This blog ‘An Overview of Arizona’s Prompt Payment Act – Dealing with Bonded Liens in Arizona,’ is part six in our series on Arizona lien laws.
Part 4: Bad Checks and Credit Card Chargebacks – How to Deal with Them in the Context of Construction Debts
Part 6: An Overview of Arizona’s Prompt Payment Act
Before we talk about the Prompt Payment Act, we will take a quick refresher on what was covered in previous articles with respect to Arizona construction law.
The first article was ‘Arizona Preliminary 20-Day Notices, Lien and bond Claim Refresher’. The second article was ‘What Happens After I Record My Mechanic’s Lien in Arizona? How Do I Get Paid?’ the third webinar was ‘Lien Waivers in Arizona – Be Careful What You Sign.’ The fourth one was ‘Bad Checks and Credit Card Chargebacks – How to Deal with Them in the Context of Construction Debts.’ The last one was ‘Dealing with Bonded Liens (i.e. Lien discharge bonds) in Arizona.’ Recording on public project payment bonds was also covered in the last one.
Most of what was covered relates to lien and bond claims in various ways. In this article, we will talk about another tool that Arizona contractors have. It is somewhat unique to Arizona, and other states are developing similar statutes. But Arizona has really been on the forefront of having a Prompt Pay Act.
Arizona has two different sectors of prompt pay laws. There are a host of public sector pay laws that are the same, but they can be found in different places in Arizona’s revised statute depending on the type of public work that one is doing.
There are also private sector prompt pay laws, but in this article, we will discuss private sector prompt pay laws.
Arizona’s Prompt Pay Laws
So Arizona has both private and public sector prompt pay laws.
a. Arizona has both private and public sector prompt payment laws
Arizona’s public sector prompt pay laws can be found in three different areas within the statutes depending on the type of work being done and the ultimate client for the project
b. A.R.S. § 28-6924, A.R.S. § 41-2577, and A.R.S. § 34-221 govern public construction projects
A.R.S. § 28-6924 is the prompt pay statutes relating to work done on Arizona Department of Transportation projects. A.R.S. § 42-2577 is the prompt pay statutes related to work done on state projects. Finally, A.R.S. § 34-221 is the prompt pay laws that apply to city, county, and improvement district projects.
So these are the statutes that govern public construction projects, and we will get into what makes those different from the private sector and vice versa.
c. A.R.S. § 32-1181 et seq., governs private construction projects
Arizona’s private sector prompt pay laws can be found in § 32-1181 et seq., and these govern private construction projects lasting more than 60 days with the following exceptions:
i. Applies to residential projects if contract with or invoices to owner-occupant contain notice that prompt pay laws apply
The first exception only applies to residential construction that is an owner-occupied project, if the contract with or the invoices to an owner-occupant contain notice that the prompt pay laws apply.
ii. Parties can alter billing cycle by two ways
Another exception is that the parties can alter the billing cycle by:
10. Providing for a different payment schedule in the prime contract in a clear and conspicuous manner, and
11. Placing a statutory notice of alternate billing cycle on every page of the construction and bid plans.
The reason for this on a fundamental level is if you want to opt out of the Prompt Pay Statutes. If the owner and general contractor elect to do that it may not funnel down to everyone on the project, and so, as a statutory mechanism to make sure everyone is aware of what is going on.
Arizona statutes require that there is clear inconspicuous language in the prime contract and that this notice of alternate billing cycle is placed on every page of the construction of bid plans so that the people who may only see portions of those plans.
If the mechanical workers see the mechanical plans, they know that the different billing cycle is being applied on the project. So the goal behind that is really to make sure everyone is aware that the typical prompt pay 30-day billing cycle may not apply and can adjust them themselves accordingly.
So this is the standard
Standard Billing Cycle on Public Projects
Now we have the standard billing cycle on public projects.
First, the owner receives the general contractor’s invoice and has seven days to review and approve it. Then there are 14 days to pay. Once the general contractor receives payment from the owner, they have seven days to pay their subcontractors. Then those subcontractors in turn have seven days to pay their suppliers, and any sub-subcontractors.
So the idea basically that you have a 30-day billing cycle wherein the owner receives the general contractor’s invoices has seven days to review and approve. The payment has to be made within 14 days and then payments have to be made to the general contractor, who makes payments to the subcontractors within 7 days.
