A number of significant changes to California construction
statutes take effect over the next year. The first group of changes
caps the amount of retention that can be withheld on public
projects and shortens the time in which progress payments to
subcontractors must be statutorily made on public and private
projects, both of which took effect January 1, 2012. Second,
sweeping modifications to California law governing mechanics liens
and stop notices become effective July 1, 2012. Third,
subcontractor interest groups championed major modifications to
California's "anti-indemnity"
statutes—modifications that are generally very protective
of subcontractors. The ramifications are so far reaching that these
changes do not go into effect until January 1, 2013. Contract forms
and contract administration need to be adjusted in light of each of
these changes to avoid inadvertent forfeiture of important rights
and unenforceable contract provisions.
Retention and Prompt Payment: Changes Effective January 1,
2012
Senate Bill 293 ("SB 293"), signed by Governor Edmund G.
Brown, Jr., on October 9, 2011, made two notable
changes—establishing a five percent cap on retention on
public contracts and shortening from 10 days to seven days the time
by which subcontractors must be paid after receipt of progress
payments.
Retention Cap on Public Contracts. SB 293 adds
Section 7201 to the Public Contract Code, which caps the retention
that may be held on a public works contract. Section 7201 applies
to contracts entered into on or after January 1, 2012, between a
"public entity"1 and an original
contractor,2 between an original contractor and a
subcontractor, and between subcontractors and lower-tier
subcontractors relating to construction of any public work of
improvement. Section 7201 provides new limits on retention,
including five percent of any payment and an overall cap on total
retention of five percent of the contract price.
Previously, public agencies could hold more than five percent of
the contract price as retention as there was no statutory cap on
what a public owner could specify as the retention percentage.
Prior to establishment of this cap, public owners in California
typically specified a 10 percent retention. Some competitively bid
projects might specify a lower retention rate or provide for a step
down from 10 percent to five percent once the project reached 50
percent completion. Similarly, on an increasing number of public
contracts awarded by means other than competitive bidding
(e.g., best value awards where statutorily permitted),
lower retention rates had become more common. The new law now
mandates a retention rate no higher than five percent. For general
contractors, this is good news as public owners will generally not
be able to withhold more than five percent in retention. However,
general contractors and subcontractors on public works projects
need to be mindful that, absent one of the exceptions discussed
below, this five percent cap applies to their contracts as well and
not just to the contract between the general contractor and the
public owner.
Many public entities opposed SB 293 on the grounds that additional
retention may be needed to ensure prompt, on-time completion of
important projects and to protect taxpayers. Contractors argued
that reduced retention was necessary, particularly in the current
economy, to provide sufficient cash flow and ensure contractors are
able to perform. Contractors prevailed in this battle. However, the
final legislation includes a sunset date of January 1, 2016.
Additionally, several statutory exceptions exist, including a
procedure whereby the public entity, after a proper hearing, can
find a particular project to be "substantially complex"
and specify a retention amount greater than five percent in the bid
documents for that project. No definition is provided for
"substantially complex," and disputes may arise between
owners and contractors as to how broadly this exception may be
applied.3
Prompt Payment. SB 293 also amends various prompt
payment statutes to expedite payments to subcontractors. Business
and Professions Code Section 7108.5 and Public Contract Code
Section 10262.5 now provide seven days for payments to
subcontractors after the prime contractor receives each progress
payment from the owner rather than 10 days under prior law. These
changes apply to both private and public construction projects. As
with the changes to the anti-indemnity statute discussed below, the
new law benefits subcontractors and is another legislative victory
for groups representing subcontractor interests. The statutory
remedies for prompt payment violations remain the same, including a
penalty of two percent of the amount due per month for every month
that payment is not made and the award of attorneys' fees and
costs to the prevailing party.
Mechanics Liens and Stop Notices: Changes Effective July 1,
2012
Senate Bill 189, signed by Governor Brown on September 30, 2010,
set forth a series of changes to the California mechanics lien and
stop notice statutes (collectively "Mechanics Lien Law")
based upon recommendations from the California Law Review
Commission. These recommendations were intended to modernize and
simplify the Mechanics Lien Law, which the Commission felt had
become "unduly complex and impenetrable as the result of
piecemeal amendments over the years." Both mechanics liens
(private projects) and stop notices (private and public projects)
are highly technical tools used to secure payment by those who
provide, for example, labor or materials to a project. Under SB
189, some of the recommended changes took effect in January 2011,
but most were deferred until July 1, 2012. Further legislation was
passed this year (Senate Bill 190, approved by the governor on June
29, 2011) to clean up some of the changes in SB 189 and facilitate
the new statutory scheme.
