Public Agencies May Withdraw Retained Funds Held in Escrow for a Construction Project Following a Contractor’s Default without Judicial Determination

In a recent decision, Pittsburg Unified School District v. S.J. Amoroso Construction Co., Inc. (December 22, 2014), the California Court of Appeal affirmed that public agencies have the right to unilaterally declare a default under a construction contract and demand a distribution of securities retained by escrow.  The Court based its decision on Public Contract Code section 22300, which provides that once a public agency sends a proper notice of default, it has the right to withdraw securities held in an escrow retention account “immediately upon its own determination” if it determines that a contractor has defaulted on the construction agreement. The key issue confirmed by the Court is that a public agency may unilaterally determine that a contractor defaulted on its obligations under a construction agreement without judicial determination, and thus, may unilaterally withdraw retention proceeds from an escrow account.

Previously, the Court of Appeal in Westamerica Bank v. City of Berkeley (2011) held that retention funds are under the control of the owner who can use them if a contractor defaults on its obligations.  Additionally, Greg Opinski Construction, Inc. v. City of Oakdale (2011) addressed the same issue and held that “the owner is entitled to convert the securities to cash and withdraw the cash in the event of default by the Contractor.” Therefore, pursuant to Public Contract Code section 22300(f), a public agency has a right to draw upon securities in the event of a default by the Contractor and the escrow agent is required, upon seven days' written notice from the owner of the contractor default, to “immediately convert the securities to cash and [to] distribute the cash as instructed by the Owner.”

Although the Pittsburg case involved a defaulted contractor, school and community college districts should consider adding provisions in their escrow agreements to allow the unilateral withdrawal of securities in situations other than a formal default.  Before making substantive changes to the agreement set forth in Public Contract Code section 22300(f), public agencies should contact and discuss any revisions with legal counsel.

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