That gets you to about 28 days in the 30-day billing cycle. This is the standard billing cycle on private projects.
Standard Billing Cycle on Private Projects
On private projects, the billing cycle is a little bit different, whereas on a public project, the owner has seven days to review and then 14 days to pay. It is the inverse on a private project. On private projects, the owner has 14 days to review and approve an invoice or payment application.
But with respect to the payments to the individuals downstream on the project. The payment cycle is still the same once the general contractor receives payment from the owner. They have seven days to turn around and pay their subcontractors and with subcontractors, they then have seven days.
Once they receive payment from the general contractor to either pay their material suppliers or subcontractors. So, the big wrinkle between the public sector and private sector prompt payment laws with respect to timing is the amount of time that the owner has to review and then pay the invoices of the general contractor.
Again, on public projects, it is seven days to review and 14 days to pay. On private projects, it is 14 days to review and then seven days to pay.
Key Provisions of the Private Sector Prompt Pay Laws
So what are the key provisions of Arizona’s private sector prompt pay laws?
a. Standard billing cycle is 30 days
A 30-day billing cycle is set up, and it puts requirements in place to make sure that individuals performing work on a construction project are in fact being paid in a timely fashion. That works out to about 30 days.
b. Owner’s time to approve pay application and pay
On private sector projects, the owner has 14 days to review and approve the general contractor’s pay application, and then seven days to pay.
c. Contractors and subcontractors must pay subcontractors and suppliers
Construction contractors and subcontractors must pay their subcontractors and material suppliers within seven days after receiving payment.
d. Owners, contractors, and subcontractors can refuse approval of invoice in writing
Owners, contractors, and subcontractors can refuse to approve and certify a subcontractor’s or supplier’s invoice for payment by objecting in writing. This is really important.
e. Sums due but not timely paid, bear 18% interest
Finally, a key component of the Prompt Pay Statute is that sums due, but not timely paid bear an interest of 18%. This is almost twice the amount of Arizona’s prejudgment statutory rate of 10%. So there is a penalty for not complying with the statutory time frames.
One other key function for the prompt pay statutes is the ability for a contractor or a subcontractor to either suspend performance or terminate a construction contract for an upstream party’s failure to make timely payments.
The statutory provisions regarding suspension and termination in situations of untimely payment can be found in A.R.S. § 32-1185 (a) through (d). We will touch on each of these briefly.
i. A.R.S. § 32-1185(a)
Pursuant to § 32-1185(a), a contractor may suspend performance under a construction contract or terminate a construction contract for failure by the owner to make timely payment certified and approved. This statute talks about the timing requirements.
In order to do this, a contractor shall provide written notice to the owner at least seven calendar days before the contractor’s intended suspension or termination, unless a shorter notice period is prescribed in the construction contract between the owner and contractor.
If a contractor does suspend or terminate pursuant to this provision, a contractor shall not be deemed in breach of the construction contract. This is an important requirement, and it gives contractors a mechanism for them to enforce payment while dealing with owners.
It is important that anyone who is thinking about terminating a construction project on a particular project, consult with an attorney before they do so. This can be a particularly precarious situation and you want to make sure that you are getting solid advice before you go down that road.
But § 32-1185 gives contractors that right to spend or terminate, providing that they provide the requisite seven calendar days' notice.
ii. A.R.S. § 32-1185(b)
Similarly, § 32-1185(b) provides that a subcontractor may suspend performance under a construction contract or terminate a construction contract if the owner fails to make timely payments of amounts certified and approved pursuant to the Prompt Pay Act for the subcontractor’s work, and the contractor fails to pay the subcontractor for the certified approved work.
In that instance, the subcontractor shall provide written notice to the contractor and the owner at least three calendar days before the subcontractor’s intended suspension or termination. Unless a shorter time is prescribed in the construction contract between the contractor and the subcontractor.
This covers a situation where the owner fails to make timely payment of amounts certified and approved. If that is the case, even though they are not in contractual privity with the owner, the subcontractor can terminate or suspend if they provide the three-day notice. That is in § 32-1185(b).
Before we get to the last component, it is important for us to go back and address this language about what is certified and approved. This is important language in the prompt pay mechanism.
