Construction & Infrastructure Law Blog

Contractors Can Recover for Public Agency's Failure to Disclose Material Information

Sheppard Mullin — Tue, 31 Aug 2010 15:40:08 -0800

In a recent decision the California Supreme Court expanded the implied warranty of specification suitability to include claims for a public agency's failure to disclose material information. In doing so it resolved a split in the decisions of the lower appellate courts. Notably, the Court adopts virtually the same rationale recognized by the Federal Circuit and Court of Federal Claims on federal procurement contracts, namely, the "superior knowledge" doctrine. In Los Angeles Unified School Dist. v. Great American Ins., 49 Cal. 4th 738, 2010 WL 2720825 (July 12, 2010), the Court held that a contractor need not prove intentional misrepresentation to recover compensation for a public entity's failure to disclose material information. The Court expressly disapproved Jasper Construction v. Foothill Junior College, (1979) 91 Cal. App. 3d 1, which held to the contrary.

Under Los Angeles Unified, recovery is qualified by a four-part test. A contractor may recover from a public entity where: (1) the contractor submitted its bid or undertook to perform without material information that affected costs, (2) the public entity was in possession of the information and was aware the contractor had no knowledge of, nor any reason to obtain, the information, (3) any contract specifications or information furnished by the public entity misled the contractor or did not put it on notice to inquire, and (4) the public entity did not provide the relevant information. Id.

Background

The underlying facts of Los Angeles Unified are straightforward. In 1996, the Los Angeles Unified School District contracted to build an elementary school. Three years later, the District terminated the construction contract declaring the contractor to be in material breach and default. The District then sought bids from contractors, including the plaintiff, to complete the project and repair defects in the existing construction. The plans and specifications available to bidders indicated that the contractor selected would be responsible for both listed and unlisted defects in the "correction list" or "pre-punchlist". After receiving the plans and conducting a site inspection, the plaintiff contractor submitted the winning bid to complete the work for $4.5 million.

Shortly after construction commenced, the contractor discovered defects more extensive than originally presumed. The contractor noted that the existing work had nonconformities that could not have been detected by simple observation and were not indicated in the correction list. For example, the repair of some stucco surfaces would have required replacing not only the stucco, but the underlying exterior wall and material at a greatly increased cost. The contractor sought extra compensation for work necessitated by what it termed "latent defects". The contractor alleged the District had breached the contract by misrepresenting the material facts and conditions of the project, and further, had breached the implied warranty that the plans were a complete and accurate depiction of the project's scope. As an example, the contractor alleged that the District had failed to disclose a consultant's report that would have indicated more significant defects in the existing construction.

The trial court granted the District's motions for summary adjudication and judgment on the pleadings, holding that the contractor had failed to recite facts indicating the District had intentionally concealed information. The California Court of Appeals reversed, reasoning that the contractor could maintain an action for breach of contract if the District "knew material facts concerning the project that would affect [the contractor's] bid or performance and failed to disclose those facts." Los Angeles Unified School Dist. v. Great American Ins. (2008), 163 Cal. App. 4th 944, 965.

Courts of Appeal Split

The Court's opinion in Los Angeles Unified began by affirming the measure of public entity liability set forth by the U.S. Supreme Court in Spearin v. U.S. (1918), 248 U.S. 132. The Spearin Court held that plans and specifications presented by a public entity were impliedly warranted to be correct. Under Spearin, a contractor can recover for an unanticipated increase in cost if this warranty was breached. The California Supreme Court clarified the application of this doctrine in Souza & McCue Const. Co. v. Superior Court (1962), 57 Cal. 2d 508, holding that:

"[a] contractor of public works who, acting reasonably, is misled by incorrect plans and specifications issued by the public authorities as the basis for bids and who, as a result, submits a bid which is lower than he would have otherwise made may recover in a contract action for extra work or expenses necessitated by the conditions being other than as represented."

Opposing opinions grew out of the California Courts of Appeal in applying this principle to situations where the plans and specifications were correct, but the contractor was misled as a result of material information unintentionally withheld by the public entity. Los Angeles Unified aimed to resolve these conflicting opinions, which are briefly considered below.

Jasper Construction v. Foothill Junior College

In Jasper (1979), 91 Cal. App. 3d 1, a contractor claimed that as a result of inadequate and defective plans for the construction of a school auditorium, it incurred delays and extra expenses. The plans, the contractor claimed, required the contractor to pour concrete by a "wall-to-wall" method, instead of a customary "floor-to-floor" method. The Court of Appeals dismissed the contractors claim against the school district. The Court, applying Souza, held that recovery in a contract action by a contractor of public works is only available where the contractor is misled by incorrect plans and specifications. The application of this rule turned on the definition of misrepresentation, an act requiring some affirmative act. Anything less than a positive act, reasoned the Court, would expose public entities to liability for contractors' lack of diligence in examining plans and specifications.

Welch v. State of California

In Welch (1983), 139 Cal. App. 3d 546, a contractor alleged it was misled by the state's failure to disclose information in its possession about similar repairs performed on the site ten years earlier. The Court held that "under certain circumstances, a governmental agency may be liable for failing to impart its knowledge of difficulties to be encountered in a construction project". It found that the state had a duty to disclose information about a prior repair if disclosure would eliminate or materially qualify the misleading effect of the plans and specifications.

Thompson Pacific Const. v. City of Sunnyvale

Thompson Pacific Const. (2007), 155 Cal. App. 4th 525, involved a claim by contractor against a city who refused to increase the contract price for the construction of a senior center due to alleged non-conforming construction. Approving of the principle in Welch, the Court noted that "careless failure to disclose information may form the basis for an implied warranty claim if the defendant possess superior knowledge inaccessible to the contractor." Id. at 552. However, the Court also pointed out that Welch was consistent with the general rule that "silence is not actionable." Id.

In Los Angeles Unified, the California Supreme Court attempted to strike a balance between the appellate decisions in Welch and Thompson, that preserved a contractor's cause of action against public entities who unintentionally fail to disclose material facts. The Court expressly rejected Jasper, which held that there must be an affirmative misrepresentation or concealment of fact in order for the contractor to recover.

Adoption of the "Superior Knowledge Doctrine"

In rejecting Jasper, the Court spent little time distinguishing the holding of Jasper itself, relying on other authority to disapprove the opinion that recovery by a contractor must be premised on the affirmative act of misrepresentation. First, Justice Werdegar pointed to California authority upholding judgments against owners for active concealment of material facts. For example, in City of Salinas v. Souza & McCue Const. Co., (1967) 66 Cal. 2d 21, 222-223, the Court of Appeals found a city had affirmatively concealed facts, and further noted that a general rule that "by failing to impart its knowledge of difficulties to be encountered in a project, the owner will be liable for misrepresentation if the contractor is unable to perform." In unintentional concealment cases, like Welch and Thompson, this principle was affirmed where disclosure would have materially qualified the misleading effect of the plans and specifications.

Second, in forming its test for liability, the Court drew on the "superior knowledge doctrine" put forth by the U.S. Court of Claims in Helene Curtis Indus. v. U.S. (Ct.Cl. 1963), 312 F.2d 774. In Helene Curtis, the Court found that the U.S. Army possessed "superior knowledge" that would have alerted bidders to the project's true requirements. The Court held that the Spearin doctrine applied. It reasoned that where a public agency "possess[es] vital information which it was aware the bidders needed but would not have, [it] could not properly let them flounder on their own." Id. at 778. The Los Angeles Unified court thereafter adopted the test articulated by Helene Curtis allowing relief where: (1) a contractor undertakes to perform without vital information or knowledge of a fact that affects performance costs or duration, (2) the public entity was aware the contractor had no knowledge of and had no reason to obtain such information, (3) the contract specifications misled the contractor or did not put it on notice to inquire, and (4) the public entity failed to provide the relevant information. Los Angeles Unified, 2010 WL 2720825 at 7.

Application of the "Superior Knowledge Doctrine"

The opinion in Los Angeles Unified highlights the Court's reliance on the "superior knowledge doctrine" to actions for unintentional misrepresentation. Helene Curtis is factually distinguishable from Los Angeles Unified. In Helene Curtis, the U.S. Army requested a disinfectant composed of a new chemical that it knew needed more processing than revealed in the "skimpy" specifications. 312. F.2d at 775. The Court found that withholding information of this nature may constitute a breach of "an independent duty to reveal data" if it "embodies material misrepresentation misleading the contractor." Helene Curtis, 312 F.2d at 778. In Los Angeles Unified, the specifications indicated that the contractor awarded the job would also be responsible for unlisted defects in existing construction and indicated that defects listed were for general review only. Whereas the U.S. Army sought to withhold information essential to the cost-effective manufacture of the disinfectant in Helene Curtis, the plans and specifications in Los Angeles Unified expressly stated that further defects may exist in the project. Nevertheless, the Court found the superior knowledge of the public agency determinative.

Further, the test articulated in Helene Curtis, and adopted by Los Angeles Unified, relies on the assumption that the public entity knows that the information it possesses may materially affect the contractor's bid or performance on the contract. Similarly, the second element of the test prescribed by Los Angeles Unified, requiring the "public entity was in possession of the information and was aware the contractor had no knowledge of [the information]", appears to make the same assumption. Los Angeles Unified, 2010 WL 2720825, at *7. How will the finder of fact evaluate a public agency's knowledge of materiality?

Totality Of The Circumstances

In practice, the public agency's knowledge that certain information was material and that the contractor had no knowledge of it would likely be proved by direct testimony and circumstantial evidence. On this point the Superior Court noted that any finding of liability for unintentional misrepresentation would be based on the "totality of the circumstances". The circumstances affecting recovery may include: (1) positive warranties or disclaimers made by either party, (2) the information provided by the plans and specifications and related documents, (3) the difficulty of detecting the condition in question, (4) any time constraints the public entity imposed on proposed bidders, and (5) any unwarranted assumptions made by the contractor. As a result, a "public entity may not be held liable for failing to disclose information a reasonable contractor in like circumstances would or should have discovered on its own, but may be found liable when the totality of the circumstances is such that the public entity knows, or has reason to know, a responsible contractor acting diligently would be unlikely to discover the condition that materially increased the cost of performance." Los Angeles Unified, 2010 WL 2720825, at *7.

Conclusion

Los Angeles Unified resolves a split in the Courts of Appeal regarding the liability of public entities for unintentional misrepresentation of material facts to contractors during the bidding process. Practitioners will be paying close attention to the trial court as it applies the Los Angeles Unified ruling on remand. The ultimate judgment will provide the first indication of how trial courts will apply this new liability regime moving forward.

Authored By:

Edward Lozowicki is a partner in Sheppard Mullin's San Francisco office, and heads the firm's Northern California Construction Practice Team. The author gratefully acknowledges the assistance of Scott Vignos, in preparing this article.

Breach of Contract May Lead to False Claims Liability on Public Works Contracts

Sheppard Mullin — Wed, 14 Jul 2010 13:30:46 -0800

By Robert T. Sturgeon & Edward B. Lozowicki

The California First District Court of Appeal has issued an opinion which may place a heavy burden on public works contractors under the California False Claims Act, Cal. Gov't Code § 12650 et seq. In San Francisco Unified School Dist. v. Laidlaw Transit, Inc., the Court of Appeal applied the federal "implied certification" doctrine to hold that when a contractor on a public works project submits a request for payment to the public entity at a time when the contractor knows it is in breach of the express terms of the contract, the contractor may be held to have submitted a false claim, and may be subject to liability under the state False Claims Act. San Francisco Unified School District ex rel. Manuel Contreras, et al. v. Laidlaw Transit, Inc., 182 Cal. App. 4th 438 (2010)

Laidlaw provided school bus services to the School District, and had done so for a number of years under a series of contracts. Under the contract at issue, Laidlaw was required, among other things, to "maintain its buses in 'excellent mechanical condition," to "replace all vehicles that are deemed to be unfit for providing the required service," and to provide buses to "meeting a specified particulate matter emissions standard" or provide emission control devices. 182 Cal. App. 4th at 443.

The plaintiffs in the case were qui tam (whistleblower) plaintiffs. The School District itself declined to participate in the lawsuit. The plaintiffs alleged that when Laidlaw had submitted requests for payment to the School District, it had impliedly certified that it was in compliance with all of the requirements of the contract. The plaintiffs further alleged that Laidlaw was in breach of various of the contract requirements when it submitted the requests for payment. Plaintiffs alleged Laidlaw had violated the contract provisions because, among other things, it had provided buses that "were in inadequate and/or unsafe operating condition and failed to meet the pollution control requirements in the Contract." 182 Cal. App. 4th at 444.

The California False Claims Act subjects contractors to civil penalties, treble damages and other penalties for, among other things, "knowingly presenting a false or fraudulent claim [to the public entity] for payment or approval." Cal. Gov't Code § 12651(a). At the time of the alleged violations in Laidlaw, the statute provided for liability only where the contractor submitted a "false claim." A "claim" is defined under the Act to include a request for payment or money.

Although the contract between Laidlaw and the School District apparently did not contain any provision requiring Laidlaw to certify that it was in compliance with all of the contract terms when it submitted a request for payment, the plaintiffs' theory was that when a contractor presents a request for payment to a public entity, the contractor impliedly certifies that it is in compliance with all of the material terms of the contract. Under this theory, if the contractor "knows" it is not in compliance with one or more material terms of the contract when it submits its request for payment, it has submitted a claim which is false in violation of the False Claims Act.

Laidlaw defended against the claim in part on the ground that the plaintiffs theory of liability "would enable any private party to sue [under the Act] based on any purported breach of any public entity's contract." 182 Cal. App. 4th at 452. The court rejected this argument for four reasons. First, the court explained, only persons who had knowledge of an actual breach would be entitled to sue, because the statute requires the plaintiff to be the "original source" of the information underlying the lawsuit. Second, the court observed that the implied certification must be "material to the government's decision to pay money out to the claimant," and thus that not all breaches of contract will suffice to impose liability under the False Claims Act. Third, the court stressed that the plaintiff must show the contractor had knowledge of its breach, and thus "knowingly" presented a false claim. 182 Cal. App. 4th at 453. Finally, the court further reasoned that if it rejected the implied certification theory of liability, that would "exclude a large category of fraud from the False Claims Act," and the Act "would provide no remedy against government contractors who intentionally breach their contracts, often in a manner evading detection." 182 Cal. App. 4th at 453.

Laidlaw has potentially serious implications for public entities and contractors working on public works projects. In at least some respects, Laidlaw arguably runs against recent California Supreme Court precedent in which the Court emphasized the distinction between contract and tort damages, and rejected theories seeking to "tortify" what are otherwise ordinary breaches of contract. See, e.g., Applied Equipment Corp. v. Litton Saudi Arabia, Ltd., 7 Cal. 4th 503 (1994) (holding that a party in breach of contract cannot be held liable for tort damages over and above ordinary contract damages on a theory that the party tortiously interfered with the contract). While Laidlaw's rationale is based on a statutory remedy, the net effect of its holding could be the conversion of a garden-variety breach of contract case to something far more serious.

