New Appellate Case Could Have an Immediate Impact on Construction Disputes

Ruling in Massachusetts on prompt-pay statutes comes amid skyrocketing costs for labor and materials.

Construction litigators have seen long periods of time when owners and developers could resolve disputes with contractors during, or immediately after, the completion of a project. Affordable building materials, reasonable hourly wages, easy access to funds at low interest rates and incoming tenants with excellent financials (or white-hot residential demand for condominiums, houses, etc.) made it easy to resolve all but the largest disputes. Everyone was making good money, and even significant change orders could be viewed as rounding errors if they kept a project on track to get space to market.

Unfortunately, 2022 and 2023 are shaping up to be years like no others, and significant claims could spike as a result. Many contractors will soon realize that they may be working on their last major project for some time, and owners and developers will lose access to low-interest funding and be asked to pay strikingly elevated prices for virtually everything associated with construction. With that in mind, developers should pay close attention to a recent appellate court decision in Massachusetts regarding prompt-pay statutes and construction projects.

Soaring Costs

The National Association of Home Builders recently reported that material prices had increased more than 33% since the start of the pandemic. At the same time, the prices for services used in the building trades, such as transportation and warehousing, have increased 39% since March 2020.

To compound these trends, the Federal Reserve has been aggressively hiking interest rates in recent months to battle inflation, which is at its highest level in 40 years. Loans that were quoted at 3% several months ago now exceed 6% and could climb higher in the coming months. Major financial institutions are no longer willing to commit to the final interest rate on pending loans until the week of closing. The added cost of new money will make it considerably harder to resolve disputes.

In the industrial sector, Amazon CEO Andy Jassy recently announced that his company is “no longer chasing physical or staffing capacity,” and the makings are in place for a shakeout in the key warehousing sector. The massive building campaign by Amazon and several national warehouse developers almost singlehandedly kept industrial construction afloat through the pandemic — despite inflationary and wage pressure. However, Amazon’s pullback on several projects, coupled with its announcement that it will likely sublease many locations, will slow the expansion of this market segment for the foreseeable future.

Meanwhile, office holdings in the U.S. could collectively lose $500 billion in value during the next decade, according to a study by the NYU Stern School of Business and the Columbia University Graduate School of Business. Their findings are based on assumptions regarding current work-at-home rates and structural losses from the nonrenewal of leased space, particularly in Class B and C buildings.

Because of this, developers are looking to convert offices to other uses. However, major building renovations, particularly full-blown use conversions, can be expensive, claims-intensive, schedule-eating monsters. Between the significant price increases that will surely not reverse themselves in the short term, the loss of low-interest capital and the market’s need to switch its focus from easier to more complex projects, all indicators point to more claims in the near term.

Prompt-Pay Statutes in the Spotlight

Against this backdrop of a rapidly changing construction landscape, many states have updated their versions of prompt-pay statutes, generally to the benefit of contractors.

In 2018, the Pennsylvania legislature passed several amendments to the Pennsylvania Contractor and Subcontractor Payment Act (CASPA). Included in those amendments is a requirement for owners who want to withhold payment from a contractor to “notify the contractor of the deficiency item by a written explanation of its good-faith reason within 14 calendar days of the date that the invoice is received.” Moreover, “failure to comply . . . shall constitute a waiver of the basis to withhold payment and necessitate payment of the contractor in full for the invoice.”

Although no Pennsylvania appellate court has yet interpreted this portion of the statute, there have been private arbitrations where owner/developers were forced to pay significant additional sums in penalties and interest because of the failure to comply with these provisions. And now, the Appeals Court of Massachusetts recently issued an opinion strictly interpreting a similar Massachusetts statute.

The Massachusetts Prompt Payment Act includes a provision stating that owners must approve or reject applications for payment within “15 days after submission.” The law goes on to state that “an application for a periodic progress payment which is neither approved nor rejected within the time period shall be deemed to be approved unless it is rejected before the date payment is due.” Any rejection of an application for payment must be in writing and must “include an explanation of the factual and contractual basis for the rejection and shall be certified as made in good faith.”

In Tocci Building Corporation v. IRIV Partners, LLC, decided in June, the court strictly applied this requirement of the Massachusetts Prompt Payment Act. The court methodically discussed seven applications for payment and the written responses, if any, provided to each by the owner. The court determined that each response did not comply with the requirements of the Prompt Payment Act, primarily because the owner did not provide “an explanation of the factual and contractual basis for the rejection.”

Even for the one response that the court noted arguably included an explanation of the factual and contractual basis for the rejection, it still held that the response did not comply with the Prompt Payment Act because it did not include an explicit certification that the withholding was made in good faith.

The procedural posture of the Tocci case is also noteworthy because the Appeals Court of Massachusetts upheld the trial court’s granting of partial summary judgment even while the owner had pending counterclaims for “breach of contract, breach of the implied covenant of good faith and fair dealing, negligent misrepresentation, fraud, negligence, unfair and deceptive conduct . . ., breach of contract as a third-party beneficiary . . ., and breach of express warranty” while alleging that the contractor “performed defective work, failed to perform contractually required work, and submitted fraudulent payment applications.”

The court in the Tocci case set the owner’s counterclaims aside, stating that “to allow the [owner] to retain the moneys wrongfully withheld in violation of the statute until the final resolution of their postcompletion contract action would eviscerate the scheme for prompt payment or rejection-and-resolution created by the Legislature.” The court did clarify that “we do not hold, that the [owner’s] claims for breach of contract have been waived by their failure to include them in a proper rejection under the statute. They may bring . . . any and all claims they have for breach of contract against [the contractor], and they may recoup any money they may be owed.”

Finally, the court closed by offering this advice to owners, which may also be good advice to owners attempting to comply with the latest amendments to CASPA: “If an owner does not wish to make a periodic payment pending resolution of a dispute because it believes it will not in the end owe the money, it must file a prompt rejection in compliance with the statute.”

For developers involved in current construction projects who believe that a potential dispute is more likely than a few months ago, it is strongly advised that they review this case, and the corresponding prompt-pay requirements in the jurisdiction where their projects are located, to avoid waiving rights that cannot be regained through ordinary litigation after the fact.

In addition to Pennsylvania and Massachusetts, other states with similar prompt-payment statutes include Alabama, Arizona, California, Delaware, Illinois, Kansas, Louisiana, Minnesota, Montana, Nevada, New Jersey, New York, Oregon, South Carolina, Utah and Vermont.

Brian Maloney and Chad Wissinger are shareholders in the Pittsburgh office of Dentons Cohen & Grigsby P.C.