Construction & Infrastructure Law Blog

Federal Courts Overrule GAO and Require Reinstatement of Low Bidder

Sheppard Mullin — Tue, 24 Jan 2012 14:19:01 -0800

Contractors who file a bid protest challenging a federal contract award can do so in one of three forums: (1) the agency whose procurement decision is being challenged; (2) the Government Accountability Office ("GAO"); or (3) the Court of Federal Claims ("COFC"). Many federal contractors choose to file protests with the GAO because the GAO represents the middle ground between an agency-level protest and a COFC protest. Typically, a protestor wants to avoid filing a protest in the very agency whose conduct is being protested and wants to avoid the time an expense of filing a protest with the COFC. Additionally, although GAO decisions are non-binding, they have almost always been fully implemented by the Contracting Officer ("CO") of the applicable agency and have traditionally been given a high level of deference by the COFC. However, a case decided by the COFC this past year may signal the deterioration of high deference afforded to GAO decisions.

In Turner Construction Co., Inc. v United States, 645 F.3d 1377 (Fed. Cir. 2011) ("Turner II"), the United States Court of Appeals for the Federal Circuit affirmed the Court of Federal Claims' ("COFC") decision in Turner Construction Co., Inc. v. United States, 94 Fed.Cl. 561 (2010) ("Turner I") that a GAO bid protest recommendation was irrational. The COFC held that the GAO's recommendation that Turner Construction Co. ("Turner") be disqualified as the awardee on the basis of organizational conflicts of interest ("OCI") under an Army hospital renovation contract was unreasonable.

Specifically, the COFC found that the GAO had failed to meaningfully consider the contracting officer's ("CO") findings and substituted its own judgment for that of the CO's by determining that the record indicated that there was an OCI due to merger discussions between Turner's design subcontractor and the parent company of the Army's design consultant that gave Turner an unfair advantage.

Of significance was the COFC's determination that the CO complied with FAR requirements 9.504(a)(1) and (2), which require a CO to (1) identify and evaluate potential organizational conflicts of interest as early in the acquisition process as possible and (2) avoid, neutralize, or mitigate significant potential conflicts before contract award, even though the CO had not conducted a documented investigation into whether OCIs existed prior to the award. Additionally, the COFC held that "hard facts" and not suspicion and innuendo are needed to show the existence of an OCI, and that the GAO had only inferred the existence of an OCI and the harm arising therefrom.

In Turner II, the court affirmed the COFC's finding that the GAO irrationally refused to follow the CO's fact-based conclusion that no OCI existed. The court further held that the COFC properly ordered the Army to restore the contract with Turner based on the COFC's broad equitable powers to fashion appropriate remedies. Sheppard Mullin's Government Contracts Group previously discussed Turner I in A Retreat From Hard Line OCI Decisions? The COFC Overturns A Controversial GAO Ruling.

Turner II is a reminder that the COFC has the independent jurisdiction to review underlying procurement decisions, as well as GAO decisions, even when the GAO recommends that an agency take corrective action. In the Turner cases, the Army was required to restore Turner's contract, even though the Army had previously followed the GAO's recommendation to rescind the contract. The Turner cases may signal a shift in the Federal Courts to give more weight to the CO's decision on a bid protest and less weight to the GAO's recommendations.

Bram Hanono is an attorney in Sheppard Mullin's San Francisco office, and a member of the firm's Construction Industry Team.

Arbitrators can decide validity of arbitration provision in construction contracts

Sheppard Mullin — Fri, 02 Dec 2011 14:57:38 -0800

By Edward Lozowicki and Robert Sturgeon

Binding arbitration of construction disputes is frequently required by standard industry contracts. For example, the contract forms published by the American Institute of Architects either require or provide an option for arbitration under the Construction Industry Rules of the American Arbitration Association ("AAA"). The latter rules authorize the arbitrator to decide whether the contractual arbitration agreement is enforceable. (See, e.g. Rule 9 of AAA Construction Industry Rules). However some courts have decided this issue should be determined by the courts, rather than the arbitrator.