In addition, while the Laidlaw court stressed the requirement that a contractor must know that it is in breach at the time it submits a request for payment, the court's opinion is not completely clear as to what qualifies to show that a contractor "knew of" any particular breach. For example, what persons are required to have knowledge -- is it sufficient that one of the contractor's workers knew he had installed work in violation of the specifications? How is the knowledge issue to be resolved in a situation where the fact of a breach is disputed at the time the contractor submits its request for payment, but it is ultimately determined at trial that the contractor was in breach? The Laidlaw case was decided on demurrer without a trial, so there was no factual record regarding what the contractor did or did not know to enable the court to make a ruling on these issues. As Laidlaw was decided without a strong factual record, the opinion might encourage qui tam plaintiffs to make allegations for which they have little or no factual basis, and then go on a "fishing expedition" in discovery to find a substantive basis for their claims, a process which can be extremely costly and time-consuming for all parties. Given these and other similar unresolved issues, Laidlaw may be a fruitful source of additional litigation under the False Claims Act.

Authored By:

Robert T. Sturgeon is a senior attorney in Sheppard Mullin's Los Angeles office (213) 617-5435. Edward B. Lozowicki is a partner in Sheppard Mullin's San Francisco office (415) 774-3273.

California Court of Appeal Limits Duties Owed by Construction Managers to General Contractors

Sheppard Mullin — Tue, 08 Jun 2010 14:42:07 -0800

By John A. Yacovelle and Matthew W. Holder

In a recent case the California Court of Appeal confirmed in an unpublished decision that, when a construction manager is tasked with supervising and managing a general contractor, the construction manager does not owe a duty of care to the general contractor to prevent economic loss. The Court reasoned that imposing such a duty would subject the construction manager to an untenable conflict in loyalties. Appellate courts in other states are split on this issue. Ledcor Builders, Inc. v. Janez Development, LLC, 2010 WL 925876 (Mar. 16, 2010).

The plaintiff in the case was Ledcor Builders, Inc. ("Ledcor"), who served as the general contractor on a residential development project called Oceanside Terraces. Ledcor alleged that the construction manager was a company called Janez Development, LLC ("Janez"), and that Janez had been hired by the owner of the project to "manage, observe, advise, and supervisor [sic] Ledcor's work" and "ensure that it was properly, competently, and timely performed." According to Ledcor, Janez did a poor job as the construction manager, which resulted in various delays and cost overruns on the project (Janez denied these allegations). Ledcor and the owner of the development project made competing claims against each other as a result of these delays and cost overruns. In addition, Ledcor filed a lawsuit against Janez for negligence, seeking the same sum of money from Janez that Ledcor was also seeking from the owner.

In response to the lawsuit, Janez immediately attacked the complaint with a demurrer, arguing to the trial court that Ledcor's negligence claim failed as a matter of law because Janez could not owe a duty of care to Ledcor, since Janez's job (as alleged by Ledcor in the complaint) was to "manage, observe, advise, and supervisor [sic] Ledcor's work." Instead, Janez owed a duty of care to its principal, the owner of the project. A finding that Janez also owed a duty of care to Ledcor would subject Janez to an untenable conflict in loyalties. In making this argument, Janez relied heavily on the case of The Ratcliff Architects v. Vanir Construction Management, Inc. (2001) 88 Cal.App.4th 595. In Ratcliff, the Court of Appeal had dismissed a similar negligence claim filed by an architect against a construction manager, because the construction manager was responsible for supervising the architect, and hence could only owe a duty of care to the owner of the construction project.

The trial court sustained Janez's demurrer without leave to amend, and dismissed Ledcor's complaint. The Court of Appeal affirmed the trial court's decision in a unanimous unpublished opinion. The Court of Appeal explained that parties who are not in privity with each other generally do not owe one another a duty of care to prevent economic loss (as opposed to damage to person or property). Such a duty of care to prevent economic loss only arises when there is a "special relationship" between the parties. Whether or not a such a "special relationship" exists is a matter of public policy, and depends on the weighing of various factors, including the extent to which the underlying transaction was intended to protect the plaintiff, the foreseeability of harm to the plaintiff, the moral blame attached to the defendant's conduct, and the policy of preventing future harm. By way of example, the seminal California case on the subject found that such a "special relationship" could exist between a lawyer who drafts a will for his client, and the intended beneficiary of the client's will, even though the lawyer and the intended beneficiary are not in privity with each other. Biakanja v. Irving (1958) 49 Cal.2d 647.

In this case, the Court of Appeal agreed entirely with Janez that a construction manager that is tasked by an owner with supervising a general contractor cannot also owe a duty of care to the general contractor to prevent economic loss. Such a rule would put the construction manager in an impossible position. The nature of construction projects is such that the interests of the owner and the general contractor will frequently be adverse to one another in disputes such as pricing and scheduling change orders. What is good for the owner may not be good for the general contractor, and vice versa. When the construction manager has been hired by the owner to serve the owner's interests and supervise and manage the general contractor, the construction manager owes its duty to the owner, not the general contractor. A construction manager cannot be expected to owe a duty of care to both the owner and the general contractor, any more than a lawyer can be expected to owe a duty of care to both sides in an adversarial transaction or piece of litigation.

It should also be noted that in response to Janez's arguments, Ledcor relied heavily on out-of-state authorities for the proposition that construction managers should be held liable to general contractors for economic losses. In particular, Ledcor argued that courts in Illinois, New York, and Tennessee have imposed such a rule. The Court of Appeal did not address any of Ledcor's arguments regarding out-of-state authority, instead finding that California law was settled on the subject. For what it is worth, courts in Georgia, Indiana, Washington, and Virginia have ruled the same as California courts by dismissing negligence claims for economic loss filed by contractors against construction managers. In addition, courts in Ohio, Wyoming, Utah, and Nevada have denied tort recovery between other participants in construction projects, absent privity of contract.

Authored By:

John Yacovelle, (858) 720-8934, is a partner in Sheppard Mullin's Del Mar office specializing in construction and commercial litigation. Matthew Holder, (858) 720-7411, is an associate in Sheppard Mullin's Del Mar office.

Modified Total Cost Method of Proving Damages: Approved For California Public Works

Sheppard Mullin — Wed, 28 Apr 2010 10:36:09 -0800

By Edward B. Lozowicki and Bram Hanono

Dillingham-Ray Wilson v. City of Los Angeles, 182 Cal.App.4th 1396 (opinion modified by 106 Cal.Rptr.3d 691, (April 16, 2010, No. B192900))

In Dillingham-Ray Wilson v. City of Los Angeles, the California Court of Appeal signaled its holding in the first sentence of its opinion: "The City of Los Angeles (City) obtained millions of dollars worth of construction work that it does not want to pay for." The City argued it was absolved of any obligation to pay the contractor, Dillingham-Ray Wilson (DRW), pursuant to Public Contracts Code sections 7105 and 7107 and Amelco Electric v. City of Thousand Oaks (2002) 27 Cal.4th 228 on the theory that they dictate a method of proving contract damages, a method DRW said was impossible under the circumstances. The Court disagreed because "section 7107 [sic] and Amelco impact the measure of damages, not the method of proving them . . . ." The Court also held that the modified total cost method of proving damages is permissible in California.

Background

The City awarded a contract to DRW to expand the digester capacity at the Hyperion Wastewater Treatment Plant. During construction, the City issued over 300 change orders containing more than 1,000 changes to plans and specifications. On rare occasions the City directed DRW to perform changes on a time and material basis, but as a general rule, the City requested an estimate of the cost of the work, told DRW to commence work, and agreed that the parties would negotiate a lump sum payment at a later date. Not all change orders were settled. When DRW completed the project, it requested an equitable adjustment to compensate it for expenses and losses incurred due to interference and delays by the City. The City refused and assessed liquidated damages against DRW. DRW sued for breach of contract, and the City cross-complained.

Before trial the City filed a motion in limine to prevent DRW from proving its damages with engineering estimates, based on Public Contracts Code section 7105(d)(2) (all further statutory references are to the Public Contracts Code). Section 7105(d)(2) states that the compensation due a public works contractor for amendments and modifications, such as change orders, can only be determined as provided in the contract. The trial court ruled the General Conditions of the contract (section 38(c) of the C-741 contract) required plaintiff to proceed on a time and materials basis and document actual costs if the parties failed to agree on a lump sum.

Based on Amelco, the City also filed a motion in limine to preclude DRW from presenting a total cost claim to the jury. The trial court agreed and precluded DRW from proceeding on a total cost theory of damages on the ground that DRW's evidence in support of that theory was insufficient, and held that a modified total cost theory was not recognized in California.

In response to the motions in limine, the trial court barred three of DRW's claims, including a claim for breach of implied warranty of correctness of plans. The jury found the City had breached the contract and caused DRW damages, and the City's assessment of liquidated damages was unreasonable.

Proof of Damages With Best Available Evidence Permitted

On appeal, the Court ruled that the in limine rulings be reversed. First, the Court held the trial court should have submitted the interpretation of the General Conditions section 38(c) of the contract to the jury. Since the terms of the contract were ambiguous as to the method to be used to document the cost of extra work, parole evidence was admissible to aid interpretation and DRW was entitled to a trial on the issue of contract interpretation.

Second, the Court held DRW was entitled to prove its damages with the best evidence available, even if that evidence takes the form of engineering estimates. Based on Amelco, DRW was precluded from recovering the reasonable value of its services based on a theory of abandonment, because the contract at issue was a public contract based on competitive bidding. Further, Amelco and section 7105 combined to prevent DRW from seeking to recover anything more for changes than it was entitled to receive by contract. Accordingly, the Court explained that "the benefit DRW would have received for change orders if the City had performed is the measure of damages." The Court concluded:

Section 7105 impacts the measure of damages for public works contracts, but it does not impact the permissible method of proof. In other words, an award of breach of contract damages under [common law] does not represent a contract modification barred by section 7105.

This is a significant clarification of this statute which has been controversial in public works circles. In effect the Court was adopting the traditional "benefit of bargain" measure of damages codified in California Civil Code §3300.

Breach of Implied Warranty of Correctness of Specifications Permitted Against Public Agency

The Court also held, pursuant to Souza & McCue Constr. Co. v. Superior Court (1962) 57 Cal.2d 508, that DRW was permitted to assert a claim for breach of the implied warranty of correctness of plans and specifications against the City. According to the Court, recovery based on a claim for breach of implied warranty of correctness would not "represent a contract abandonment barred by Amelco, nor would it represent a payment for an amendment barred by section 7107, subdivision (f)[sic]. Rather, it would simply represent an award for contract damages under longstanding common law."

Modified Total Cost Method of Proving Damages Permitted in California

Finally, the Court held that on remand DRW may pursue a modified total cost theory, if it is not required to document its actual costs. Under the total cost method, damages are determined by subtracting the contract amount from the total cost of performance. Under Amelco, the total cost method may be used only after the trial court determines the contractor has a prima facie case by showing the following: (1) it is impractical for the contractor to prove actual losses directly; (2) the contractor‘s bid was reasonable; (3) its actual costs were reasonable; and (4) it was not responsible for the added costs. If some of the contractor's costs were unreasonable or caused by its own errors, then those costs are subtracted to arrive at the modified total cost.

In its Order Modifying Opinion and Denying Petition for Rehearing, the Court held, "Amelco recognizes that a contractor can recover on a total cost or modified total cost theory." Therefore, the trial court abused its discretion by not following Amelco. "Section 7105 does not expressly abrogate common law, and the statute and common law can be harmonized because the total cost and modified total cost theories are merely methods of proving damages."

Conclusion

Dillingham significantly clarified Amelco, and breathed new life into the total cost and modified total cost methods of proving damages. Since Amelco was decided, common law contract damage principles as to public agencies have been under attack. Public agencies have argued with some success that Amelco insulated them from any form of damage proof other than daily costs tracked in the field, even where it was impossible to do so and could only be determined by engineering estimates or a modified total cost method at a later time. Dillingham holds that Amelco did not limit common law methods of proving damages against a public agency. Rather, it held only that the abandonment theory of liability is not allowed against a public agency.

Authored By:

Edward B. Lozowicki is a partner in Sheppard Mullin's San Francisco office (415) 774-3273. Bram Hanono is an attorney in Sheppard Mullin's Del Mar office (858) 720-8900.

Federal Court Holds "No Damage for Delay" Clauses Are Per Se Enforceable on Federal Public Works Projects in California

Sheppard Mullin — Tue, 23 Mar 2010 12:39:08 -0800

By Robert T. Sturgeon

Harper/Neilsen-Dillingham, Builders, Inc. v. United States, 81 Fed. Cl. 667 (2008)

California has long followed a public policy which limits the enforcement of so-called "no damage for delay" clauses in construction contracts on public projects. The policy is embodied in part by section 7102 of the Public Contract Code, which limits the enforcement of such clauses contained in both public contracts between contractors and public entities, and in subcontracts between private parties relating to public projects. The rule against "no damage for delay" clauses is based on the common law principle that courts should strictly construe clauses which work a forfeiture, a policy which arguably applies with equal force to both public and private contracts. In this regard California Civil Code section 1635 provides that public and private contracts are to be interpreted by the same rules. Thus, many California practitioners believe that the rule does or should extend generally to all construction contracts, both public and private. The case of Harper/Nielson-Dillingham Builders, Inc. v. United States is significant because it presents a potential exception to this long-standing rule. In Harper/Nielson-Dillingham, the United States Court of Federal Claims held that under California law, "no damage for delay" clauses in contracts between private parties on federal public works projects are per se enforceable, and that a federal agency may successfully defeat a subcontractor's pass-through delay claim by relying on a "no damage for delay" clause in the subcontract between the general contractor and subcontractor.

Harper/Nielson-Dillingham Builders, Inc. ("Harper") was the general contractor under a contract with the Air Force for the demolition and replacement of over 140 base housing units, removal of several underground storage tanks, and associated site work. As part of its work, Harper subcontracted with Karleskint-Crum, Inc. ("KCI") to perform landscape and irrigation work for the project. During the course of the work, KCI claimed it had been delayed by the government and by the work of other subcontractors on the project. KCI contended that delays by the subcontractor performing the underground storage tank removal work had caused a "domino effect" which pushed KCI's work into the rainy season, and resulted in its work being delayed over 200 days beyond its scheduled completion date.

Because KCI was not in privity with the government, KCI asserted its delay claims against Harper, the general contractor with whom it was in privity. In turn, Harper filed a lawsuit against the government and asserted the delay claim on behalf of KCI on a "pass-through" basis pursuant to the Severin doctrine. Under the Severin doctrine, "a prime contractor may 'sue the government on behalf of its subcontractor, in the nature of a pass-through suit, for costs incurred by the subcontractor [due to the government's conduct] . . . [i]f the prime contractor proves its liability to the subcontractor for the damages sustained by the latter . . . a showing [which] overcomes the objection to the lack of privity between the government and the subcontractor. Harper/Nielson-Dillingham Builders, Inc., 81 Fed. Cl. at 674-675; see also E.R. Mitchell Constr. Co. v. Danzig, 175 F.3d 1369, 1370 (Fed. Cir. 1999).

