***UPDATE – 7/23/2019***
The Court of Appeals’ decision in SK Builders, Inc. v. Smith, which is the subject of this post from April 2019, will cease being good law on August 27, 2019. The case was legislatively overruled by SB 1397, which was signed into law by Governor Ducey in April 2019 and will become effective on August 27, 2019. A post on the effects of SB 1397 and its overruling of the SK Builders decision will be forthcoming.
It is no secret that Arizona’s Prompt Pay Act (the “PPA”) is constructed around a 30-day billing cycle. Indeed, the PPA codified monthly progress billings as the standard payment arrangement on all Arizona construction projects. It was not, however, the understanding or practice of those in the construction industry that payment applications submitted at the end of a billing cycle were limited to work performed or materials furnished in the preceding 30 days. But this changed with the Arizona Court of Appeals’ recent decision in SK Builders, Inc. v. Smith. In SK Builders, the court held that the PPA provision stating that “billing[s] or estimate[s]” be based on “work performed and…materials supplied during the preceding thirty day billing cycle” means that the PPA does not apply to general contractors’ billings or estimates that contain work furnished outside the past 30 days.
SK Builders arose from a 2010 prime contract between Owners and a Contractor for the construction of a $1.6 million home. The Contractor obtained a certificate of occupancy for the home in March 2012, but performance and payment issues remained thereafter.
By May 2012, the Owners had paid the Contractor approximately $1.5 million in response to numerous monthly payment applications that had been submitted throughout the course of construction. On May 1, 2012, the Contractor submitted a third amended version of Payment Application No. 19 (“Pay App 19”) to the Owners, claiming that the Contractor was owed roughly $180,000.00.
Previously, however, the architect had advised the Contractor in writing that no further payments would be made until certain outstanding performance issues were resolved. These issues included an interior concrete crack and the absence of wire mesh in the concrete that formed the back patio. The Contractor attempted to remedy the crack and retained engineers to show that the back patio concrete was stronger than required by the specifications. Pay App 19 did not request payment related to the concrete work, which the Owners had already paid for in connection with previous payment applications.
On May 5, 2012, the Owners terminated the contract, without having paid or objected to Pay App 19. The Contractor subsequently sued the Owners: (1) alleging a violation of the PPA, breach of contract, and unjust enrichment; and (2) seeking payment of the amount requested in Pay App 19, interest, and attorneys’ fees. The Owners counterclaimed for, among other things, breach of contract stemming from the allegedly defective work. A bench trial ensued and the trial court: (1) found that the Owners had violated the PPA by failing to object to Pay App 19 in 14 days; but (2) concluded that the Owners prevailed on the Contractor’s breach of contract and unjust enrichment claims. The trial court ultimately entered judgment in the Contractor’s favor in the principal amount of $180,289.61, together with attorneys’ fees in the amount of $50,000.00, and the Owners appealed.
On appeal, the Owners primarily argued that Pay App 19 did not comply with the PPA because a substantial portion of the work reflected therein was completed outside the preceding 30-day billing cycle. Specifically, they argued that the PPA provision providing that owners are required to pay general contractors “on the basis of a duly certified and approved billing or estimate of the work performed and the materials supplied during the preceding thirty day billing cycle,” rendered the PPA (and its objection requirement) inapplicable to Pay App 19.
The Contractor countered that applying the PPA’s plain language as the Owners argued would “create an absurd result.” In support of its position, the Contractor gave an example of “an appliance being purchased one month, stored the next month, installed the next month, and then tested as operational the next month” to ostensibly show that the Owners’ literal interpretation of the PPA would be practically unworkable in these circumstances. The Contractor also argued that the Owners’ strict reading of the 30-day billing cycle requirement was inconsistent with contractor-subcontractor dealings.
The Court of Appeals accepted the Owners’ position and rejected the Contractor’s positions. As an initial matter, the Court noted that the Contractor “overlook[ed] the demanding standard for finding absurdity[,]” which is that “[a] result is ‘absurd if it is so irrational, unnatural, or inconvenient that it cannot be supposed to have been within the intentions of persons with ordinary intelligence and discretion.'” On this point, and in response to the Contractor’s appliance example, the Court held that: (1) the PPA “expressly allows progress payments to include either a ‘billing or estimate’ of ‘work performed’ and ‘materials supplied” in the preceding 30-day billing cycle; and (2) “requiring compliance with the plain language of the [PPA’s 30-day] billing provision does not lead to an absurd result.” The Court also dispatched of the argument concerning contractor-subcontractor dealings, finding, among other things, that “a subcontractor is not obligated to provide a contractor with payment applications limited to the preceding [30-day] billing cycle.”
In sum, the Court of Appeals held that the plain language of the PPA “necessarily means that [it] does not allow relief for work performed or materials supplied outside the preceding [30-day] billing cycle,” because the PPA “unambiguously provides that a contractor must base a progress payment ‘billing or estimate’ on ‘the work performed and the materials supplied during the preceding [30-day] billing cycle.'” With respect to the facts at issue, the Court concluded that while the Contractor “met its burden of proving that [Pay App 19] was submitted…and not objected to or paid, [it] failed to prove compliance with the [30-day] billing cycle requirement.” Accordingly, the Court reversed the trial court’s judgment in the Contractor’s favor on the PPA claim.
The Contractor has since petitioned the Arizona Supreme Court to review this matter. But until such time as the Court of Appeals’ decision is overturned (if ever) or the Arizona Legislature decides to clarify the statutory language, SK Builders is going to have a profound effect on certain PPA claims. This is because, as noted above, it has never been the understanding or practice of those in the construction industry that payment applications submitted at the end of a billing cycle were limited to work performed or materials furnished in the preceding 30 days. Indeed, the inconsistency between the decision in SK Builders and the standard practice in the construction industry is best illustrated by the following quote from the case—”[n]one of the items in [Pay App 19] list the dates when the work was performed or the materials supplied, so it is unclear which items, if any, were within the applicable billing cycle.” As those in the industry know, applications for payment rarely, if ever, include the dates when specific line items were performed.