But a recent Supreme Court decision determined that an arbitrator can decide enforceability issues if the arbitration clause expressly provides such authority, similar to the AAA Rule 9. In Rent-A-Center West, Inc. v. Jackson, the United States Supreme Court held in a 5-4 decision that under the Federal Arbitration Act ("FAA"), a contractual arbitration clause which "clearly and unmistakably" delegates to the arbitrator the authority to determine the validity of the arbitration agreement is enforceable and binding on the parties, and that the issue is not to be decided by the court. In doing so, the Supreme Court reversed the prior ruling of the Ninth Circuit Court of Appeals, which had held that it is for the court and not the arbitrator to decide whether the arbitration agreement is valid and enforceable in the first instance. 130 S. Ct. 2772, 177 L. Ed. 2d 403 (2010)

Plaintiff Jackson was a former employee of Rent-A-Center who had sued for employment discrimination under state and federal law. In the course of his employment, Jackson and Rent-A-Center had signed a Mutual Agreement to Arbitrate Claims ("Agreement") which stated called for arbitration of all disputes arising out of Jackson's employment. The Agreement also provided that the "Arbitrator, and not any federal, state or local court or agency, shall have exclusive authority to resolve any dispute relating to the interpretation, applicability, enforceability or formation of this Agreement including . . . any claim that all of part of this Agreement is void or voidable." The trial court ruled that based on the Agreement, it was for the arbitrator to decide whether the agreement was unconscionable and unenforceable, and therefore ordered that the case proceed in arbitration rather than court. On appeal the Ninth Circuit reversed and ruled that, as the plaintiff contended he did not consent to the contract as a whole, the question of whether he consented to the arbitration agreement contained within the contract was a question for the court, not the arbitrator.

In reversing the decision of the Ninth Circuit, the majority of the Supreme Court focused on its prior decision in Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 87 Sup. Ct. 1801, 18 L.Ed.2d 1270 (1967). In Prima Paint, the Court had held that under § 2 of the FAA, an arbitration agreement in a contract is "severable" and may be enforced by a federal court even if the balance of the contract is unenforceable. In Rent-A-Center, the majority relied on Prima Paint to focus its inquiry on the procedural issues in the case. The Court emphasized that Jackson had challenged the contract as a whole on the ground that it was unconscionable, but that he had not raised a specific challenge in the trial court to agreement allowing the arbitrator rather than the court to decide whether the arbitration provision was enforceable. It further relied on the fact that Jackson's reasoning for why the contract was unconscionable focused on the contract as a whole, and that Jackson did not specify grounds as to why the specific agreement to delegate the decision to the arbitrator was unconscionable.

The Court explained that although "agreements to arbitrate are severable," that "does not mean that they are unassailable. If a party challenges the validity under § 2 of the precise agreement to arbitrate at issue, the federal court must consider the challenge before ordering compliance with that agreement under § 4" of the FAA. 130 S. Ct. 2778. The Court then noted that the "District Court correctly concluded that Jackson challenged only the validity of the contract as a whole," not specifically the validity of the agreement to allow the arbitrator to decided the validity of the agreement. 130 S. Ct. at 2779. Jackson had argued that fee-sharing procedures and discovery limitations in the agreement rendered it unconscionable. But the Court concluded that because "Jackson . . . did not make any arguments specific to the delegation provision; [but instead] he argued that the fee-sharing and discovery procedures rendered the entire Agreement invalid," his challenge was procedurally insufficient to invoke federal court review of the enforceability of the delegation provision. 130 S. Ct. at 2780.

Many construction contracts involve use of materials purchased in interstate commerce, and the FAA is therefore often applicable to arbitration provisions in such contracts, Allied Bruce Terminix Cos. Inc. v. Dobson, 513 U.S. 265, 115 S. Ct. 834 (1995). Contractors and developers who wish to preserve the right to judicial review of the enforceability of an arbitration delegation provision should first ensure the language of the contract is clear that the court and not an arbitrator is to decide issues of enforceability of the arbitration agreement. On the other hand, if a party wishes to challenge such an agreement, it must be careful to satisfy the procedural requirements. First, it must raise a specific challenge to the agreement to allow the arbitrator to decide the validity of the contract, not merely a challenge the general enforceability of the contract as a whole. Second, the party must support the challenge with reasons why the agreement to allow the arbitrator to decide the issue is unconscionable (or otherwise invalid), not merely reasons why the contract as a whole is unconscionable.