To prevail under the Severin doctrine, the general contractor must show, at a minimum, that it had potential liability to its subcontractor on account of the government's actions. Id. In Harper/Nielson - Dillingham, the government argued that Harper could not establish that it had potential liability to KCI for the alleged delays because a "no damage for delay" clause in the Harper-KCI subcontract precluded any such liability. The Harper-KCI subcontract provided:

"A. In the event of any delays, entailed as a result of the fault of Contractor or Owner, then Contractor shall grant Subcontractor an extension of time equal to the delay and Subcontractor shall be entitled to no other or further damages against Contractor or Owner.
B. Any delays or additional work entailed as a result of weather conditions, storms, acts of God, delay in construction, delays by governmental bodies will not entitle Subcontractor to any extras whatsoever."

The subcontract also provided that any claims arising under it would be governed by California law. 81 Fed. Cl. at 669.

In opposition, Harper contended that "no damage for delay" clauses are not strictly enforceable under California law generally, and therefore that the clause did not immunize Harper from any potential liability to KCI. Harper relied on California Public Contract Code section 7102, which generally bars enforcement of "no damage for delay" clauses "in construction contracts of public agencies and subcontracts thereunder" where the delays are (i) caused by a contracting party and (ii) are "unreasonable in the circumstances." Harper also relied on Hawley v. Orange County Flood Control District, 211 Cal. App. 2d 708 (1963), a case which was decided prior to the 1984 enactment of section 7102. Hawley held that "no damage for delay" clauses, like all clauses in public or private contracts which may result in a forfeiture, are to be strictly construed against enforcement, and should only be enforced where all of the circumstances show that the parties intended the clause to apply to the particular delays and facts at issue.

The Harper/Nielson-Dillingham court agreed with the government, and held that "no damage for delay" clauses in contracts between private parties on federal projects are per se enforceable under California law. The court further held that that because the "no damage for delay" clause insulated Harper from any liability to KCI for the alleged delays, Harper could not recover against the government under the Severin doctrine. In reaching this conclusion, the court held that outside of Public Contract Code § 7102, "neither the California legislature nor the California Supreme Court has set forth any exceptions to enforceability of express 'no damage for delay' clauses in agreements between private parties." 81 Fed. Cl. at 677.

The court further explained that Public Contract Code 7102 applies to contracts by "public agencies," and that under Government Code section 4401, "public agencies" are defined to include state agencies only, and the statute makes no reference to federal agencies. Thus, the court concluded, section 7102 does not apply to subcontracts between private parties on federal projects in California. The court stated that

"the only exception to enforceability of such clauses has been codified at Cal. Pub. Contract Code § 7102, … [but that section] does not apply to the subcontract in this case because the federal government is clearly not a 'public agency' as defined in Cal. Gov't Code § 4401 . . . Thus, the court finds that under California law, the express and unambiguous 'no damage for delay' clause in the subcontract in this case provides an iron-bound bar against any potential liability on the part of Harper to KCI for all of its delay-related damages."

81 Fed. Cl. at 678-679. The court further held that, even assuming arguendo that California law provided that "no damage for delay" clauses are not enforceable if the parties did not contemplate the type of delay at issue, any such exception would not apply to KCI's claim because it was aware of the delays caused by the other subcontractors at the time it entered into its contract with Harper. 81 Fed. Cl. at 679.

Based on Harper/Nielson-Dillingham, contractors and subcontractors performing work on federal projects in California should be aware that, unlike the case on state projects, "no damage for delay" clauses in their subcontracts may be enforceable. However, it is not clear that the Claims Court correctly interpreted California law, or whether a California court deciding the issue would reach the same conclusion.

First, the federal court's reliance on Government Code section 4401 is not necessarily well-founded. As noted above, the court relied heavily on the definition of "public agency" found in Public Contract Code section 4401, specifically noting that the definition includes only state agencies, and not federal agencies. However, the Claims Court apparently ignored, or was not aware, that the definition contained in section 4401 is not a general definition applicable to all California statutes, but by its own terms is applicable only to the California "Emergency Termination of Public Contracts Act," of which it is a part. Section 4401 expressly provides:

"'Public agency,' as used in this chapter, includes the State, its various commissions, boards and departments and any county, city, district or state agency . . . (emphasis added).

The reference in the statute to "this chapter" refers to Chapter 5 of Division 5, Title 1 of the Government Code, which constitutes "The Emergency Termination of Public Contracts Act," Cal. Gov't Code § § 4400-4412. As the name implies, that Act concerns grounds and procedures for the emergency termination of public contracts. In quoting section 4401, however, the Harper/Nielson-Dillingham court omitted the "as used in this chapter" language, and inserted ellipses in its place. See Harper, 81 Fed. Cl. at 677 n.11.

Second, some California construction lawyers believe that a California court might be more restrictive in applying a "no damage for delay" clause in a private subcontract than was the federal court. As set forth in the Hawley case, the California courts apply a broader test in assessing whether a "no damage for delay" clause is enforceable, based largely on the principle, applicable to both public and private contracts alike, that a "clause which in ultimate result has the effect of imposing a forfeiture will be strictly construed, especially where the contract . . . was prepared by the one seeking to impose the forfeiture." Hawley, 211 Cal. App. 2d at 713. Other California courts have reached the same conclusion as Hawley, again based on the general common law rule that "the law abhors a forfeiture." See, e.g., McGuire & Hester v. City and County of San Francisco, 113 Cal. App. 2d 186 (1952). California Civil Code sections 1442 and 3275 also express a strong statutory policy against enforcement of contractual clauses which operate to cause a party to forfeit its rights or claims. And finally, as noted above, California Civil Code section 1635 provides that public and private contracts are to be interpreted by the same rules. Taking all of these factors together, a California court might be less inclined to enforce a "no damage for delay" than was the federal court in Harper/Nielson-Dillingham.

Authored By:

Robert T. Sturgeon
(213) 617-5435
RSturgeon@sheppardmullin.com

Robert Sturgeon is an attorney in Sheppard Mullin's Los Angeles office.

Trust, But E-Verify: A Cheat Sheet for Mandatory Employment Eligibility Verification By Federal Construction Contractors

Sheppard Mullin — Tue, 05 Jan 2010 12:21:29 -0800

This article was originally posted on Sheppard Mullin's Government Contracts Blog, which can be found at governmentcontractslawblog.com. For further information concerning our Government Contracts Practice, contact either of our Practice Group Leaders, Bryan Daly in Los Angeles at (213) 617-5466 or Anne Perry in Washington, D.C. at (202) 218-6875.

By: Daniel J. Marcinak & Edward B. Lozowicki

Introduction

Construction companies performing projects for federal agencies such as the Corps of Engineers, Veterans Administration, and General Services Administration are now subject to the new E-Verify rules summarized in this article. Under the new rules hiring is now more risky since the building trades may have workers who have immigrated to the United States from other countries and may not have properly documented immigration status. Further, project estimators and engineers may also have entered the United States from other countries, and should be properly documented. The E-Verify requirements flow down to subcontractors as well as general contractors on covered projects.

The final rule mandating E-Verify for federal construction and other contractors became effective on September 8, 2009. The lawsuit that stayed implementation of E-Verify since January ended with the district court’s granting of the Government’s motion for summary judgment. As long as Congress continues to fund E-Verify, it should remain a permanent fixture of federal procurement.

Covered contracts must now include Federal Acquisition Regulation (“FAR”) 52.222-54, Employment Eligibility Verification. Contracting officers may now begin modifying covered contracts. Similarly, FAR 52.222-54, which is a mandatory flowdown clause for commercial items, can now be flowed down by prime contractors to their subcontractors.

The Basic Requirements

Previously, we discussed the requirements, applicability, and exemptions of E-Verify. Briefly, E-Verify covers contracts that are:

Longer than 120 days in performance;
Above the simplified acquisition threshold ($100,000); and
Performed in the fifty states, District of Columbia, Guam, Puerto Rico, or the U.S. Virgin Islands.
Most federal construction contracts fall within these criteria. There are important qualifications regarding coverage of E-Verify: Subcontracts for supplies are not covered. But subcontracts are covered if they are (1) performed in the United States; and (2) valued at more than $3,000. This means virtually all construction subcontracts are covered.

Not only must all employees “assigned to the contract” be verified through E-Verify, but all new employees must also be verified through E-Verify unless a contractor is an institution of higher learning; a state or local government; a government of a federally recognized Indian tribe; and a surety performing under a takeover agreement with a federal agency.

Enrollment and Verification Deadlines

Being a government contractor means never having a good enough excuse for missing a deadline. Federal contractors using E-Verify have strict timelines to observe:

Company Enrollment

Verification of employees “assigned to the contract”

Verification of new hires

Not Yet Enrolled in E-Verify

Within 30 calendar days of contract award

Either within:

30 calendar days of an employee’s assignment to the contract

90 calendar days after enrollment

whichever is later.

Within 90 calendar days of enrollment; once verification has begun, queries must be initiated within 3 business days after date of hire

Already Enrolled in E-Verify

Update profile to reflect “Federal Contractor” status

Either within:

30 calendar days of an employee’s assignment to the contract

90 calendar days after contract award

whichever is later.

Same as above (if enrolled less than 90 calendar days)

Within 3 business days after date of hire (if enrolled 90 calendar days or more)

Some Suggestions for Implementation

Implementing the E-Verify mandate should not be hard for a well organized compliance program. Any compliance program ought to give serious consideration to the following:

• Responsibility for implementation should be centralized. Consider entrusting compliance to your Human Resources department or Compliance Manager. Compliance with E-Verify will require more than initial registration and simply processing applicants through the system. Among other things, contract award dates and deadlines can easily be missed, as can the inclusion of an “employee assigned to the contract.” Centralization should minimize the occurrence of these mistakes.

• Collaboration with Legal Counsel is essential. Your company may decide to flow down FAR 52.222-54 to subcontractors and prime contractors may decide to flow the clause down to your company. Whether E-Verify is required for your company in the first place is a legal question, and if that’s not answered correctly, compliance with E-Verify may be wholly unnecessary.

• Carefully scrutinize the Memorandum of Understanding (“MOU”) that E-Verify requires your company to enter into with the Government, and then incorporate the terms into your compliance program. Among other terms of the MOU, your company agrees to: follow the E-Verify User Manual; post notices; complete tutorials; maintain lawful employment practices (including anti-discrimination laws); and cooperate with the Government as it monitors your company’s compliance with E-Verify. Perhaps most important, violations of the terms of the MOU may be reported to contracting officers and other Government officials who review your company’s compliance with federal contracting requirements.

• E-Verify is optional for your entire workforce, which means your company can verify employment eligibility for existing employees who are not working on a federal contract. Blanketing your workforce with E-Verify coverage may simplify compliance.

The official Government website for E-Verify may be found here and a Supplemental Guide for government contractors is here.

Authored By:

Daniel J. Marcinak
(202) 772-5391
DMarcinak@sheppardmullin.com

and

Edward B. Lozowicki
(415) 774-3273
ELozowicki@sheppardmullin.com

New Legislation on Wrap-up Insurance And Indemnity Clauses

Sheppard Mullin — Mon, 28 Dec 2009 12:45:41 -0800

By Edward B. Lozowicki and James G. Higgins

Owners, developers and major general contractors are ramping up their use of wrap-up insurance policies on building and industrial projects. When sponsored by an Owner, wrap-ups are dubbed Owner-Controlled Insurance Program ("OCIPs"). If the general contractor sponsors the wrap-up, it is termed a Contractor Controlled Insurance Program ("CCIPs"). These policies offer significant cost savings to owners and generals. Traditionally, bid packages required the general contractor and its subcontractors each to carry liability insurance and to indemnify the Owner and name it as an additional insured. This arrangement has been criticized as requiring costly duplication of coverage, and causing needless litigation over indemnity rights. Wrap-ups seek to avoid these consequences by affording liability coverage to all participants on a project under a single policy. However there have been problems with wrap-ups such as inadequate policy limits and gaps in coverage. And the controversy over contractual indemnity clauses continues.

To address some of these problems California has enacted a new law, Assembly Bill ("AB") 2738, which affects wrap-up policies in residential, commercial, and public works construction. It also restricts indemnity clauses in residential projects. In light of the increased use of wrap-ups and continuing controversy over indemnity clauses, AB 2738 will likely have an immediate effect. AB 2738 is codified in California Civil Code sections 2782, 2782.9, 2782.95, and 2782.96.

On new for-sale residential projects which commence construction after January 1, 2009, AB 2738 places restrictions on self-insured retentions ("SIRs"); and requires disclosure of other policy terms. SIRs are limited to a “reasonable” amount but such term is not defined. No premium contribution or SIR allocation to contractors or subcontractors is permitted unless several disclosures are made, for example: the policy limits, the scope of policy coverage, the policy term, and the basis upon which the deductible or occurrence is triggered by the insurance carrier. Moreover, the party obtaining the wrap-up must disclose an estimate of the available limits remaining under the policy. However if the policy is a multi-project or "rolling" wrap, such disclosure could prove difficult, if not impossible, to make accurately. Further, indemnity clauses between participants in the wrap-up on any residential project are unenforceable for claims covered by the policy.

Separate disclosures are required for public works projects and non-residential projects put out for bid after January 1, 2009. For wrap-up policies on these projects, the bid documents must clearly disclose the total amount or method of calculation for subcontractor premiums. The named insured shall also disclose policy limits, exclusions, and the length of the policy term.

In addition contractual indemnity provisions on new for-sale residential construction contracts executed after January 1, 2009 are restricted. Indemnification for reimbursement of insurance or defense costs for claims unrelated to a subcontractor’s scope of work is unenforceable. In addition a subcontractor owes no defense or indemnity obligations until the builder or general contractor provides a written tender of the claim to the subcontractor. Upon tender arising from the subcontractor’s scope of work, the subcontractor may either: (1) defend with counsel of its own choosing and maintain control over that portion of the claim against the builder or general contractor to which the indemnity applies. Written notice of this election must be made within a reasonable time and no later than 90 days after receipt of tender. (2) Alternately, a subcontractor can pay within 30 days of receipt of an invoice from the builder or general contractor, no more than a reasonable allocated share of the builder’s or general contractor’s defense fees and costs on an ongoing basis during the pendency of the claim. Ironically this defense-election provision may lead to higher litigation costs because multiple subcontractors, having cross-claims against one another, could also be paying for a portion of defending third-party claims against the builder / general contractor based on the latter’s reasonable allocations.

AB 2738 may create some conflicts. For example, what is the scope of an insurer’s defense obligation? The legislation states that it does not affect the holding of Presley Homes, Inc. v. American States Insurance Company (2001) 90 Cal.App.4th 571, which held that if the insurer has a duty to defend any portion of a claim, it is obligated to defend the entire claim. But the indemnity provisions of AB 2738 invalidate for-sale residential construction contracts that require the subcontractor to insure, indemnify, and defend the builder/general contractor for claims not arising from the subcontractor’s scope of work. Will insurers be permitted to refuse a defense to an insured subcontractor which is sued for claims which it is not required to defend under AB 2738? This new law could well lead to more litigation over such issues.

