The CASPA Amendments Part II – the New Rules for Withholding Payment from Subcontractors/Suppliers

This is Part II of a series of articles on the recent amendments to the Contractor and Subcontractor Payment Act (“CASPA”) (if you missed Part I discussing the new rules for the withholding of payment by owners, just send me an email and I’ll forward it to you). This article focuses on the prime/general contractor’s right to withhold payment from a subcontractor/supplier (this right to withhold applies equally to a subcontractor that withholds payment from a sub-subcontractor /supplier, etc.).

Fundamental Payment Obligations Under CASPA

Under CASPA, the prime/general contractor (hereinafter “contractor”) is obligated to pay to its subcontractors the full or proportional amount that the contractor receives from the owner for each subcontractor’s work and materials, based on work completed or services provided, within 14 days after receipt of each progress or final payment from the owner or within 14 days after receipt of the subcontractor’s invoice, whichever is later. The only exception to this obligation recognized by CASPA is that a contractor may withhold payment from a subcontractor for a “deficiency item”. You’ll recall from my prior article, Part I, the owner also has the right to withhold payment from a contractor for a “deficiency item”, which is defined under CASPA as “work performed but which the owner, contractor or the inspector will not certify as being completed according to the specifications of a construction contract.” A “deficiency item” is essentially an item of work, material or services that does not conform to the specifications, and, therefore is “deficient”. The foregoing payment model has been part of CASPA since it was enacted in 1994 and was not changed by the amendments.

Written Notice of Withholding and Waiver of the Basis to Withhold Payment

The amendments impose a new written notice requirement on a contractor that intends to withhold payment from a subcontractor for a deficiency item. Now, if a contractor intends to withhold payment from a subcontractor for a deficiency item, the contractor must notify the subcontractor and the owner in writing of the good faith reason for the withholding within the time period specified in the subcontract or within 14 calendar days of the date after receipt of the notice of the deficiency item. The amendments have also established a clear, adverse legal consequence for failing to comply with this notice requirement. If the contractor fails to comply with the notice requirement, the contractor waives the basis to withhold payment and must pay the subcontractor in full for its invoice or payment application. This waiver of the basis for withholding effectively strips a contractor of the right to withhold payment from a subcontractor for a deficiency item if the contractor fails to properly and timely issue written notice to the subcontractor. A contractor that fails to comply with the notice requirement (and therefore waives any basis to withhold payment), but continues to withhold payment, subjects itself to liability for interest (at 1% per month) and penalty (at 1% per month) until the withheld amount is paid. This waiver provision arms subcontractors with significant leverage in a payment dispute with a contractor that withholds payment after failing to comply with the notice requirement.

Time Period for Notice of Withholding

The amendments allow a contractor and subcontractor to agree upon and set forth in their subcontract, a time period (other than the default 14 calendar day period) within which the contractor must issue the written notice of withholding to the subcontractor. A contractor will likely want to include in the subcontract a time period longer than 14 calendar days to issue the written notice of withholding simply to give itself more time to issue the notice without risk of waiving any legitimate basis for withholding that it may have. While agreeing to a longer notice period in the subcontract appears to be permissible, the written notice still must comply with the other CASPA requirements (i.e, must be sent to the subcontractor and the owner, must be in writing, and must state the good faith reason for the withholding). When reviewing a proposed subcontract from a contractor, subcontractors should look to see if there is any time period stated for the written notice of withholding. If the subcontract is silent on a time period for issuing the notice of withholding, then the default 14 calendar day period in CASPA will apply. On the other hand, if there is a time period stated in the subcontract that exceeds 14 calendar days, it is in a subcontractor’s interest to try to negotiate it down to 14 calendar days or something close to that. Logically, the longer the contractor has to issue a notice of withholding, the more likely the contractor will timely issue a notice. In other words, shorter time periods in a subcontract for issuing the notice of withholding will increase the chance that the contractor will fail to timely issue the notice (simply because it has less time to do so), and therefore increase the chance that the contractor will waive any basis it has to withhold payment.

Also, contractors that decide to include a time period for the notice of withholding in their subcontract form should consider establishing separate time periods for issuing notice to subcontractors for deficiency items determined by the owner and for deficiency items that the contractor discovers first (i.e., before the owner). In the latter situation, the contractor will not have received a notice of deficiency from the owner, but must still comply with the written notice requirement as to the subcontractor responsible for the deficiency item if the contractor intends to withhold payment on account of that deficiency item.

Several Angles of Attack

As I discussed in Part I, in the owner/contractor context, what is less clear is whether the contractor waives its right to withhold payment in the situation where it timely issues a written notice to the subcontractor, BUT either: (a) fails to send the notice to the owner; (b) fails to explain in the notice its reasons for withholding; or (c) gives a baseless or unsupportable reason for withholding payment. An argument can certainly be made that each of these circumstances constitute a failure to comply with the CASPA notice requirements, and, as a consequence, the contractor has waived any basis to withhold payment on that application. Whether the courts will ultimately agree with this argument is “to be determined” as the amendments have yet to be litigated, but it is certainly a valid legal argument that a subcontractor can now assert when pursuing payment.

Contractor Must Pay for All Satisfactorily Completed Items

Lastly, the amendments mandate that when a contractor withholds payment from a subcontractor for a deficiency item, the contractor “shall remit payment to the subcontractor for each other item that has been satisfactorily completed” under the subcontract. For example, assume there is a genuine deficiency in the partition framing work performed by a drywall subcontractor on one particular floor (and this is the only deficiency at the time). The contractor can withhold payment for the partition framing work on that floor (subject to the notice requirements discussed above), but the contractor must pay for all of the other items of work certified as complete in the subcontractor’s pending payment application. If the contractor has to pay the subcontractor for all satisfactorily completed items on a payment application, as the amendments mandate, then the amount the contractor can withhold for a deficiency item appears to be limited to the scheduled value for the deficient item. A contractor that withholds amounts due for properly completed items in order to compensate itself for other deficient items is likely subjecting itself to liability for interest (at 1% per month) and penalty (at 1% per month) on the amount wrongfully withheld for the properly completed items.

Stay tuned for Part III of this series which will examine the new right to suspend work added by the CASPSA amendments….

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