penalties and attorneys’ fees related to the disputes under Section 7107. Section 7107(f) provides for a penalty of 2% per month on any amount improperly held, plus attorneys’ fees and costs.