Effective July 1, 2012, the existing Mechanics Lien Law (commencing
with Section 3082 of the Civil Code) will be repealed and replaced
with new provisions in three titles relating to: (i) works of
improvement generally (commencing with Civil Code Section 8000);
(ii) private works of improvement (commencing with Civil Code
Section 8170); and (iii) public works of improvement (commencing
with Civil Code Section 9100). Although many provisions are
renumbered without substantive changes, new terminology is used
throughout to attempt to modernize and clarify the statutes. For
example, stop notices are now referred to as "stop payment
notices," and the term "original contractor" is
changed to "direct contractor."
In addition, substantive changes were made in a number of areas,
including:
- Standardized contents and procedures for giving notice and standardized notice periods;
- "Completion" no longer includes "acceptance by an owner," which may affect the time for recording a lien or filing a stop notice;
- New required releases and forms, such as mandatory conditional and unconditional waiver and release forms (see, e.g., Civil Code Sections 8132 and 8134);
- The amount of lien release bonds has been reduced from 150 percent of the lien amount to 125 percent of the lien amount, making it easier to obtain such bonds;
- Both direct contracts (contracts directly between the owner and a contractor) and subcontracts must provide for identification of any construction lenders, and the owner must give notice of the name and address of the lender if a construction loan is obtained later in the project;
- Direct contractors, including general contractors, must now give a preliminary notice to a construction lender;
- If there are multiple direct contracts, the owner may record separate notices of completion, and the owner has 15 days to do so instead of 10;
- Separate design professional lien laws (Civil Code §§ 3081.1, et seq.) have been repealed, and design professional liens are now included in the new Mechanics Lien Laws.
- The limit on attorneys' fees that can be recovered by a successful owner who challenges a stale lien (which had been capped at only $2,000 under Civil Code Section 3154) has been removed.
Despite SB 189's goal of simplifying the Mechanics Lien Law,
the repeal of these long-standing statutes and enactment of a new
statutory scheme is likely to lead to more confusion (at least in
the short run). Some parties are sure to continue to use their
outdated forms and file liens and stop notices based upon statutes
that are no longer on the books. Careful planning is needed to
ensure that important rights are protected and that notices are
given in the time, manner, and form required by the new statutes.
In the case of mechanics liens and stop notices, the devil truly is
in the details, and those seeking to protect their rights need to
make sure that they adjust to the new requirements. Similarly,
transactional lawyers involved in deals attaching lien release
forms that are contractually specified for use need to make sure
that current statutory forms are used or specify that the
"attached form or such other form as consistent with
applicable law" shall be used.
Indemnity and Defense Costs: Changes Effective January 1,
2013
Senate Bill 474, signed by the governor on October 9, 2011,
broadens the types of indemnity provisions related to construction
contracts that are unenforceable under California law. Due to the
broad ramifications of this law and the need for ample lead time,
these changes to California's "anti-indemnification"
statute do not become effective until January 1, 2013. This new law
is part of a growing national movement by subcontractors to secure
legislatively mandated restrictions on the scope of indemnification
obligations that can be imposed on subcontractors. For example, on
January 1, 2012, a new Texas law supported by subcontractor
interests became effective; it significantly restricts
indemnification agreements in construction contracts in a state
that allowed substantial freedom of contract as to such
matters.
By way of overview, Senate Bill 474 makes three primary changes to
California's anti-indemnity statute. Each of these changes
essentially makes unenforceable "Type I" or
"broad" form indemnity that extends to "active"
negligence and makes clear that subcontractors cannot be required
to provide indemnity against another's active negligence,
whether on public or private contracts. Subject to certain
exceptions, California's anti-indemnity statute has for years
made unenforceable true broad form indemnity in connection with
construction contracts by prohibiting a party from obtaining
indemnity against its own sole negligence or willful misconduct or
"for defects in design furnished" by such party. Cal.
Civ. Code § 2782(a).4 The new law makes clear that
an indemnity for active negligence is also generally
unenforceable.
The first place where this change is implemented concerns public
contracts. Although the existing law made indemnity provisions in
construction contracts for public projects unenforceable where the
indemnity purports to shift liability for the active negligence of
a public agency from the government to the "contractor,"
this limitation did not expressly extend to subcontractors and
suppliers. See Cal. Civ. Code § 2782(b). Under SB
474, a new subsection is added for public contracts entered into on
or after January 1, 2013 that expressly extends this prohibition to
"any contractor, subcontractor or supplier of goods and
services." Cal. Civ. Code § 2782 (b)(2). In other words,
a prime contractor on a public works project may not require that a
subcontractor provide an indemnity against liability for the active
negligence of the public agency.