As mentioned before, the owner has 14 days to certify, approve, or object in writing to a contractor’s invoice. And what happens if the owner does not respond either in writing or after being given affirmative approval of the invoice within that 14-day period? It is deemed as a matter of law to be certified and approved.
If you are an upstream party, you want to be very careful in reviewing those invoices and realizing you have the time period prescribed by the statute whether it is a public sector project or a private sector project. Be mindful of those deadlines to object to a pay application.
The same thing applies for individuals downstream, especially if you are a general contractor and you are receiving invoices from subcontractors or suppliers. You want to make sure that you are reviewing those in detail and objecting before you submit those upstream to the owner for approval and payment.
You see this happen quite a bit and it is really a misunderstanding of the way the Arizona Prompt Pay Act works, you will see on particular projects where general contractors will get copies of subcontractor and supplier invoices. They will send them upstream to the owner, and the owner will certify and approve those amounts and then make payments back to the general contractor of the amount certified and approved, which will include the relevant subcontractor and supplier invoices.
At that point, the general contractor will sometimes say that there is a problem with the work that was done or that there is a problem with the materials that were delivered. So they are going to hold back money. Well, pursuant to Arizona’s Prompt Pay Statute, that is too late in the game.
Once the general contractor sends it upstream and gets it approved by the owner, effectively they certify that it is approved at that point. The money then flows back down to the general contractor for that work. The deadline to object has come and gone, and now we turn back to § 32-1185 and the mechanism for suspension and performance.
iii. A.R.S. § 32-1185(c)
The second component for a subcontractor is that it is pursuant to § 32-1185(c). A subcontractor may suspend performance under a construction contract or terminate a construction contract if the owner makes timely payment of amounts certified and approved for the subcontractor’s work. But the contractor fails to pay the subcontractor for the certified and approved work.
This really gets to the instance we were just talking about where the subcontractor’s pay applications or the supplier’s payment application will make it all the way up to the owner, and payment will be made to the general contractor for that.
Then there is a decision to withhold monies at that point. In this instance of the owner paying the general contractor, but the general contractor not paying the subcontractor, the subcontractor shall provide written notice to the contractor and owner. This shall be done at least seven calendar days before the subcontractors intended suspension or termination, unless a shorter period is prescribed in the construction contract between the contractor and subcontractor.
Again, that is a powerful remedy that both contractors and subcontractors have and helping enforce prompt pay. They have the statutory right to suspend performance if the owner or general contractor, depending on the situation, are not complying with the Prompt Pay Statute and if they follow the notice requirements.
There are methods by which these notices have to be given. If those are complied with, pursuant to § 32-1185, then the party who has not been paid, will not be deemed to be in breach of the construction contract.
Payment Application Must Comply with the Law and the Contract
The obligation to accept or reject a contractor’s or supplier’s invoices arises when the invoice complies with both statutory and contractual requirements. So it is important for the upstream party when they are receiving invoices to make sure that they are reviewing and approving them.
However, pursuant to the Prompt Pay Act, there is a technical requirement that they have. They have an obligation to accept or reject a contractor’s or supplier’s invoice when the contractor or supplier’s invoice complies with the terms of the contract.
So that means if the contract specifies that invoices or payment applications should look a certain way. Then it has to comply with the statutory requirements. When those things happen, that is when the obligation is triggered for the upstream party to review and approve within 14 days or seven days depending on the particular project.
We discussed situations in which an owner or upstream contractor may want to withhold payment for a particular portion of a specific invoice or the specific invoice on a construction project. Generally, Arizona’s Prompt Pay Laws provide certain circumstances when that is appropriate.
Defenses to Contractors’ or Suppliers’ Invoices
Now we will talk about the above-mentioned circumstances where a contractor or an owner may certify or may object to or disapprove of an invoice. An owner, contractor, or subcontractor may disapprove all or part of a lower-tier provider’s invoice in writing for:
- unsatisfactory job progress;
- defective or disputed work or materials;
- failure to comply with the construction contract;
- third-party claims or failure to pay suppliers;
- damage to general contractor or other trades;
- reasonable evidence that contract cannot be completed for the contract price.
These are six of the most prevalent and statutorily identified reasons for disproving lower-tier providers’ invoices. Again, as the upstream party, you want to make sure that you are objecting to the invoices in a timely fashion. And you want to make sure that you are objecting in writing.