Authored By:

Edward Lozowicki
(415) 774-3273
ELozowicki@sheppardmullin.com

and

James G. Higgins
(415) 774-2926
JHiggins@sheppardmullin.com

General Contractors' Liability to Subcontractors' Employees On Public Infrastructure Projects

Sheppard Mullin — Wed, 28 Oct 2009 16:00:37 -0800

By Edward B. Lozowicki

As residential and commercial construction markets evaporate and contractors fight for survival, new opportunities are appearing in the form of public infrastructure projects. The federal government is pouring money into public infrastructure and construction projects, to the tune of about $143 billion in total. Of that total, about $14 billion is designated for the California market. In addition, the State continues to fund projects from Proposition 1B and 1C bonds, and gas tax revenues. Much of the money will fund infrastructure projects awarded by the state and local government agencies. These new opportunities, however, come with new risks. One such risk is a general contractor's liability for its subcontractors' unpaid or under-paid employees on public infrastructure projects.

Liability For Unlicensed Subcontractors' Employees

One such scenario where a general contractor can incur liability is when an unlicensed subcontractor does not pay its employees earned wages. For example, in the recent case of Sanders Construction Company, Inc. v. Cerda, a general contractor was placed on the hook for unpaid wages to a subcontractor's employees.[1] The appellate court held, under California Labor Code § 2750.5[2], that employees of the unlicensed subcontractor were also "statutory employees" of the general contractor.[3] Accordingly, the general contractor shared and inherited the wage debts of the unlicensed subcontractor.[4] And it appears the general contractor did not have sufficient retention to set off against the wage claim. To limit this risk, general contractors should verify licensure of their subcontractors at bid time by searching the website of the Contractors State License Board.

Prevailing Wage Liability

Both general contractors and subcontractors working on a public works project for a state or local government agency must pay their employees at or above the prevailing wage rate.[5] The prevailing wage rate is determined by the Department of Industrial Relations.[6] While a general contractor is liable for failing to pay its own workers at or above the minimum prevailing wage rate, the general contractor is also jointly and severally liable to a subcontractor's employees for any wage rate deficiencies unpaid by the subcontractor.[7] Just like the general contractor, its subcontractors must pay their employees at the prevailing wage rates. If they fail to do so, the general contractor inherits the liability.

To enforce this law, the Labor Commissioner is authorized to pursue a general contractor for wages unpaid to a subcontractor's employee, because a subcontractor's employees individually cannot maintain a suit against the general contractor based on prevailing wage rate violations.[8] While the Labor Commissioner must exhaust all reasonable remedies to collect amounts due from the subcontractor prior to pursuing a claim against the general contractor, the general contractor is still exposed to this liability if, for example, the subcontractor closes its doors or files for bankruptcy.[9] In addition, an awarding public agency, upon determining a violation has occurred, can then withhold contract payments from the contractor found to be in violation.[10] In effect, the general contractor becomes the guarantor of proper wages paid to the subcontractors' employees.

Penalties

In addition to wage assessments, monetary penalties of up to $50 per worker, per day[11] may also be assessed against the general contractor based on the subcontractor's conduct. Those circumstances under which a general will be liable include instances when the general knew the subcontractor failed to pay prevailing wages to the subcontractor's workers, or the contract between the general and the subcontractor fails to provide for the payment of prevailing wages; the general fails to monitor the subcontractor's payments by reviewing the subcontractor's payroll records; and the general fails to obtain an affidavit from the subcontractor stating legal wages were paid.[12] Finally, a contractor may be debarred from bidding public works projects for willful[13] or fraudulent violations.[14]

Payroll Records

Still another obligation unique to public works projects is that a general contractor and its subcontractors are obligated to maintain certified payroll records and make them available upon request.[15] In particular, a contractor must provide certified payroll records including the worker's name, address, social security number, work classification, straight time and overtime hours worked for each day and for each week, and the actual per diem wages paid. Failure to adhere to recordkeeping and record availability regulations subjects the contractor or subcontractor to a penalty of $25 per worker, per day.[16] The general contractor should require compliance with certified payrolls in its subcontract terms, and verify that the subcontractor submissions are timely and complete.[17]

Protective Measures

The general contractor can manage these risks. In addition to checking the license status of its subcontractors, the general contractor should require weekly certified payrolls from its subcontractors and use them to verify prevailing wage compliance. If the subcontractor's employees are union members, then the general contractor can contact the union to verify that the subcontractor is paying the required fringe benefits. Finally, the general contractor can and should withhold retention from each progress payment as security for any failure of the subcontractors to pay its employees according to law. Retention can be held until the contractor confirms prevailing wage compliance during the project close-out process.

Conclusion

Contractors who are bidding or securing public works contracts must be aware of the potential liability to subcontractors' employees for unpaid wages, whether it be with state or local public agencies. Unlike private projects, contracting for public infrastructure entails the added obligations and liabilities for payment of prevailing wages and keeping and making available the required payroll records. These risks can be mitigated by providing subcontract terms which require compliance, and most importantly, policing compliance through use of certified payrolls and other methods described above.

Authored By:
Edward Lozowicki
(415) 774-3273
ELozowicki@sheppardmullin.com

[1] Sanders Construction Co., Inc. v. Cerda (June 29, 2009) 175 Cal.App.4th 430.

[2] Cal. Lab. Code § 2750.5(c).

[3] Sanders Construction Co., Inc., at [2–7].

[4] Id. at [7].

[5] See, e.g., Cal. Lab. Code § 1771.

[6] Cal. Lab. Code § 1770.

[7] Cal. Lab. Code § 1743(a).

[8] Violante v. Communities Southwest Development and Construction Co. (2006) 138 Cal.App.4th 972, 979 (rev. den'd, July 12, 2006) (employees of subcontractor sued general contractors of a public works project for the subcontractor's failure to pay its employees according the prevailing wage laws; court dismissed suit for lack of standing, holding section 1774 does not create a private right of action for a subcontractor's employees to sue the general contractor for prevailing wage rate violations.). A subcontractor's employee has standing to maintain an independent action against the subcontractor for a violation of their rights under California's Unfair Competition Laws (Bus. & Prof. Code, § 17204) or the Labor Code Private Attorneys General Act of 2004 (Lab. Code, § 2698 et seq.).

[9] Cal. Lab. Code § 1743(a).

[10] Cal. Lab. Code § 1727(a).

[11] Cal. Lab. Code § 1775(a)(2)(a) (establishes factors Labor Commissioner must consider when determining the penalty).

[12] Cal. Lab. Code § 1775(b); see also Violante 138 Cal.App.4th at 979.

[13] Cal. Lab. Code § 1777.1(c).

[14] Cal. Lab. Code §§ 1777.1(a)–(b). On federal construction projects, contractors must also pay their workers a prevailing wage rate. 40 U.S.C. § 3142. A failure to do so can result in the general contractor losing a portion of the project or the entire project. 40 U.S.C. § 3143.

[15] Cal. Lab. Code § 1776(a)–(f).

[16] Cal. Lab. Code § 1776(g).

[17] Cal. Lab. Code § 1775(b)(2)

Launch of Our New Construction and Infrastructure Law Blog

Sheppard Mullin — Wed, 02 Sep 2009 12:41:13 -0800

We are excited to announce the launch of our new blog dedicated to the needs of the construction and infrastructure industry. Refer back to this blog for updates on such topics as federal and local stimulus plans, claims on government and private projects, public-private partnerships, and the legal issues that impact the success or failure of construction and infrastructure projects.

Courts Uphold Disgorgement Penalty For Unlicensed Contractors

Sheppard Mullin — Wed, 02 Sep 2009 12:00:51 -0800

By Candace L. Matson

As most construction professionals know, California law requires that any person engaged in the business of a contractor, or that acts in the capacity of a contractor, must be properly licensed by the Contractors State License Board (“CSLB”). Cal. Bus. & Prof. Code § 7028. A contractor is defined broadly, as follows:

. . . a contractor is any person who undertakes to or offers to undertake to, or purports to have the capacity to undertake to, or submits a bid to, or does himself or herself or by or through others, construct, alter, repair, add to, subtract from, improve, move, wreck or demolish any building, highway, road, parking facility, railroad, excavation or other structure, project, development or improvement, or to do any part thereof, including the erection of scaffolding or other structures or works in connection therewith, or the cleaning of grounds or structures in connection therewith, or the preparation and removal of roadway construction zones, lane closures, flagging, or traffic diversions, or the installation, repair, maintenance, or calibration of monitoring equipment for underground storage tanks, and whether or not the performance of work herein described involves the addition to, or fabrication into, any structure, project, development or improvement herein described of any material or article of merchandise. "Contractor" includes subcontractor and specialty contractor. "Roadway" includes, but is not limited to, public or city streets, highways, or any public conveyance.

Cal. Bus. & Prof. Code § 7026.

Harsh penalties may be assessed against an unlicensed contractor for performing work in California requiring a license, and are reputedly designed to protect the public against incompetency and dishonesty in those who providing construction services. Hydrotech Systems, Ltd. v. Oasis Waterpark, 2 Cal. 3d 988, 995 (1991). For example, an unlicensed contractor may be subject to both civil and criminal penalties. See, e.g., Cal. Bus. & Prof. Code § 7027.3 (one year imprisonment and/or $10,000 fine for intentional use of another person's license with intent to defraud), Cal. Bus. & Prof. Code § 7028 (contracting without a license is a misdemeanor; penalty for second offense is $4,500 minimum and 90 day county jail time), Cal. Bus. & Prof. Code § 7028.7 (CSLB citation and fine of $200-$15,000), Cal. Bus. & Prof. Code § 7117 (CSLB disciplinary action); and Cal. Lab. Code §§ 1021-1023 (civil penalty of $200/day per employee performing work for unlicensed contractor).

In addition, section 7031 of the California Business & Professions Code precludes an unlicensed contractor from maintaining a lawsuit to recover compensation for its work. Section 7031(a) states, in relevant part:

[N]o person engaged in the business or acting in the capacity of a contractor, may bring or maintain any action, or recover in law or equity in any action, in any court of this state for the collection of compensation for the performance of any act or contract where a license is required by this chapter without alleging that he or she was a duly licensed contractor at all times during the performance of that act or contract, regardless of the merits of the cause of action brought by the person . . .

Finally, perhaps the most onerous penalty of all is that an unlicensed contractor may be required to disgorge any compensation it has previously been paid for performing work requiring a license. Cal. Bus. & Prof. Code § 7031(b). Under section 7031(b), "[a] person who utilizes the services of an unlicensed contractor may bring an action . . . to recover all compensation paid to the unlicensed contractor for performance of any act or contract." There is little case law interpreting the so-called “disgorgement” penalty since its addition to Section 7031 is relatively recent (added by amendment in 2001). The four opinions published to date which address disgorgement, directly or indirectly, are discussed below.

In the first case, Wright v. Issak, 149 Cal. App. 4th 1116 (2007), a contractor sued two homeowners for unpaid amounts in connection with a home remodeling project. The homeowners responded with a cross-complaint against the contractor seeking, among other things, the return of all amounts they had paid him on the ground he did not have a valid contractor's license. Although the contractor held a California contractor's license, he grossly underreported his payroll to the State Compensation Insurance Fund, and never obtained workers compensation for his crew working on the home remodeling project.

Both the trial court and court of appeal agreed with the homeowners that, under Business & Professions Code section 7125.2, the contractor's license was automatically suspended for his failure to obtain workers compensation insurance for his employees. Both courts rejected the contractor's argument that such suspension could not take effect until the contractor received a notice of suspension from the registrar of contractors. Because the contractor failed to properly report his payroll and obtain insurance for his workers before, during, and after the home remodeling project, the contractor was not properly licensed. The homeowners were entitled to recover all amounts paid to the contractor under Cal. Bus. & Prof. Code section 7031(b), compensatory and punitive damages for fraud, and contractual attorney's fees.

A year later, the Court of Appeal issues its opinion in Goldstein v. Barak Construction, 164 Cal. App. 4th 845 (2008). In this case, Homeowners entered into a contract with Barak Construction to remodel their home in mid-June 2004. Barak began work on the project right away, but did not obtain a contractor's license for the first time until mid-September 2004. Homeowners paid Barak $362,629.50 before Barak abandoned the incomplete project. Homeowners then filed suit under Business and Professions Code Section 7031(b), seeking a writ of attachment against Barak for the full amount paid, plus an amount for attorneys’ fees and costs. The superior court granted the writ of attachment.

Barak appealed the order granting the attachment and the court of appeal affirmed. It concluded that the homeowners' recoupment action satisfied all of the requirements for a prejudgment attachment set forth in Code of Civil Procedure Section 483.010. It rejected Barak's contention that the recoupment action was punitive in nature rather than a claim for money based upon a contract that will support a writ of attachment. Because a contract for services lies at the heart of a claim against the unlicensed contractor, such a claim is fundamentally contractual in nature and can be the basis for obtaining an attachment order. It also rejected Barak's contention that the amount of the attachment was improper and excessive because Barak had passed along most of the money it received to laborers or material suppliers for the project. Though the court recognized the draconian nature of the recoupment action, the Contractors License Law allows recovery of all compensation paid to the unlicensed contractor regardless of whether the amounts paid are ultimately retained by it. And the court of appeal rejected the contention that the amount of the attachment should be reduced by the amount earned by Barak after it became a licensed contractor. The court reiterated that to recover for work performed on a project, a contractor must be licensed at all times during which it performs the contractual work.

A third unlicensed contractor scenario was discussed in Oceguera v. Cohen, 2009. WL 756 296 Cal. App. 2d 2009. There, the contractor was a general partnership consisting of three general partners. Only Mr. Golen, the RME, was licensed as a contractor. Mr. Golen executed a disassociation notice in accordance with section 7076(c) of the California Business & Professions Code which provides that "a partnership license shall be canceled upon the disassociation of a general partner or upon the dissolution of the partnership . . . [T]he remaining general partner or partners may request a continuance of the license to complete projects contracted for or in progress prior to the date of disassociation or dissolution for a reasonable length of time . . . "

After Mr. Golen filed his disassociation notice, the partnership embarked on a residential construction project. Following completion, the project owner sued the partnership for defective construction. In addition to seeking damages for repair of the defective work, she also sought disgorgement of the $32,000 paid under section 7031(b) of the California Business and Professions Code. The issue on appeal was limited to whether the trial court erred in entering a judgment in favor of the owner on the refund of the $32,000. The court of appeal affirmed that defendants did not establish that the substantial compliance doctrine applied because they were never licensed before entering into and performing the June 2003 contract, and because Golen's association with the partnership ended on May 24, 2003, the date stated in the application for replacing the qualifying individual filed by Golen. Neither of the other individuals in the partnership could satisfy the substantial compliance doctrine because neither was licensed before entering into the June 2003 contract. In contrast, the partnership was licensed at one time and so did meet the first prong of the substantial compliance doctrine. However, it did not meet the remaining requirement: both partners knew they were not licensed, knew the RME had executed a disassociation, and did not act with prompt good faith efforts to secure a license.

