California Building Owners and Contractors: Act before January 1, 2018, to Minimize Risks of Non-Paying Subcontractors

This past weekend Governor Brown signed AB 1701, a bill that requires direct contractors to pay any wages, fringe benefits, or other benefit payments or contributions owed by a defaulting subcontractor, plus interest. This new statute provides the potential for significant liability to direct contractors. A direct contractor should protect itself upfront during the negotiation of the subcontract before problems arise.

Here's what you need to know:

• The bill applies to contracts entered into on or after January 1, 2018.
  The take-away: To the extent possible, a direct contractor should enter into any covered contracts during 2017.
• The bill confers broad standing on a number of persons and entities on behalf of for the affected workers: California's Labor Commissioner and joint labor-management committees for wages and third-party benefit providers for fringe benefits and other benefit payments.
  The take-away: If a subcontractor does not pay the required wages, fringe benefits, etc., these persons and entities may now file suit against the direct contractor for monies owed by that subcontractor.
• The court "shall award" attorneys' fees and costs, including expert witness fees, against a direct contractor (with respect to a default by a subcontractor, even when the direct contractor has already paid its subcontractors) where a third-party benefit provider or a joint labor-management committee brings a court action.
  The take-away: The bill provides strict liability where the subcontractor has failed to pay the required wages and fringe benefits. On its face, the bill provides no defenses for a good faith direct contractor, with double payment of wages and fringe benefits a very real possibility.
• Upon request by the direct contractor, the subcontractors (of all tiers) must provide payroll records and project award information. If the subcontractor fails to provide the requested information, the direct contractor may withhold any disputed sums until the information is provided.
  The take-away: This provision gives direct contractors potential access to additional information, but in reality, monitoring the subcontractors' payroll records is neither easy nor efficient, thus requiring the direct contractor to incur additional back-office expenses just to stay even. Withholding payment from the subcontractor may cause nonpayment by the subcontractor and ultimate liability by the direct contractor under AB 1701.
• An action must be brought within one year of the earliest of (1) recordation of a notice of completion of the direct contract, (2) recordation of a notice of cessation of the work covered by the direct contract, or (3) actual completion of the work covered by the direct contract.
  The take-away: On large projects, the potential liability can extend for years, well after the work in question was performed, making it difficult to defend claims. Direct contractors should obtain and maintain records from the subcontractors until such time period has expired.

Here's what you need to do:

• As noted above, execute (and have your direct contractors and all of its subcontractors) execute their contracts in 2017, if possible. Keep records of when the parties fully executed those contracts.
• Choose your subcontractors very wisely.
• Include broad audit provisions in the subcontracts.
• Consider requiring appropriate payment bonds and letters of credit. However, a subcontractor that will have difficulty paying its employees will not likely have much ability to obtain either a payment bond or a letter of credit.
• Include broad defense and indemnity provisions. Supplement these provisions by obtaining, when possible, true guarantees from appropriate representatives of the subcontractor, such as the owner, managing member, and officers.
• Implement a system that will allow the direct contractor to verify, in real time, its subcontractors' payments to its employees.
• For owners, make sure your direct contractor selects appropriate subcontractors, including a provision giving the direct contractor (and, either directly or derivatively, the owner) the ability to approve certain/all subcontractors. Selection of a subcontractor solely on the basis of the lowest bid can provide a recipe for disaster.