Second, SB 474 further extends this limitation on indemnifications
for active negligence to owners of private construction projects.
For contracts entered into on or after January 1, 2013, a new
provision is added making indemnity obligations on private
contracts unenforceable if they purport to relieve the owner from
its active negligence. Cal. Civ. Code §
2782(c).5
Third, the new law is not limited to indemnity obligations that run
in favor of the owner. SB 474 also adds a new section that applies
to indemnity obligations by subcontractors in favor of general
contractors, construction managers, or other subcontractors on both
public and private projects.
For contracts entered into on or after January 1, 2013, indemnity
obligations extending to the active negligence of the general
contractor, construction manager, or subcontractor are void and
unenforceable. Cal. Civ. Code § 2782.05 (a). This new section
also prohibits terms that would require indemnity (including costs
to defend) by subcontractors for claims that "do not arise out
of the scope of work of the subcontractor pursuant to the
construction contract." Id. This limitation is meant
to address what subcontractors believed were overbroad indemnities
that by their terms extended beyond the scope of the
subcontractor's own work. Additionally, this section proscribes
imposing an indemnity obligation on subcontractors for defects in
design furnished by the contracting party. The new section also
specifies how the indemnification obligation is satisfied (modeled
after an existing section applicable to residential construction)
and sets forth a number of statutory exceptions. Cal. Civ. Code
§ 2782.05(b). The exceptions, among other things, specify that
this new section protecting subcontractors does not apply to
wrap-up insurance policies, indemnity agreements required by
sureties, and contracts with design
professionals.6
The overall intent of SB 474 is to "ensure that every
construction business in the state is responsible for losses that
it, as a business, may cause." SB 474 applies to construction
performed on property located in California even if the parties
have attempted to opt out of these changes or have agreed to a
non-California choice of law provision in their contract. Cal. Civ.
Code §§ 2782.05(c), (d). In other words, the statute
limits the ability of parties to contract out of this law by
incorporating a choice of law provision of another state like
Nevada that does not prohibit indemnification for active
negligence.
SB 474 will require careful analysis by owners, contractors,
construction managers, and subcontractors as to risk allocation on
a project and reexamination of standard contract terms, including
indemnity and insurance provisions. A number of groups have
expressed concerns with various aspects of this legislation and may
seek clarifying amendments or other changes before it becomes
effective on January 1, 2013.
This brief summary of the new law is meant to heighten awareness so
that parties can take advantage of the lead time afforded by the
legislature to adjust contracts, contract administration, and risk
management programs. We will be issuing a Commentary
shortly that addresses in greater detail the many ramifications of
Senate Bill 474.
Footnotes
1. "Public entity" is broadly defined in new
Section 7201 to mean "the state, including every state agency,
office, department, division, bureau, board or commission, the
California State University, the University of California, a city,
county, city and county, including charter cities and charter
counties, district, special district, public authority, political
subdivision, public corporation or nonprofit transit corporation
wholly owned by a public agency and formed to carry out the
purposes of the public agency." Pub. Cont. Code §
7201(a)(3).
2. Section 7201 uses the term "original contractor" to
include general contractors. Other statutes, discussed below,
specifically refer to general contractors and/or prime contractors.
Each of these terms is used interchangeably herein.
3. Even if an exception does not apply, Section 7201 expressly
makes clear that it does not limit the ability of a public entity
to withhold 150 percent of the value of any disputed amount of work
from final payment as permitted in Public Contract Code Section
7107(c). Section 7201(a)(2) further provides that "in the
event of a good faith dispute, nothing in this section shall be
construed to require a public entity to pay for work that is not
approved or accepted in accordance with the proper plans or
specifications."
4. The general limitation on indemnity in Section 2782 does not
prevent agreements between the owner and the contractor as to
"allocation, release, liquidation, exclusion, or limitation as
between the parties of any liability (a) for design defects, or (b)
of the promisee to the promisor arising out of or relating to the
construction contract." Cal. Civ. Code § 2782.5.
5. This provision does not apply to a homeowner performing a
project on a single family dwelling. Cal. Civ. Code Section
2782(c)(3).
6. Design professionals previously received some protection from
indemnity obligations on public contracts under SB 972. SB 972 does
not apply to private projects. See Cal. Civ. Code §
2782.8(e).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.