The most recent case is White v. Cridlebaugh, F053842 (July 29, 2009). In it the Whites retained Cridlebaugh and JC Master Builders, Inc. (collectively, the “contractor”) to build them a log cabin. Due to concerns over the contractor’s billing and competency, the Whites terminated the construction contract. The parties filed complaints against one another, the contractor to foreclose on its mechanic’s lien, among other things, and the homeowners to recover disgorgement of amounts paid, among other things. On appeal, the court considered, among other things, “whether the Whites properly brought a claim for reimbursement under section 7031(b).”

The appellate court concluded that the contractor was not qualified to be licensed because it did not have a qualified responsible managing officer or employee in place, and that its license therefore was suspended by operation of law. Hence, disgorgement under section 7031(b) was authorized. The court further considered “whether “the recovery of compensation authorized by section 7031(b) [may] be reduced by offsets for materials and service provided or by claims for indemnity and contribution?” The court concluded that it may not, and that under the express terms of the statute, “unlicensed contractors are required to return all compensation received without reductions or offsets for the value of the materials or serviced provided.”

The above-described opinions make it clear that disgorgement under Section 7031(b) is a penalty against unlicensed contractors that has been accepted by the courts despite its draconian nature. The lesson for contractors is clear: they must be scrupulous in maintaining proper licensure at all times. Otherwise, in the event of a lawsuit with its customer, a contractor with a lapsed or suspended license could be forced to return to the customer all compensation received for work on the project. Such a scenario could bankrupt the business.

Authored By:
Candace L. Matson
(213) 617-5489
cmatson@sheppardmullin.com

Candace L. Matson is a partner in Sheppard Mullin's Los Angeles office where she specializes in construction law.

Two New Laws Create More Design-Build Opportunities for Local Governments and State Agencies

Sheppard Mullin — Wed, 02 Sep 2009 11:22:34 -0800

By Meredith A. Jones-McKeown

Most Local Governments Can Now Use Design-Build Methodology on Projects Over $1 Million

All cities can now use design-build project delivery systems for buildings with a value above $1 million. For solid waste management and wastewater treatment facilities, a pilot program also allows cities, counties, and special districts to use the design-build method on 20 such projects if valued above $2.5 million. Assembly Bill 642, codified at Public Contract Code §§ 20175.2 and 20193, took effect January 1, 2009. Existing law (Public Contract Code § 20133) already authorizes counties to use the design-build methodology for building and wastewater projects over $2.5 million.

Although the design-build authorization will give local governments more flexibility in structuring new projects, the design-build process is still regulated, and many prominent features of California's Public Contract Code remain applicable (albeit in modified form). For example, the new law still requires that the subcontracting process be fair and competitive. Subcontractors must be listed in the design-build proposals, and any non-listed subcontractors must be selected through a competitive selection process. Additionally, payment and performance bonds are also required on the projects. For large projects, as a practical matter, the use of joint ventures may be necessary in order to access adequate bonding capacity to meet this requirement. Finally, the government entities seeking to use design-build process must pre-qualify bidders, and then use a formal evaluation process to select a winning bidder. The government entities have the choice of awarding the contracts either on a lump-sum, lowest bid basis (which seems inconsistent with the concept of design-build) or by evaluating the bidders using "best value" criteria, with minimum weights for the following factors: price (10%), technical and construction expertise (10%), 15-year building life cycle costs (10%), skilled labor availability (10%), and acceptable safety record (10%).

State Agencies and Local Governments Have Design-Build Authority for Highway, Bridge, and Tunnel and Other Building Projects

On February 20, 2009, Senate Bill 4 (enacted in Public Contract Code § 6800 et. seq. and 20688.6; and Government Code § 14661.1, § 70391.7) became law and changed the traffic patterns for highway construction. Under the new law, CalTrans can use the design-build methodology to implement 10 new highway, bridge, and tunnel projects; and local transportation agencies can use design – build on 5 such projects (with CalTrans authorization). An additional 5 design-build authorizations are earmarked for building projects by the Department of Corrections, Judicial Council, and Department of General Services. Redevelopment Agencies can also enter into up to 10 design-build infrastructure contracts (with State Public Works Board authorization), although each individual redevelopment agency is eligible for no more than 2 design-build projects.

The new design-build projects will be selected from bids presented by prequalified firms under one of three models, depending on size. For projects between $250,000 and $10 million in value, selection must be made based on lowest responsible bidder (raising the question of whether such a selection process is truly "design-build" in nature). For projects larger than $10 million in value, selection can be made based on either (1) price and performance ("best value"); or (2) other criteria set forth by the agency in the design-build solicitation package. Where agencies use "best value" criteria to evaluate proposals, they must specify what criteria will be used to evaluate the proposals, with mandatory evaluation of price, life-cycle costs, construction experience, and building features. The "best value" projects may also include negotiations with responsive bidders pursuant to published rules, an innovation viewed by industry experts as an important tool. The awards are issued by a written decision that ranks the top three proposals. Errors & Omissions insurance is required for the design work portion of the projects.

As with AB642, SB4 maintains many requirements familiar to public works contractors. For example, the new law requires awarding agencies to implement new labor compliance programs to ensure prevailing wage minimums are met, and contains interim measures to ensure compliance prior to the adoption of such guidelines. Additionally, the bill contains subcontractor listing protections. Certain subcontractor trades may be identified and listed in the proposal, and where subcontractors are not listed, awards must be made pursuant to a competitive bidding process (either on a low-bid or best-value basis). Finally, performance and payment bonds are required. Unlike the equivalent provision in AB642, under SB4, the awarding agency has the discretion to determine the required amount of the bonds.

Authored By:
Meredith A. Jones-McKeown
(415) 774-3278
mjonesmckeown@sheppardmullin.com

Meredith A. Jones-McKeown is an associate in the Construction, Environmental, Real Estate and Land Use Litigation practice group in the firm's San Francisco office.

The President Admits the Stimulus Is Not Working as Hoped. Well, Duh.

Sheppard Mullin — Tue, 07 Jul 2009 08:04:50 -0800

ARRA has choked itself. Complexity, inflexibility, and draconian oversight provisions have combined to confuse and frighten contractors and state and local governments. Timely award of contracts funded by ARRA and, if the contracts are awarded, their performance, have become impracticable.

We told you so.

Companies interested in pursuing stimulus funds are realizing that ARRA imposes stringent rules and regulations, whether the company is a seasoned government contractor or a strictly commercial enterprise. Companies accepting stimulus funds will pay applicable employees the prevailing wage rates that are determined by the Department of Labor. Companies whose inventories include substantial quantities of foreign-made products must keep those products on the shelves because ARRA’s “Buy American” provision incorporates strict country-of-origin requirements. Moreover, so much confusion remains in the interim guidance about the coverage of “Buy American” that some companies are adopting a wait-and-see attitude. ARRA’s promoting of such behavior is directly contrary to its stated purpose. The rules are also substantively confusing. The applicability of each rule can vary depending upon whether the federal, state, or local government funds and disburses the money for a given project. Under these circumstances, hesitation is nothing short of reasonable self-defense and preventive maintenance.

Thus it comes to pass that state and local governments are finding that they cannot spend stimulus money with the ease anticipated by the Administration and Congress. They are discovering that foreign sourcing is so common that it is impracticable to avoid foreign content for at least some percentage of components, and that “Buy American” excludes contractors who would ordinarily bid on projects but for the restrictions on foreign components. Making matters worse, not all states or state agencies are exempted from these country-of-origin requirements, which create a patchwork across states and even within some states. Inexplicably, the Administration has fed this disorder by taking one statutory authority, ARRA, and authorizing two disjunctive regulatory regimes for it -- the FAR Councils and Office of Management and Budget (“OMB”). They have been tasked with implementing regulations for the federal government and state and local governments, respectively, and at least so far in the rulemaking process, have shown little sympathy for the lack of clarity and the imprecision that abound.

Labyrinthine rules are only one aspect of ARRA’s built-in disincentives for accepting stimulus funds. The law's reporting and auditing requirements verge on the impossible. Every quarter, companies must report to the federal government information such as the jobs “created or saved” because of the use of stimulus funds -- now there is a statistic that will most assuredly exhibit precision -- progress on the project receiving funds, and, in some cases, the salary for the five most highly-paid employees in the company. To ensure utmost compliance, companies are flowing down these requirements to subcontractors, vendors, and suppliers. All this information is subject to audit by the Government Accountability Office, the Office of Inspector General, the Recovery and Accountability Board, and state agencies. It is hardly surprising that an Administration that thinks government contracting is broken because “spending is plagued by massive cost overruns, outright fraud, and the absence of oversight and accountability” would create such a bureaucracy. But doing so amounts to a promise to hound and vilify contractors -- not an approach reasonably calculated to entice most companies to do business in the federal marketplace. Far from encouraging contractors to spend the government’s money, ARRA has made them risk-averse and discouraged efficiencies that are celebrated in the commercial world (e.g., refusing to permit, in the interim regulations, an exemption to “Buy American” for commercial items).

As we suggested before ARRA metastasized, the federal government’s own backyard needs more upkeep than it is receiving. And yet, while the federal government bemoans the absence of government contracting employees to oversee procurement adequately, it then burdens the existing corps of contracting personnel with extensive requirements for the oversight of a supposedly expedited process for the disbursement and expenditure of $787 billion. State government officials have now also been conscripted for ARRA, but they are -- understandably -- less familiar with even the pre-ARRA federal government procurement process. Add to this morass that the Administration has also famously admitted that stimulus funds are being wasted, and no one should be shocked to discover that the federal government’s scheme for stimulating the economy is clearly failing to achieve its fundamental purpose.

For further information concerning our Government Contracts Practice, contact our Practice Group Leaders, Bryan Daly in Los Angeles at (213) 617-5466 and Anne Perry in Washington, D.C. at (202) 218-6875.

Authored by:

Daniel J. Marcinak
(202) 772-5391
dmarcinak@sheppardmullin.com

Recovery Act Update -U.S. Stimulus: "Buy American" PRC Stimulus: "Buy Chinese" Canada and WTO: "Not Pleased"

Sheppard Mullin — Mon, 06 Jul 2009 10:02:43 -0800

Now that we have had a chance to see how the policies behind the Recovery Act are unfolding in reality (and there are advocates and detractors on all sides of this debate), we thought it might be interesting to review how the Buy American provision of the Recovery Act (Section 1605) is impacting U.S. relations with its international trade partners. In brief, many countries remain cautiously optimistic about U.S. Buy American practices under the Act, while other countries (such as Canada) seem to be gearing up for a trade war. This latter development should not, we think, be surprising -- a protectionist reaction on the part of at least some of our trading partners seemed likely when the "Buy American" provision was first proposed in January 2009.

Buy American

When Congress first proposed including "Buy American" restrictions in the Recovery Act in January 2009, a number of commentators warned that such measures would prompt an international protectionist reaction resulting in "trade wars," along the lines of those that developed during the initial years of the Great Depression following passage of the Smoot-Hawley Tariff Act of 1930. In an attempt to assuage these concerns, the Senate added language indicating that the "Buy American" provision would be "applied in a manner consistent with United States obligations under international agreements" (§ 1605(d)). While many hoped that this provision would do the trick, it appears that its drafters did not understand that, in the context of stimulus legislation aimed primarily at State and local governments, its ameliorative effect would be minimal to nonexistent.

It turns out that international trade agreements are, for the most part, entered into between the U.S. and other foreign countries; individual States are sometimes covered by the agreements, but only selectively (and city and county governments are rarely covered at all). The Senate may have dressed up the "Buy American" provision with a fig leaf and a nod toward international trade, but the plain fact is that the Recovery Act "Buy American" provision has effectively created an almost pure "Buy American" requirement that bars most foreign companies and foreign products (even if sold by a U.S. company, employing U.S. persons) from participating in Recovery Act opportunities at the State and local levels. (Click here for our previous discussion on the impacts of the Buy American provision of the Recovery Act).

Buy China

As if in fulfillment of the warnings about the international backlash to the "Buy American" restriction, the Financial Times recently reported that China has included a "Buy China" provision in its latest stimulus package. The new Chinese edict, dated June 1, 2009, directs that "Government investment projects should buy domestically made products unless products or services cannot be obtained in reasonable commercial conditions in China." It continues: "Projects that really need to buy imports should be approved by the relevant government departments before purchasing activity starts."

The Financial Times observes that "[t]he new edict bans local governments and departments from discriminating against domestic suppliers in their procurement. [However, f]oreign companies operating in China argue that the opposite is in fact true and that they have been largely cut out of procurement related to the government’s stimulus package."

Chinese officials have expressed dismay at the fact that anyone in the international community would have a problem with a "Buy China" provision, especially given the fact that the U.S. included a "Buy American" provision in its stimulus package. The Financial Times observes that this move by the Chinese will likely "amplify tensions with trade partners and increase the likelihood of protectionism around the world."

Bye-Bye Canada?

Our neighbor to the north is learning the hard way the difficult truth of the "true impact" of the Recovery Act's "Buy American" provision. Even though the U.S. and Canada share close to $600 billion in bilateral trade and are each other's largest trading partners, and even though the U.S. and Canada have entered into numerous free trade agreements, Canadian companies continue to find themselves locked out in the cold when it comes to participating in the many U.S. Recovery Act projects that occur below the federal level. Canadian trade representatives and industry on both sides of the border have loudly challenged the exclusion of Canadian companies and Canadian products, and the issue has been raised all the way to the U.S. Trade Representative and President Obama. Both have assured Canadian authorities that the issues can be resolved. Just last month, Debbie Meloh, spokeswoman for the U.S. Trade Representative, stated, perhaps disingenuously, that the U.S. Government is willing to negotiate with Canada for access, provided there is suitable "reciprocity." Canadian municipal leaders, meanwhile, are threatening to retaliate by keeping U.S. companies from selling to local governments in Canada, giving the U.S. until the middle of October 2009 to roll back the "Buy American" requirements. Rumors of a trade war abound.

The WTO's Reaction

When the Recovery Act was originally passed in February 2009, many members of the WTO (especially the European Union) were very skeptical of the "Buy American" provision. President Obama assured the WTO that the provision would be applied consistent with America's free trade obligations. The lack of penetration into the State and local market was, of course, not loudly proclaimed. While the WTO has continued to question the wisdom of the "Buy American" provision and warned against other protectionist measures, it has since remained relatively silent on publicly criticizing the "Buy American" provision.

This may well be due to the fact that the WTO is already hosting a number of other trade disputes between the U.S. and its foreign trading partners, perhaps most notably with regard to allegations of illegal subsidies to aircraft manufacturers -- the U.S. alleges that the E.U. is illegally subsidizing EADS/Airbus with improper launch aid, and the E.U. argues that the U.S. is improperly subsidizing the Boeing Company. Just last month, U.S. Trade Representative Ron Kirk warned that the U.S. would move "swiftly and quickly" to squelch any additional aid provided to Airbus from members of the E.U. The underlying dispute of "illegal subsidies" has been simmering since before 2005 (when the U.S. raised its claims with the WTO), and the WTO is expected to issue a preliminary ruling later this year. But, in the meantime, the rhetoric of a "trade war" informs the cross-Atlantic dialogue between the U.S. and the E.U.

