On May 11, Arizona Governor Jan Brewer signed into law a bill that substantially modifies existing Arizona law concerning the prompt payment of contractors, subcontractors and materials suppliers on private projects. Although Arizona law requires prompt payment of contractors on both public and private construction projects, the new law, S.B. 1375, alters only the statutes that govern private contracts.

No Change to Payment Cycle
The bill retains the existing 21-day cycle for progress payments (14 days for the owner to certify and approve the payment application from the prime contractor and seven days thereafter to make the payment). It also expressly addresses final payment and payment of retention and establishes the same 21- day payment cycle for payment of retention and final payment.

An owner may withhold retention or final payment for, among other things, failure to complete requirements of the construction contract, but the owner must issue a written statement to the contractor within 14 days that explains, in reasonable detail, the owner’s reason for withholding. Furthermore, the owner may only withhold payment if the contractor is actually responsible for the owner’s loss and the owner may withhold no more than 150 percent of the costs that the owner can reasonably expect to incur as a consequence of the problem.

Legislative Fix to the Stonecreek Decision
The new law’s most significant revisions abrogate Stonecreek Building Company Inc. v. Hecker, an Arizona Court of Appeals decision that limited the circumstances under which owners could lawfully withhold payment due to concerns about work included on a previously paid invoice. In Stonecreek, the owners of a custom residence withheld payment on a contractor’s invoice because they were unhappy with a subcontractor’s masonry work that the contractor had billed and the owner had paid for on a prior bill.

The issue presented in Stonecreek was whether an owner had a right to object to a general contractor’s pay application for work for which the owner had previously paid the contractor. The prompt payment statute included a detailed list of the reasons an owner could object to payment, including unsatisfactory job progress and defective construction work not remedied. The court of appeals ignored this list and instead focused on language in the statute that gave owners the right to withhold a progress payment by “detailing those items in the billing that are not approved.” The court held the owners violated the prompt pay law by withholding payment based on masonry work for which they had already paid the contractor, reasoning that owners could only withhold payments for “items” of work billed in the current invoice.

The Court’s decision was not consistent with what the Legislature intended when it enacted prompt payment. The revised statute deletes the language referring to “items in the billing” and allows an owner to withhold payment so long as it specifies its “reasons” for withholding the payment. As amended, the pertinent provision reads:

[A] billing or estimate for a progress payment shall be deemed certified and approved . . . unless . . . [the owner] prepares and issues a written statement stating in reasonable detail the owner’s reasons for not certifying or approving all or a portion of the billing or estimate.

Under the new law, contractors and subcontractors must send a copy of the owner’s written statement that identifies the work to which the owner objects to all affected subcontractors or material suppliers within seven days. The contractor must pay any subcontractor or material supplier whose work was not the basis for the owner’s withholding payment within 21 days after payment would otherwise have been made by the owner under the typical 21-day billing cycle.

Notice Required on Residential Projects
Significantly, for residential (owner-occupied) projects, the law requires contractors to include specific language in each invoice to the owner that gives the owner notice of and explains the prompt pay laws. Failure to include such language renders the prompt pay laws inapplicable to the project.

The new provisions in 1375 strike a balance. Owners wanted to clarify the intent of the original prompt payment legislation and make it clear that Stonecreek was wrongly decided. Contractors wanted modifications to prompt payment statutes to address payment issues that were simply missed or not addressed when the bill was originally enacted. The bill generally achieves this balance.

The Arizona legislature has made substantial and important revisions to the prompt pay laws governing private contracts. Not all of these changes could be fully addressed here. Those engaged in private construction work in Arizona should consult with qualified counsel to determine how the new law affects their business.

Useful Sources

View the modified law at http://www.azleg.gov/ArizonaRevisedStatutes.asp?Title=32
Click on the links for article 32-1129 under the ‘Contractors’ heading.