By: William E. Underwood Partner, Jones Walker LLP.
Withholding sums during a dispute can be an effective and perfectly legitimate means to protect against the harms caused by another party’s breach. However, withholding too much money during a dispute can turn a position of strength into one of weakness.
“Why should I fund the other side’s litigation war chest?” and “Isn’t this just a display of weakness?” are common questions raised by contractors when this issue is discussed. Often, the contractor is well within its contractual or legal rights to withhold money from a breaching subcontractor (another topic for another day). But it may not always be in a contractor’s best interest to withhold every single penny available.
Withholding Too Much Money Can Impact Attorneys’ Fees – Yours and Theirs
Attorneys’ fees are a huge consideration when entering formal litigation. But they can also matter during “just” an informal dispute, as these fights still cost money and a party can later seek these fees if a lawsuit or arbitration is filed. And withholding too much money can impact a contractor’s ability to later recover attorneys’ fees. Depending on your contract and/or applicable state law, the “prevailing party” may be entitled to recover attorneys’ fees at the conclusion of litigation. But how do you determine if you are the prevailing party? Is winning $1.00 enough? Or do you have to do more?
Although it differs state-to-state, the general rule is that the prevailing party is the one who prevails on its “substantive claims.” This general finding is still not particularly informative, and it is obviously important to understand the laws and rules governing your specific dispute, but usually a contractor must recover more than a few dollars to claim victory and recover attorneys’ fees.
With that in mind, withholding too much money going into litigation can impact a contractor’s ability to “prevail.” Although there may be a defensible basis to withhold all of that money, the withholding contractor may ultimately still have to return some of the money to the subcontractor depending on the final outcome of the litigation. If that is the case, then the subcontractor can argue that it prevailed—and is therefore owed its attorneys’ fees; not the other way around—because it was able to recover a portion of money that it (correctly) alleged was wrongfully withheld. Or at the very least, an argument can be made that the withholding contractor did not “prevail” on its substantive claims because it had to give some of the money back.
Regardless, having to return a portion of withheld funds at the conclusion of litigation can impact a contractor’s ability to recover attorneys’ fees. And in some instances it can even lead to paying the other sides fees. This payment of fees can have a significant impact on the overall financial outcome of a case. So returning a portion of withheld money—if appropriate—can positively impact the overall financial result of the case.
Withholding Too Much Money Can Lead to Counterclaims for Bad Faith
Withholding sums that are plainly not in dispute can quickly lead to a counterclaim for bad faith—which is generally defined as violation of basic standards of honesty and fairness in contractual dealings. And in many states, a successful bad faith claim can offer the claimant an avenue to recover attorneys’ fees (in addition, or as an alternative, to any of the “prevailing party” considerations discussed above).
Most states recognize some form or another of bad faith within the context of contractual dealings (but again, it is always important to understand the laws governing your dispute). Construction contracts are no different. And clearly withholding more money than reasonable or defensible often provides solid grounds for the other party to claim bad faith. Although the bar to prove bad faith is usually high, it should not be taken lightly. Not only can a bad faith claim serve as a defense to a breach of contract, but it can also serve as an affirmative claim and a basis for attorneys’ fees. So although a contractor may have good claims and a solid basis to withhold some money, objectively withholding too much can jeopardize the chances for success by opening the door to accusations of bad faith by the other side.
So again, a contractor can quickly ruin a good claim by withholding too much money.
Interest Can Accrue on Improperly Withheld Sums.
In many states, improperly withheld sums can (and will) accrue interest during the lifecycle of the dispute. For example, many states have prompt payment statutes that provide for the recovery of high interest rates on withheld sums if those must be returned. And no claim for bad faith or other improper behavior is needed to recover this interest. For example, Georgia’s Prompt Payment Act (O.C.G.A. § 13-11-1 et seq.) provides for an interest rate of 12% per annum on unpaid sums owed to a contractor or subcontractor. This interest can add up quickly, particularly because formal disputes can drag on for years. And generally any portion of withheld money that must be returned is subject to the accrual of this interest (assuming the subcontractor met the statutory requirements).
But even if a contractor does not meet the requirements to recovery interest under a prompt payment act, many states will allow contractors to recover what is known as prejudgment interest on withheld sums that are later returned. For example, New York allows for a prejudgment interest rate of 9% per annum. This interest is typically added to any withheld sums that must be returned at the conclusion of a dispute. And it usually begins to accrue at the outset of the dispute.
So withholding too much money, even if it is not in bad faith, can still lead to a reduced recovery once improperly withheld sums are returned with interest.
Returning A Portion of Withheld Sums Can Increase Your Chances of Winning And Possibly Lower Your Litigation Costs
Returning a portion of withheld funds (if appropriate) can also have practical benefits for the remainder of a dispute. On a basic level, it can narrow the number of issues the parties are fighting over, which in turn can decreases costs and fees. If there is less to fight about, then (in theory) there is less to spend money on.
But returning a portion of withheld sums for weaker claims can also allow a party to focus on its strongest claims—thereby increasing its chances of “prevailing” and potentially recovering its attorneys’ fees (as discussed above). Much like the raccoon that refuses to drop a shiny object, sometimes it is best to let go of claims that may have initially seemed appealing but ultimately prove worthless. Doing so can allow a party to pursue the strongest claims while maximizing its overall chances for recovery.
Conclusion
Withholding too much money can have long-term negative impacts on otherwise good claims. And although this article does not address every single negative consequence of withholding too much money, it does highlight some of the very real financial impacts that it can have on a claim. So when entering a dispute, it is important to consider these impacts and to adjust your withholding strategy accordingly.
The views expressed in this article are not necessarily those of ConsensusDocs. Readers should not take or refrain from taking any action based on any information without first seeking legal advice.