Conclusion

If the Smoot-Hawley Tariff Act of 1930 taught us anything, it is that protectionist walls do not rescue a nation from a depression. Quite the contrary, they simply frustrate economic recovery and stifle economic growth. But there are many on Capitol Hill and many across America who do not see it that way; and there are apparently many in China who do not see it that way either. And, perhaps as a simple case of "tit for tat," it seems that there are an increasingly large number of people in Canada who may not see it that way either.

Apparently, Chris Braddock of the U.S. Chamber of Commerce sees things a bit more clearly. The Canadian Business Online Blog reports that, in Mr. Braddock's view, the "Buy American" end-game is becoming clear: "The point was to stimulate American jobs with American funds," says Mr. Braddock. "Unfortunately, it hasn’t quite worked out that way."

Alas, when it comes to its "Buy American" restrictions, the Recovery Act has stimulated only international bickering, both with our single largest trading partner and our largest potential trading partner. Probably the last thing the present Administration wanted to do was to prove the wisdom of former President Reagan’s oft repeated criticisms of Smoot-Hawley protectionism. History, President Reagan observed, "points in the opposite direction: more trade, not less; increasing cooperation, not isolationism and retaliation; expanding global networks of investment, production, and communication, not mercantalist national economics shrinking behind tariff barriers." President Reagan summed it up succinctly -- "Protectionism isn't just bad economics, it's bad politics." But, as we all know, politics are often oblivious to the ironic imperative we know as the Law of Unintended Consequences.

For other recent developments with regard to free trade agreements with Taiwan and China, click here.

For further information concerning our Government Contracts Practice, contact our Practice Group Leaders, Bryan Daly in Los Angeles at (213) 617-5466 and Anne Perry in Washington, D.C. at (202) 218-6875.

Authored by:

David S. Gallacher
(202) 218-0033
dgallacher@sheppardmullin.com

and

W. Bruce Shirk
(202) 741-8426
bshirk@sheppardmullin.com

Construction Manager Not Required To Be Licensed Pursuant To The Contractors' State License Law

Sheppard Mullin — Thu, 16 Apr 2009 19:30:44 -0800

The Fifth Day, LLC v. James P. Bolotin, et al., ___ Cal.App.4th ___(March 27, 2009, No KC047712)

By Jon E. Maki & Bram Hanono

The California Court of Appeal for the Second Appellate District determined that an entity which provided construction management services to a private owner developing commercial real property was not required to be licensed as a contractor pursuant to the Contractors' State License Law ("CSLL") (opinion by Acting Presiding Justice Armstrong, concurrence by Justice Krieger). In a lengthy dissent, Justice Mosk disagreed, highlighting that the intent of the CSLL is to protect consumers from unqualified and unlicensed contractors and predicted that the decision on a case of first impression creates a loophole in the license requirements by allowing unlicensed contractors to call themselves "construction managers."

Background

The plaintiff entered into a Development Management Agreement ("DMA") with defendant to provide certain "industrial real estate development and construction project management" services. Plaintiff sued defendant for compensation alleged to be due for services rendered by plaintiff. The trial court granted summary judgment in favor of defendant on the grounds that plaintiff was acting as a contractor required to be licensed pursuant to Business and Professions Code section 7026, which barred plaintiff's claim for compensation under section 7031(a) since plaintiff was not licensed. On appeal, plaintiff contended that it was not a "contractor" within the meaning of section 7026. The Court of Appeal agreed with plaintiff and reversed the trial court's judgment.

Discussion

The case turned on whether plaintiff performed services which required it to be licensed as a contractor. The services at issue were summarized by the Court as follows:

to assist, on behalf of the Owner, in coordinating the activities of the various workers to enable them to complete their assigned tasks in an organized and efficient manner, on time and on budget; to maintain records such as insurance certificates, as well as the financial books and records for the project; to keep the Owner apprised of the status of the project; to be the on-site "point person" to respond to issues as they arose; and generally to act as the Owner's agent with respect to the various parties connected with the development of the project.

In a fairly brief opinion, the majority concluded that plaintiff had no responsibility to perform any construction on the project or enter into any contract for such performance. In a rather literal and narrow reading of section 7026, the Court found that plaintiff did not contract with the owner to "perform any of the activities listed in the section 7026's definition of a contractor."

Additionally, the Court was persuaded by the fact that defendant had hired a general contractor to oversee the construction of the project, which indicated that the DMA did not contemplate that plaintiff would perform construction services. The Court also noted that the Legislature specifically provided that construction managers on public works projects are required to the licensed architects, engineers or general contractors. Therefore, the Court concluded that the absence of a similar statute regarding privately owned development projects "strongly suggests that the Legislature determined that licensure of construction managers was not necessary in that arena."

Dissent

Justice Mosk, in his dissent, interpreted the definition of a "contractor" under section 7026 more broadly and argued that the plaintiff was a contractor under the CSLL, whether or not its primary duty was to act as a "construction manager." He analyzed plaintiff's services in the DMA and concluded that "plaintiff acted in the capacity of a contractor by undertaking to perform such services as the coordination of work and supervision of other licensed construction professionals." Justice Mosk also concluded that section 7026.1 does not designate the only circumstances in which a consultant to an owner-builder must hold a contractor's license and that the use of the term "includes" indicates a non-exclusive list of such circumstances.

Additionally, Justice Mosk focused on the intent of the CSLL in general, which he summarized as providing strict licensing rules to protect people from "unqualified, unscrupulous and unlicensed contractors." Requiring the licensing of construction managers who undertake to supervise the work of other licensed contract professionals is consistent with the CSLL according to the Justice Mosk. Justice Mosk predicts that this decision has created a loophole for unlicensed contractors who merely call themselves "construction managers."

Authored By:

Jon E. Maki

(858) 720-8962

JMaki@sheppardmullin.com

and

Bram Hanono

(858) 720-7461

BHanono@sheppardmullin.com

Jon Maki is a senior associate in the Intellectual Property Litigation and Technology Transactions Practice Group in the firm's Del Mar office. Bram Hanono is an associate in the Business Trial Practice Group in the firm's Del Mar and San Diego offices.

New Recovery Act Rules Implement Provisions Relating To Government Audit Access, Whistleblower Protections, And Buy American Requirements; Much Confusion Remains

Sheppard Mullin — Thu, 09 Apr 2009 09:37:50 -0800

Reporting Requirements for Recipients of Recovery Funds (see 74 Federal Register 14639)
Publicizing Contract Actions (see 74 Federal Register 14636)
GAO and IG Access to Company Employees (see 74 Federal Register 14646)
Whistleblower Protections (see 74 Federal Register 14633)
Buy American Requirements for Construction Materials (see 74 Federal Register 14623)

This blog focuses on the final three sets of rules – those relating to Auditor access; Whistleblower protections; and Buy American requirements. The first set of rules is discussed separately here.

1. GAO and IG Access to Company Employees

The Recovery Act gives GAO increased audit access to recipients of Stimulus monies, including access to documents and employee interviews. See Section 902. Sections 1514 and 1515 also give the Government other broad audit rights. We have previously discussed these new and expansive audit rights here, observing that one of the biggest risks associated with the Government's ability to conduct employee interviews are potentially making criminal false statements (under 18 U.S.C. § 1001).

The new interim rule has the following effect for any contract or subcontract receiving (in whole or in part) Stimulus monies:

Modified Contract Clauses. It modifies standard FAR clauses to expand GAO's and the agency's Inspector General rights to include:

o Access to Records. The right to "examine any of the Contractor's or any subcontractors' records that pertain to, and involve transactions relating to," a covered contract;

o Employee Interviews. The right to "interview any officer or employee" regarding transactions involving Stimulus monies. Curiously, while the authority of GAO to interview employees under the newly modified contract clauses applies at all contract levels (both prime-level and subcontractors), the authority of the IG is limited only to the prime-level.

Applicability to Commercial and COTS Contracts and Subcontracts. The new interim rule also specifically applies to vendors of commercial and COTS products and services despite the general statutory policy disfavoring government-unique contract provisions for commercial and COTS contracts. The new interim rule extends its reach to subcontractors at all levels that are receiving Stimulus funds, even if a subcontractor is otherwise exempt from the requirement to provide cost or pricing data.
Applicability to Contracts and Subcontracts Under $100,000. Similarly, the new interim rule extends these increased audit rights to contracts and subcontracts involving Stimulus funds that are below the simplified acquisition threshold (currently $100,000).

While the purported goal of this broad audit authority is to provide "transparency" into the Federal contracting processes and to ensure the ability to monitor how Government monies are properly spent, perhaps a better means to achieve this goal would be to extend the current audit requirements already in force against Government contractors. Creating new regimes of audit rights seems duplicative and unnecessary. But this kind of expansive audit right is something that many Government regulators have wanted for a very long time, and the amount of money at issue with the Stimulus Act does create a very real obligation among Government personnel to ensure that oversight is properly conducted.

2. Whistleblower Protections

Section 1553 of the Recovery Act provides heightened whistleblower protections for employees of companies that receive Stimulus monies. We have previously briefly discussed these new whistleblower provisions here , noting that companies must be extremely cautious in handling employees that might (even potentially) be perceived as "whistleblowers." This includes employees whose job it is to investigate and audit company compliance.

Section 1553 joins a host of other whistleblower protections granting special protections for employees of federal contractors, including (apparently) State and local governments and other grantees that receive Stimulus monies. These numerous whistleblower statutes protect employees from reprisal and retaliation for merely investigating or disclosing information relating to gross misuse of federal money.

Applicability. Similar to the audit access rule discussed above, the new interim rule for whistleblowers applies to all commercial and COTS contracts receiving Stimulus money, as well as contracts and subcontracts beneath the simplified acquisition threshold.
Mandatory Flowdowns. This new rule requires that it be flowed down to all subcontracts, regardless of their dollar amount, and regardless of whether the subcontractors are commercial vendors.
Posted Notice. Employers who receive Stimulus monies are also required under the new rule to post a public notice of employees' rights and remedies for whistleblower protections under section 1553 of the Recovery Act.
"Covered Information." The new rule prohibits reprisals against employees who disclose "covered information," which includes information that the employee reasonably believes is evidence of:

o Gross mismanagement of the contract or subcontract related to Stimulus funds;

o Gross waste of Stimulus funds;

o A substantial and specific danger to public health or safety related to the implementation or use of Stimulus funds;

o An abuse of authority related to the implementation or use of Stimulus funds;

o A violation of law, rule, or regulation related to an agency contract awarded or issued relating to Stimulus funds.

Includes Internal Reporting. Notably, the protected conduct includes all employees – even those who make internal disclosures to company personnel in the regular course of their job duties. The functional impact of this broad scope of protections is that even a company's internal auditors may qualify as a "whistleblower" simply by doing their job. The formulation under Section 1553 and the new interim rule may be counter-productive from the Government's perspective, because it may inevitably force companies to treat their internal auditors differently than the rest of their workforce – because the mere fact that these employees are routinely engaged in activities designed to ensure compliance with the law means that all such employees could automatically be entitled to claim protection under Section 1553, regardless of whether they are, in fact, a bona fide "whistleblower." Any adverse employment decision taken by a company against an internal auditor could be viewed as a "discriminatory" or "adverse" employment action that an employee may later challenge under Section 1553.
Complaints with the Inspector General. Employees who feel that they have been mistreated because they have engaged in protected conduct may file a complaint with the relevant agency's Inspector General, which may decline to pursue a formal action, but which will liberally construe all whistleblower allegations. Generally speaking, the IG should have approximately 30 days to conduct their investigation and make a recommendation to the agency head.
Uneven Burdens of Proof. In order to prevail on a whistleblower claim, an employee need only demonstrate that engaging in the protected conduct was merely a "contributing factor" in whatever reprisal the employee claims the employer took against him or her. The employer, on the other hand, must demonstrate by clear and convincing evidence (i.e., contemporaneously documented; not merely anecdotal) that the adverse action would have been taken regardless of the employee's participation in the protected conduct. Obviously, this burden of proof greatly favors the whistleblowers and places employers at a disadvantage. Employers must be careful, therefore, not only to document all decisions fully, but also to handle all potential whistleblowers very carefully.
Private Right of Action. If no action is taken by the IG within 210 days of an employee filing a complaint or if the Agency declines to grant the employee relief, the employee is free to file suit in federal court. Note however that because the Recovery Act does not include a statute of limitations for bringing such claims, companies will be forced to let the courts decide whether and when such actions are "timely."
Waiver Unavailable. Though not specifically spelled out in the interim rule, Section 1553(d) is clear that these whistleblower rights cannot be waived by employees. Moreover, the Recovery Act whistleblower rights do not preempt other whistleblower rights (see Section 1553(f)) – so most whistleblowers could easily have different remedies available under different statutes (including, for example, 10 U.S.C. § 2409, 41 U.S.C. § 265, and 31 U.S.C. § 3730(h)) that provide whistleblower protections.

Attempting to enlist an army of "deputized" whistleblowers is not a new Government strategy. It is one that the Government has long used to great advantage in connection with the civil False Claims Act (31 U.S.C. §§ 3729-3730). In fact, there are at least two different bills currently before Congress that would encourage expanded whistleblower activities under the FCA, discussed here, in addition to the increased whistleblower protections under the Recovery Act. If history is any indicator, disgruntled employees of companies that receive Stimulus monies will inevitably cast themselves as "whistleblowers" – filing a suit under the civil False Claims Act, while simultaneously claiming protections under the host of statutes preventing adverse actions against the "whistleblower."

3. Buy American Requirements for Construction Materials

One of the most widely discussed sections of the Recovery Act relates to the Buy American provision – Section 1605 (previously discussed here), which prohibits Stimulus money from being spent on public works unless the iron, steel, or other construction materials are produced in the U.S. The interim rule creates a new, modified hybrid regime, borrowing from the regulatory concepts currently in place relating to the Buy American Act (BAA) and the Trade Agreements Act (TAA). Not surprisingly, this new "hybrid" regime is complicated and will well prove maddening to companies trying to comply with the Section 1605 Buy American requirements.

Applies to Construction Contracts. Notably, based on the plain language of the interim rule, it seems that the Section 1605 restrictions apply only to construction contracts – not more broadly to contracts for goods or services from foreign suppliers, as formulated under the TAA or under FAR Subpart 25.1 for the BAA. It is unclear at the present time whether this plain language means that the section 1605 Buy American restrictions are, in fact, limited only to construction contracts for "public buildings" and "public works" (including those under $100,000) or whether the Government views all purchases (including those for goods and services) under the Recovery Act as those falling under a broad umbrella of "construction contracts," such that the Section 1605 restrictions apply universally to all purchases using Recovery Act funds. While the latter formulation seems strained and unlikely, clarification from the Government would be appreciated.
New Regulations and Clauses. The new interim rule creates a new FAR Subpart 25.6, and adds new contract and solicitation clauses at FAR Part 52 (all referring to construction materials). The regulations are complicated, and any company performing work on construction contracts should carefully evaluate the risks under these new provisions.
Component Requirements. FAR 25.602 requires that the public building be located in the U.S. and that the iron, steel, or other manufactured goods be produced in the U.S. This requires that all manufacturing processes must take place in the United States, "except metallurgical processes involving refinement of steel additives." This does not, extend to the component materials (as under the BAA), merely to the final manufacture of the construction materials. The interim rule does seem to indicate, however, that the "component test" does separately apply to "unmanufactured construction materials."
BAA-Like Evaluation Preferences. Similar to the BAA (albeit in a more complicated fashion), FAR 25.605 requires that a contracting officer must consider whether the cost of domestic construction material is unreasonably high in comparison to the foreign alternative. Consequently, contracting officers are directed to use the following evaluation scheme in considering all offers:

1. Use an evaluation factor of 25%, applied to the total offered price of the contract (not merely the foreign products) if foreign iron, steel, or other manufactured goods are incorporated in the offer as construction material based on an exception for unreasonable cost requested by the offeror.

