by Nicholas A. Merrell, Associate

Successful and costeffective defense of prompt payment lawsuits can be challenging.  Most California prompt payment statutes, which serve to deter the wrongful withholding of progress and retention payments, provide monthly interest penalties to prevailing plaintiffs and attorneys’ fees to the prevailing party.  Motivated by the prospect of recovering attorneys’ fees, some plaintiffs take positions that force both sides to spend more money on attorneys and experts than the expected value of litigation justifies.

Owners, general contractors, prime design consultants and sureties defending these actions should consider using statutory offers of compromise, authorized by California Code of Civil Procedure section 998 (“998 Offers”), as a way to tip the odds in their favor.  A party that rejects a reasonable 998 offer — but fails to obtain a more favorable judgment at trial — will be charged with the post-offer “costs” of the offering party as a penalty.  If attorneys’ fees are authorized by contract or statute, then the offering party’s post-offer attorneys’ fees will be included as “costs.” Thus, recovering attorneys’ fees based on a 998 Offer depends on the underlying statutory or contractual basis for attorneys’ fees.  Importantly, under certain prompt payment scenarios, only defendants will have a chance to recover attorneys’ fees, making 998 Offers critical.

Prompt Payment Defendants Can Win Attorneys’
Fees

Using 998 Offers to defend prompt payment lawsuits requires an understanding of the statutory basis for recovering attorneys’ fees.  Recently, in Taylor v. Van-Catlin Construction (2005) 130 Cal.App.4th 1061 (Taylor), the court of appeal affirmed an arbitrator’s award of attorneys’ fees to an owner as the prevailing defendant to a contractor’s prompt payment action, in which the contractor sought attorneys’ fees pursuant to Civil Code section 3260.  Taylor interpreted section 3260, a prompt payment statute governing private works of improvement, as follows:

Where there is no bona fide dispute, the owner may be liable for interest penalties and attorneys fees if the contractor is the prevailing party.

Where there is a bona fide dispute regarding nonpayment, the owner may withhold up to 150% of the disputed amount without fear of either an interest penalty or liability for the contractor’s attorneys’ fees.

The Taylor court found that a bona fide dispute existed.  Furthermore, the court found that because the owner had won on an affirmative claim for damages against the contractor, which made it the prevailing party, the owner was entitled to attorneys’ fees pursuant to Civil Code section 3260.  The Taylor court reasoned, “[i]f the Legislature had intended only the successful demanding party to receive attorneys’ fees, it would have so stated instead of permitting an award to the ‘prevailing party.’” Thus, in cases where a prompt payment defendant is the prevailing party, and where there is a good faith dispute, the defendant may be entitled to recover attorneys’ fees.

Plaintiffs That Recover Unpaid Funds May Fail to Recover Attorneys’ Fees

Although prevailing defendants can recover attorneys’ fees, prompt payment statutes do not necessarily confer reciprocal entitlement on plaintiffs.  Regardless of entitlement to additional compensation, independent defenses may bar plaintiffs from recovering attorneys’ fees based on a prompt payment statute.  As discussed in Taylor, courts have found that the existence of a bona fide dispute may exempt a defendant from liability for attorneys’ fees and interest penalties.

Furthermore, many prompt payment statutes, such as Civil Code section 3260, do not require middle-tier actors (i.e., general contractors and prime design consultants) to make payments until some time after receipt of funds.  For example, section 3260 does not require a contractor to pay a subcontractor until 10 days after receipt of funds from the owner.  Thus, prompt payment statutes do not authorize attorneys’ fees with the same reciprocity one might ordinarily associate with a contractual attorneys’ fees provision.

In the end, even if a prompt payment plaintiff is able to recover the unpaid funds, in the absence of a contractual attorneys’ fees provision, that plaintiff may be unable to recover its attorneys’ fees.  This can have a profound impact on the value of 998 Offers in prompt payment cases.

Application of the 998 Offer

998 Offers can be extremely valuable in defending prompt payment actions because, if rejected, they can have a devastating effect on the plaintiff’s expected value of litigation, especially if there are valid defenses to nonpayment.

For example, assume that you are a general contractor defending a subcontractor’s claim of $500,000, including a demand for attorneys’ fees based on a prompt payment statute.  Also assume that you are a sophisticated general contractor that did not pay the subcontractor because: 1) you were never paid by the owner, and 2) you have a good faith dispute as to your liability for nonpayment, which you documented to the subcontractor when payment was allegedly due.  Practically speaking, even if the subcontractor prevails at trial, it stands little chance of recovering attorneys’ fees based on these independent defenses.

Under these circumstances, it is not only logical for the general contractor to make a 998 Offer as soon as possible (shifting more attorneys’ fees into the post-offer category), it should be automatic.  Assume the subcontractor has a 25% chance of winning the full $500,000, a 50% chance of winning $250,000, and a 25% chance of taking nothing.  If it will cost each side $250,000 in attorneys fees to try the case, the subcontractor’s expected value of litigation would be $0, which may encourage a roll of the dice at a large judgment.  However, a 998 Offer of $250,000 would decimate the subcontractor’s expected value of litigation:

1)    Complete Victory:
    .25 x ($500,000 - $250,000
    [own fees]) = $62,500
        +
2)    Partial Victory:
    .5 x ($250,000 - $500,000
    [own fees]) = $125,000
        +
3)    Total Loss:
    .25 x ($0 - $500,000 [own fees])
    = - $125,000

    Subcontractor’s Expected Value
    at Litigation:  $187,500

Apart from reinforcing the value of alternative dispute resolution, this exercise demonstrates the power of the 998 Offer in defending prompt payment actions.  Importantly, the complete victory scenario would be less favorable to the subcontractor here than if it had sought attorneys’ fees pursuant to a contract clause. Even if the subcontractor shoots for the moon at trial, the payoff will be anticlimactic.  Both parties will bear their own costs and attorneys’ fees because of the general contractor’s good faith basis for withholding payment, and because it was never paid by the owner.  If attorneys’ fees were based on contract, however, the subcontractor would have likely recovered them as the prevailing party.

Furthermore, under the partial victory scenario, because the subcontractor will have failed to obtain a judgment more favorable than the 998 Offer of $250,000, it will be liable for the attorneys’ fees of both parties.  The same is obviously true in the total loss scenario.  The subcontractor’s best option is to clearly accept the 998 Offer.

Conclusion

Although 998 Offers can be effective in many cases where attorneys’ fees are at stake, they are particularly useful in defending nonpayment lawsuits involving knee-jerk claims for prompt payment penalties and attorneys’ fees. Nonetheless, it may be optimistic to assume that a party willing to engage in internecine litigation will appreciate the consequences of rejecting a 998 Offer.  As such, 998 Offers should be served with a thoughtful cover letter explaining why the plaintiff has little to gain by refusing to settle, and much to lose.


The information or opinion provided in this article is the author's own and not necessarily that of Watt, Tieder, Hoffar & Fitzgerald, LLP. The author is solely responsible for the information and opinion that he or she has provided. The information contained herein does not replace seeking specific legal counsel to directly address individual client needs.

Watt, Tieder, Hoffar & Fitzgerald is one of the largest construction law firms in the world, with a practice that encompasses all aspects of construction contracting, claims and disputes resolution, and transactional legal services. WTHF principally represents large general contractors, design firms, and sureties throughout the country and internationally.