2. Additionally, use an evaluation factor of 6% applied to the cost of foreign unmanufactured construction material incorporated in the offer based on an exception for unreasonable cost requested by the offeror.

3. Total evaluated price = offered price + (.25 × offered price, if Factor #1 applies) + (.06 × cost of foreign unmanufactured construction material, if Factor #2 applies).

Exactly how this evaluation scheme should or will be employed in actual practice remains a mystery. Clearly, it is confusing and it will be difficult to segregate the costs of the various foreign unmanufactured construction materials. Looking into our crystal ball, we see many future bid protests sustained on procurements using Stimulus funds because the agency has had difficulty properly applying this complicated evaluation requirement.

TAA-Like Approved Foreign Countries. For purposes of construction contracts valued at $7,443,000 or higher, certain Recovery Act Designated Countries can qualify for equal treatment with domestic companies and domestic products (similar to the TAA). For purposes of the Recovery Act, the countries to which this exception applies include: World Trade Organization Government Procurement Agreement (WTO GPA) signatories; U.S. Free Trade Agreement partners; and Least Developed Countries. Notably, this list does not include companies that might normally qualify under the Trade Agreements Act, such as Caribbean Basin countries.

While the Recovery Act Buy American regime represents a hybrid of both the BAA and the TAA, the new rule does not exactly mirror either pre-existing regime, which lends itself to significant confusion. And confusion, when taking money from the federal Government, is not the emotion that companies want to experience. Hopefully, the public comments and the final rule will address the more ambiguous aspects of this new interim rule.

4. Effective Date

All of these new rules apply to solicitations issued or contracts awarded after March 31, 2009 and that incorporate any Stimulus monies (either in whole or in part). For contracts that have already been awarded, the Government will issue a bilateral modification to the contract to incorporate the new clause. If a contractor does not agree to a bilateral modification, then absolutely no Stimulus monies should be spent on the subject contract. These new rules are non-negotiable and contractors hoping to receive Stimulus monies will not be able to escape the additional regulatory and administrative requirements by claiming a unilateral "change" to their contract.

Conclusion

Accepting these new rules is the price that companies must pay if they accept Stimulus funds. Companies would be wise to consider whether they are willing (or even able) to comply with these terms and conditions, which impose massive burdens and carry significant risks, before participating in a mad dash for the Stimulus funds. As we have already discussed previously, accepting Stimulus monies comes at a high cost and contractors will be striking a Faustian bargain. As recipients of the TARP funds have learned, the Government may later change the rules, regardless of the deal that was originally struck. There are always risks associated with taking money from the U.S. Government.

The Government is accepting public comments on these new interim rules until June 1, 2009. Since no one in Congress appears to have read the Stimulus Act before passing it, this may be the first real opportunity for the public to engage in any type of meaningful debate about the impacts of the Act and how it should be implemented. We encourage citizens everywhere to express their comments on these proposed rules, so that a reasonable (and, hopefully, workable) regulatory regime may ultimately emerge, and so that the risks associated with receiving Stimulus monies can be properly managed.

For further information concerning our Government Contracts Practice, contact our Practice Group Leaders, Bryan Daly in Los Angeles at (213) 617-5466 and Anne Perry in Washington, D.C. at (202) 218-6875.

Authored by:

David S. Gallacher
(202) 218-0033
dgallacher@sheppardmullin.com

Public-Private Partnerships: A Growing Trend (Part I)

Sheppard Mullin — Mon, 23 Mar 2009 08:41:06 -0800

This article is part one of a series of three articles by the author regarding public-private partnerships.

By Edward B. Lozowicki

At an increasing rate, state and local governments are considering public-private partnerships, or "P3s," to finance, design and build public infrastructure projects. A P3 refers to a contractual agreement between a public agency and a private entity, whereby the private entity provides the financing, design, development, construction, operation, and/or maintenance of a public infrastructure project. It could be said that the trend in the U.S. toward P3 financing structures began in 1989, when California enacted Assembly Bill 680, authorizing P3s for several transportation projects and leading to the construction of two toll roads in Southern California. Today more than half the states have P3-enabling legislation, and P3s are being considered for an increasing number of projects. Canada has likewise seen the growth of P3s in recent years, with 27 such projects reaching financial closing between 2004 and 2007. Indeed, Canada now has a federal P3 office, and P3 agencies in Quebec, Alberta, Ontario and British Columbia.

Unlike privatization, in a P3 agreement the public agency typically retains ownership of the project and oversight of its operation, and controls the amount of involvement of the private entity. Some of the benefits of a P3 are that the costs of the investment can be spread over the life of the project, as compared to traditional "pay as you go" financing, and many of the risks of financing, construction and maintenance of the project are transferred to the private sector. There are, however, some areas of concern in a P3 structure that should be borne in mind by the public entity. First, regardless of who is legally responsible for which aspect of the project, because it is a public project the public agency will be held accountable for any of its failings by the general public. Second, public agencies will have to plan for longer-term contract management when entering into these sorts of arrangements. Third, there is a potential for job loss in the public sector in large P3 projects, as private entities assume responsibility for various facets of the project that would traditionally be carried out by the public sector.

P3 projects may be procured through a variety of contractual structures. One of the more common P3 procurement types is a concession agreement, in which a private entity finances, designs, builds and operates the project under a long-term license from the public agency. Title remains with the public agency through completion of construction, but the private entity takes possession and continues to operate the project for the period of the license. Another common type of procurement is lease-leaseback, in which a private entity enters into a ground lease from the public agency, designs and builds a project, then leases it back to the public agency until the lease is fully paid, at which time the lease terminates. Here the agency remains in possession of the project and retains title to the project. In the former case, the concessionaire collects revenue from the operation of the asset and uses it to pay the cost of finance, design and construction. In the latter, the public agency is paying rent to the developer, who uses it to pay back the costs of the project. In both scenarios, however, the public agency retains title. This is a fundamental difference between P3 and privatization, since in the latter, title transfers to the developer up front. Several permutations of the procurement structures described above are also possible. For more information and for case studies of various P3s planned and in use throughout the U.S., see The National Council for Public-Private Partnerships, How Partnerships Work (April 27, 2007).

Statutory recognition of P3s

To date, P3 structures for the financing of public infrastructure projects are authorized by statute in at least sixteen states, and the use of P3s is under evaluation in several others. These statutes are predominately found under code provisions for transportation projects. One reason this type of project has been so well-suited to the P3 structure is that the public is used to and generally accepts transportation fees, such as those imposed by rail tickets and toll roads and bridges. Private financing of these projects is thus easier than other types of public projects because the direct fees of the project users can offset the cost of service.

P3s have also been utilized for other public purposes, including water, wastewater, schools, and prisons, to name a few. In California, P3s are now authorized for use by local public agencies in such diverse fee-producing construction projects as energy or power production, water supply, treatment and distribution, commuter and light rail, highways and bridges, and buildings not used primarily for sports or entertainment events. (However, the enabling statute for these projects expressly excludes state agencies from its provisions.) The Natomas school district in Sacramento, for example, employed a P3 financing structure to build a new high school, using a lease-leaseback model to lease part of its land to a private developer, who financed and built the school. Another example of a successful P3project in California is the Alameda Corridor Rail Project, in which a collection of bridge, rail and street improvements were accomplished along a 20-mile stretch of railway in southern California using a P3 financing structure between a joint powers agency and the user-railroads which paid fees to finance design and construction.

In parts two and three of this series, we will address how P3 structures may conflict with other public works laws.

Authored By:
Edward B. Lozowicki
(415) 774-3273
ELozowicki@sheppardmullin.com

Edward B. Lozowicki is a partner in the Business Trials Practice Group in Sheppard Mullin's San Francisco office. He has over 35 years' experience in construction law and litigation, renewable energy cases, and complex commercial litigation, on diverse public and private projects.

Public-Private Partnerships: Potential Conflicts With Prevailing Wage Laws (Part II)

Sheppard Mullin — Mon, 23 Mar 2009 08:39:22 -0800

This article is part two of a series of three articles by the author regarding public-private partnerships.

By Edward B. Lozowicki

The advent of public-private partnership agreements in turn gives rise to potential conflict with other statutes regulating procurement of public works projects. For example, is the P3 infrastructure project a "public work," and are "public funds" used to fund the project? If the answer to one or both of these questions is yes, then the private entity may incur liability if the design, construction and/or operation of the project would result in the violation of any local regulations pertaining to public works. For example, a "public work" could be subject to state prevailing wage laws, whereas a privately funded work would not.[1] Thus, the definition of "public work" and "public funds" as applied to P3s may lead to litigation if not addressed up front.

For example, in the case of Greystone Homes, Inc. v. Cake, the determination of whether the project was a public work and hence subject to California's prevailing wage law turned on the definition of "publicly funded."[2] Although not specifically a P3 case, it is illustrative of the care that must be taken when structuring funding for private-public works, and may be analogous in the context of P3s. In that case the appellate court held that the development at issue, although built on land purchased with public funds, was not a public work under state law. The holding of the case turned on the definition of "construction," which, under the law at the time of the developer agreement (former California Labor Code § 1720(a) (amended 2000 and 2001)), did not include pre-construction design efforts, but "only the actual physical act of building the structure."[3] Because "construction" by the private developer, as was then legally defined, did not begin until after conveyance of the property from the public sector to the developer, no public funds were used in construction, the development was not a "public work," and hence no liability for prevailing wages accrued to the developer.

Subsequent to the amendment of California Labor Code § 1720(a) [4] and at the time of this writing, the issue whether there was public funding of pre-construction efforts of a P3 or otherwise private project (thus making it subject to prevailing wage laws) has been little litigated in California. City of Long Beach is one case in which the public agency's financial contribution to the project was limited to pre-construction expenses, in this case design and architecture.[5] The case was litigated after amendment of § 1720(a) and its broadening of the definition of "construction." Based on the public funding of pre-construction expenses, the appellate court held that the project was a public work, and hence subject to the prevailing wage law.[6] However, the Supreme Court of California reversed. Similar to the project in Greystone, the Supreme Court held that this project was not a public work as defined by the statute in effect at time of the conveyance of public funds. Because no publicly funded construction was involved, the court reasoned that the project was not subject to the prevailing wage law.[7]

Clearly, companies considering a P3 agreement in California today must take note that the term "construction" now encompasses the pre-building phases of a project. If funding of the Greystone and City of Long Beach projects were at issue today, under the current statute their respective holdings might be different. One might argue that "construction" of the Greystone project, for example, began at conveyance of public land to the developer ("pre-construction phase"), thus turning it into a "public work" for purposes of prevailing wage laws. And the project in City of Long Beach initially was held to be subject to the prevailing wage law, but was ultimately held not subject to that law because the public funding occurred before the amendment was enacted. Query whether the private developer of a California P3 agreement that includes project design could be subject to prevailing wage liability if design efforts or land conveyance is publicly funded, even where the actual construction is privately funded.

Public funding

As demonstrated above, careful structuring of a P3 transaction may be needed to avoid the possible creation of statutory "public funding" for a project and the liability this entails. San Antonio Bldg. and Constr. Trades Council v. City of San Antonio illustrates the point.[8] In this case, the city created a non-profit finance corporation to issue bonds, including some tax-exempt, expressly "for the purpose of financing a portion of the costs required to construct . . . a privately-owned hotel . . . ."[9] Proceeds of the bonds were loaned to a private developer, who entered into a design-build-operate-lease agreement with the city for a convention center hotel. During the lease term, possession of all improvements on the premises would remain with the tenant developer, but would revert to the city at expiration of the lease.[10]

The San Antonio hotel project was challenged as a public work, based on its being partially funded through bonds issued by a local government corporation, and thus subject to Texas' prevailing wage law. The wage law applied "only to the construction of a public work . . . paid for in whole or in part from public funds . . . ."[11] The court held that the funds from bonds raised for hotel construction by a local government corporation were not "public funds," mainly because the government did not remain liable for repayment to bondholders if the corporation defaulted[12], and no funds from the state or city were used to secure or pay the bonds.[13] Because no public funds (as the court interpreted the term) were used in this project, it was not a "public work"; thus, the prevailing wage law did not apply.[14]

However, the dissent in this case would have viewed the arrangement in question as one that did involve public funding; thus the project was, in its view, a public work and subject to the prevailing wage law. The dissent strongly criticized the majority's definition of public funding as "very restrictive,"[15] and the majority's holding as against public policy in Texas.[16] In the dissent's opinion, the arrangement between the city and developer was a P3, the hotel project was publicly funded, and the city was merely seeking to avoid the reach of the prevailing wage statute through an artfully crafted contract.[17]

In a similar case in Pennsylvania, the court came to the opposite conclusion from that of the San Antonio majority. In Lycoming County Nursing Home Assoc., Inc. v. Commw. of Pa., Dep't of Labor & Indus., Prevailing Wage Appeal Board, county commissioners set up a non-profit corporation to build and operate a project, in this case a nursing facility.[18] The county authorized the issuance of bonds, loaned the proceeds to the newly established corporation to develop the facility, and the corporation contracted with a developer to construct the facility. The court held that the project was a public work for purposes of the prevailing wage law[19], because the project was paid for, at least in part, with public funds.[20]

The primary rationale for the Lycoming court's determination that public funds were used in the project at issue was that the county remained liable on the bonds if the non-profit corporation defaulted.[21] In San Antonio, however, no political subdivision of the state would have been liable for default.[22]

The take-home message from Lycoming and San Antonio is that P3 agreements must be carefully drafted, with an eye to the legal ramifications of the funding structure selected; and even then, the definition of what makes a work "public" may be open to interpretation and subject to skilful advocacy.

To read Part I of this series please click here. To read Part III of this series please click here.

Authored By:
Edward B. Lozowicki
(415) 774-3273
ELozowicki@sheppardmullin.com

[1] See, e.g., Cal. Lab. Code § 1771 ("[N]ot less than the general prevailing rate of per diem wages . . . shall be paid to all workers employed on public works.")

[2] 135 Cal. App. 4th 1, 3 n.1 (2005).

[3] Id. at 9 (citing City of Long Beach v. Dep't of Indus. Rel., 34 Cal. 4th 942, 950 (2004)).

[4] Cal. Lab. Code § 1720(a)(1) (2002) ("'[C]onstruction' includes work performed during design and preconstruction phases of construction including, but not limited to, inspection and land surveying work.").

[5] City of Long Beach at 948.

[6] Id. at 949.

[7] Id. at 954.

[8] 224 S.W.3d 738 (Tex. App. 2007).

[9] Id. at 741 (quoting Ordinance No. 100685).

[10] Id.

[11] Id. at 746 (quoting Tex. Gov't Code Ann. § 2258.002 (Vernon 2000)).

[12] Id. at 747.

[13] Id. at 749.

[14] Id. at 751.

[15] Id. at 752.

[16] Id. at 751.

[17] Id. (The hotel project as "a prime example of a public-private venture" wherein, "[t]hrough artfully crafted project documents, the City [sought] to avoid application of the prevailing rate statute . . . on publicly-funded public projects.").

[18] 627 A.2d 238 (Pa. Commw. Ct. 1993).

[19] 43 P.S. § 165-3.

[20] Lycoming at 243.

[21] Id.

[22] San Antonio at 749.

Public-Private Partnerships: P3s and Competitive Bidding Laws (Part III)

Sheppard Mullin — Mon, 23 Mar 2009 08:38:18 -0800

This article is part three of a series of three articles by the author regarding public-private partnerships.

By Edward B. Lozowicki

In the United States, public contracts are generally subject to the competitive bidding process as a matter of public policy. This is considered the best way to serve the public interest, if for no other reason than to save the taxpayer money by securing construction services at the lowest possible cost. With the growth of P3s, however, local governments are more likely to apply alternative approaches for procurement, which in turn face criticism, and challenges in court.

In American Recycling Company, for example, the county procurement code allowed for an exception to the standard competitive bidding process, such that at the county's discretion, a contract could be entered into by a competitive proposal method.[1] In the proposal method, the contract would be awarded to the offeror whose proposal was most advantageous to the county, and not necessarily the one who presented the lowest bid price.[2] The developer in American Recycling submitted a proposal to the county for a design-build-operate project, was awarded the position of lowest proposal, but then was not awarded the contract. The developer sued the county for breach of contract and on due process claims, challenging the county's discretionary procurement method. The court upheld the method, and stated that no contract existed where, as in this case, the code specifically distinguished between an award of a bid and award of a contract; "by accepting the bid, the . . . county, as a matter of law, is not accepting the bidder's offer."[3]

One of the criticisms of procurement methods that differ from the competitive bidding process, such as competitive proposals or single-source procurement[4] that are frequently used in P3 arrangements, is that they give too much discretion to the government entity.[5] Where price is not a controlling factor, there is concern that the government is less accountable for its decisions, more open to favoritism or corruption in the award of "discretionary" contracts.[6] The benefit of such alternative procurement methods, however, is that they permit the execution of a single contract for multiple phases of the design-build process, rather than requiring a series of competitively bid contracts, thus shortening the procurement process.[7] Additionally, design and construction can proceed concurrently, which shortens project duration.[8] And importantly, discretionary contract awards allow the government to consider other factors than price, such as the experience and expertise of the various design-build team members and how they relate to each other, all of which is crucial in putting together a productive and efficient design-build team, and one that will best serve the needs of the public.

Conclusion

With many states experiencing infrastructure deficits, P3s are one tool governments may use to create public infrastructure projects. They are attractive in that they allow for streamlining of the procurement process by bringing together all facets of a project into one team; they shift construction and financial risks to the private sector, while allowing the public to maintain control of the project; and, in some cases, they may be structured to avoid the liabilities that could arise from purely public works. Criticisms of P3s include that they may allow public entities to avoid regulations specifically imposed on public works as a matter of public policy, such as prevailing wage laws; and that discretionary or single-procurement contract awards may leave government bodies open to corruption and favoritism, leading to increased costs to the taxpayer. These arguments appear to be based on policy or politics, rather than legal defects. It appears that the trend toward more P3 projects nationwide continues. More than half the states now have P3-enabling legislation, and P3s are being considered as the structure for a greater variety of infrastructure projects.[9]

To read Part I of this series please click here. To read Part II of this series please click here.

Authored By:
Edward B. Lozowicki
(415) 774-3273
ELozowicki@sheppardmullin.com

Edward B. Lozowicki is a partner in the Business Trials Practice Group in Sheppard Mullin's San Francisco office. He has over 35 years' experience in construction law and litigation, renewable energy cases, and complex commercial litigation, on diverse public and private projects.

[1] American Recycling Co. v. County of Manatee, 963 F. Supp. 1572 (M.D. Fla. 1997).

[2] Id. at 1574.

[3] Id. at 1582.

[4] See, e.g., Sloan v. Greenville County, 590 S.E.2d 338, 343 (S.C. Ct. App. 2003).

[5] Id. at 344 ("Critics espouse that design-build vests too much discretion with the governing body regarding when and to whom public contracts are awarded.").

[6] Id.

[7] Id. at 343.

[8] Id.

[9] Deloitte at 7.

California Budget Plan Will Delay Off-Road Diesel Emissions Regulations

Sheppard Mullin — Tue, 10 Mar 2009 00:06:06 -0800

On February 19, 2009, California legislators ended a three-month-long stalemate and passed a budget designed to meet the $41 billion budget shortfall through 2010. A major provision in the bill package adopted as part of the proposed budget would delay the retrofitting of heavy diesel equipment, which would save the construction industry millions of dollars but hurt efforts to reduce harmful emissions.

In July of 2007, the California Air Resources Board (ARB) passed regulations intended to reduce emissions of particulate matter (PM) and nitrous oxide (NOx) from off‑road diesel engines. These regulations require businesses to retrofit or "turn over" their fleets over time. This was the first statewide rule in the nation to require companies to retrofit existing heavy equipment to reduce these toxic pollutants. Please visit the following links for information regarding the original regulations: ARB Off-Road Diesel Vehicle Regulation, CARB New Diesel Emission Regulations Proposal, Update to CARB New Diesel Emission Regulations Proposal.

The California Legislature has directed the ARB to make several changes to the in-use off‑road diesel vehicle regulation. The changes will relax the requirements of the regulation for many large fleets in the early years of the regulation and include the following:

For the total cumulative turnover and retrofit requirements for the years 2011 through 2013, fleets may complete 20 percent of the total turnover and retrofitting by March 1, 2011, an additional 20 percent by March 1, 2012, and the balance by March 1, 2013.
Fleets using their off‑road vehicles less than they did as of July 1, 2007 may now take credit for this reduced fleet activity to satisfy turnover and retrofitting requirements in 2010 and 2011.
Fleets will now be given credit, both PM and NOx, for any vehicle retirements made between March 1, 2006 and March 1, 2010 as long as total fleet horsepower decreased from the previous year.

Although the above changes have been made, the reporting deadlines for the off‑road regulation remain unchanged as follows: April 1, 2009 for large fleets, June 1, 2009 for medium fleets, and August 1, 2009 for small fleets.

ARB staff will hold a workshop to discuss implementing these changes and ways of mitigating the loss in emission benefits caused by these changes sometime in March. A public notice with details regarding this workshop will be released soon.

Authored By:

Kyndra Joy Casper

(213) 617-4157

kcasper@sheppardmullin.com

Kyndra Casper is an associate in the Real Estate, Land Use and Environmental Practice Group in the firm's Los Angeles office.

Stimulation Has Its Price - The Audit and Oversight Provisions of The 2009 Stimulus Bill Are Unlike Anything Most Funding Recipients Have Ever Seen

Sheppard Mullin — Mon, 23 Feb 2009 05:12:34 -0800

The author is a member of the Firm's Government Contracts & Regulated Industries Practice Group. For additional articles and postings concerning this and related topics, please refer to Sheppard Mullin's Government Contracts Blog, which can be found at www.governmentcontractslawblog.com.

On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Tax Act of 2009 ("the Act" or "the Stimulus Bill") (P.L. 111-5) (H.R. 1). As widely reported in the media, the Stimulus Bill includes approximately $787 Billion in government spending and tax cuts. With regard to the government spending provisions (Division A of the Act, which appropriates approximately $520 Billion), the U.S. Government (as well as the State and local governments receiving this money) will disburse the funds through a number of different vehicles – namely government contracts, grants, cooperative agreements, and other transactions. The legislation is intended to deal with, on an expedited basis, economic conditions that many Americans have not experienced in their lifetimes and for which they want an accelerated cure. Those familiar with the federal acquisition and grant processes, however, know that immediacy is not built into those processes. Moreover, to the extent that the “need for speed” overtakes process, recipients of the funds will almost assuredly find themselves downrange from one of the most rigorous oversight regimes ever enacted. Companies, and even States and localities – should familiarize themselves with the full terms of the Faustian bargain they will be striking.

Traditional Government contractors are familiar with the rigorous oversight to which they have been customarily subjected by federal instrumentalities such as the Defense Contract Audit Agency, the Inspectors General, the Government Accountability Office, the Department of Justice and, of course, the armies of potential whistleblowers who are continually encouraged by the prospect of a hefty “finder’s fee” for bringing contractors to the bar of justice under the auspices of the qui tam provisions of the False Claims Act (31 U.S.C. §§ 3729-3731). However, non-traditional Government contractors (who may well be the bulk of companies pursuing the new Stimulus money) would be well advised to review the Stimulus Bill carefully before seeking financial stimulation, because – to quote the legendary Al Jolson – “You ain’t seen nothing yet.” Even traditional Government contractors – particularly those operating outside of the classified and Department of Homeland Security arenas – may find the panoply of oversight mechanisms to be startling:

Inspectors General. The Act appropriates over $200 million for the various agency Inspectors General. Unsurprisingly, Sections 1514 and 1515 require the IG to investigate allegations of wrongdoing and to examine the records of every contractor, grantee, subcontractor and subgrantee, and any State or local agency administering the affected contracts, subcontracts, grants and subgrants. But the mandate transcends traditional “audit” practice (which has traditionally accorded only a right to review company records) and accords the IG a statutory right to something for which DCAA has been arguing for years, i.e., the right “to interview any employee of the contractor, grantee, subgrantee, or agency regarding such transactions.”
GAO Investigations. Section 901 requires the GAO to conduct ongoing oversight regarding the use of Stimulus dollars, and to issue reports accordingly. Section 902 requires all individuals receiving Stimulus money to agree to GAO audit access – access to records and, again, the right to interview employees at all tiers in the transaction hierarchy.
The “Recovery Accountability and Transparency Board.” This new oversight Board – most assuredly to live in acronym history as the “RAT” Board – has the express mission of coordinating and conducting “oversight of covered funds to prevent fraud, waste and abuse.” The charter of the RAT Board is incredibly broad. For instance, it can:
- Issue “flash reports” – yes, that is the language of the statute – to the President and Congress on pressing management and funding problems that require immediate attention. This, of course, is in addition to whatever non-“flash” reports the Board may consider “appropriate” from time to time.
- Submit quarterly reports to the same recipients that summarize the findings of the RAT Board and of the Inspectors General of the various agencies. These reports, of course, are also in addition to the “flash reports” and any other “appropriate” reports the Board may elect to submit.
- Then there will be the mandatory “annual report” of the RAT Board. Contractors, subcontractors, grantees, subgrantees, and State and local authorities can take comfort in the statutory provision that allows – but does not mandate – the redaction of information that would not be subject to disclosure under FOIA from publicly available copies of any RAT Board reports.
- In the time left to it after preparing all these reports, the RAT Board is also empowered to conduct its own independent audits and reviews and to collaborate with IG investigations. The Board has the power to issue subpoenas to compel the testimony of non-Federal officers and employees, to hold public hearings, to compel testimony at those public hearings, and to “contract” out in support of its oversight functions.
- The Board will also provide transparency to its functions by establishing a website that will include findings from audits, as well as Inspectors General and GAO investigations – somewhat akin to a 21^st Century electronic version of the public stocks used to punish and embarrass reprobates in Puritan New England, albeit in advance here of any adversarial process to resolve factual disagreements.

To complement – or perhaps to "stimulate" – all of the Government reports that will be generated in connection with the above-described oversight functions, Section 1512 of the Stimulus Bill also requires companies and States that receive Stimulus dollars directly from the Government to provide detailed quarterly reports on how the money was spent. This does not appear to apply to companies who receive money from prime contractors or from a State recipient of the Stimulus funds.

All of this oversight comes with three purposes – to deter, detect, and punish “fraud, waste and abuse.” Government contractors are well aware of how and with what effect the Government pursues these purposes and, given the political climate of the day and the unrest within the electorate, one need not overwork the imagination to envision the relish with which federal enforcement hierarchies will enlist in the crusade. They will be well armed. For instance:

Criminal False Statements (18 U.S.C. § 1001). There will be many, many interviews, and many, many opportunities for lies, half truths and obfuscation. Miguel Tejada of the Houston Astros recently learned in connection with the Congressional inquiry into steroid use, as did Martha Stewart and so many before them, that it often is not the initially threatened allegation that gets you – “it’s the cover up.” Section 1001 is a powerful enforcement tool in the Government's arsenal.
The Civil False Claims Act (31 U.S.C. §§ 3729-3731). The FCA imposes treble damages and penalties on individuals and companies that “knowingly” (which does not have the meaning most would attribute to it in everyday parlance) submit false claims to the Government for payment. FCA liability is a huge club in the Government's "compliance tool box" to ensure that companies do not misuse federal dollars. Senator Charles Grassley has already encouraged the Government to vigorously pursue FCA actions against companies that fraudulently obtain Stimulus support. The applicability of the FCA to stimulus transactions is a complicated issue that is beyond the scope of this article, but one should expect it to be a heavily litigated issue, raising a number of questions left unresolved by the Supreme Court’s 2008 decision in Allison Engine (discussed here).
Whistleblower Protections. Section 1553 prohibits any type of discrimination or recrimination against an employee that "reasonably believes" that Stimulus funds may have been improperly used. Traditional government contractors are well familiar with whistleblower protections, but the Section 1553 requirements may catch other non-traditional contractors off guard. Remember that these provisions are broadly construed, and that the IG has the right to investigate any such claims of discrimination if requested by the whistleblower. What this means is that, regardless of whether a whistleblower has a "legitimate" basis for complaining, the down-side risk (including an IG and DOJ investigation) forces companies into a proactive position where they must ensure that they are treating all whistleblowers (potential or actual) with respect and providing even-handed treatment.

If you are one of the many, many companies contemplating the chase for Stimulus Dollars, you are well advised to remember the good Dr. Faustus – every deal that we strike, every agreement into which we enter, comes at a price. You will live in a proverbial fishbowl. Be prepared – understand the risks, understand the burden you undertake to withstand that scrutiny, and put in place a system of internal controls that you can defend without qualification when the IG, the GAO, the RAT Board, casual viewers of your company website, and the Fourth Estate – come knocking on your door to find out where that money went, and why.

For further information concerning our Government Contracts Practice, contact our Practice Group Leaders, Bryan Daly in Los Angeles at (213) 617-5466 and Anne Perry in Washington, D.C. at (202) 218-6875.

Authored by:

John W. Chierichella
(202) 218-6878
jchierichella@sheppardmullin.com

and

David S. Gallacher
(202) 218-0033
dgallacher@sheppardmullin.com