Authored By:

Edward Lozowicki and Robert Sturgeon

Public Private Partnership Upheld For Construction of Presidio Parkway

Sheppard Mullin — Wed, 07 Sep 2011 09:37:05 -0800

By Edward Lozowicki and Robyn Christo

In 2009, the California legislature amended Section 143 of the Streets and Highways Code and greatly expanded availability of the public-private partnership ("P3") as a mechanism to finance transportation infrastructure projects. In early 2010, under the authority of the newly amended Section 143, the California Department of Transportation ("CalTrans") began to implement part of the Presidio Parkway Project ("Project") as a P3.

The two-phase Project involves replacement of the 75-year-old, seismically-deficient southern approach to the Golden Gate Bridge (also known as Doyle Drive). Phase I (which is currently underway) will be delivered via a traditional design-bid-build model. Phase II, however, is set to be financed and constructed through a P3 contract between CalTrans and its selected bidder, Golden Link Partners.

The process of implementing Phase II as a P3 was attacked on November 2, 2010, when Professional Engineers in California Government (“PECG”) (a union representing state-employed engineers and other professionals) challenged the P3 as violating various provisions of Section 143.

PECG’s combined petition for writ of mandate and complaint for declaratory and injunctive relief was dismissed at the trial level and PECG appealed. The appeal was expedited (so as not to delay the Project or interfere with CalTrans’ negotiated rights of entry on surrounding federal land) and, on August 8, 2011, the Court issued a succinct opinion, in which it rejected all three of PECG’s arguments employing basic canons of statutory construction. Professional Engineers in California Government v. Department of Transportation (2011) 198 Cal.App.4th 17.

PECG first argued that the P3 was invalid because CalTrans was not acting as the “responsible agency” as required by Section 143(f)(1)(A). PECG argued that because CalTrans did not actually perform preliminary (i.e., pre-P3) engineering work on the Project (consultants did) it could not be the responsible agency. The Court employed a “common sense” reading of the statute and determined that CalTrans was only required to be responsible for the work, not to actually perform the work. Furthermore, the Court found it “unreasonable to invalidate an earlier phase of a lengthy, ongoing project because of a change in the law meant to enhance and encourage such projects.”

PECG next argued that the Project did not qualify as a P3 because it would rehabilitate or reconstruct an existing facility and not "supplement an existing facility" as required by Section 143(a)(6). The Court agreed that Section 143 does require a project to supplement existing facilities. Because the Project involves a series of supplemental new improvements to existing facilities, however, it meets this requirement “under any standard definition.”

Finally, PECG argued that in order to be a valid P3, the Project must “require” funding through tolls and user fees. The argument stemmed from language found in Section 143(j)(1), which provides that P3 agreements “shall authorize” the imposition of tolls and user fees and “shall require” that such authorized fees be applied to payment of various costs. The Court quickly rejected this argument, finding that “the clause providing [that] P3 agreements ‘shall require’ [] any toll revenues be used to defray certain costs . . . falls short of requiring the use of tolls and user fees as a necessary funding element or the sole funding source in every P3.”

Comment: This is the first appellate case construing Senate Bill 2X4 (2010) which greatly expanded authority for the state of California and regional transportation agencies to utilize P3 agreements. Most significant is the Court's holding that tolls or user fees are not required. This opens the door for public agencies to use creative financing techniques such as availability payments or lease provisions to pay the P3 entity for the project's costs.

Authored By:

Edward Lozowicki and Robyn Christo

Construction Arbitration Clause Calling for Expanded Judicial Review Must be Explicit and Unambiguous

Sheppard Mullin — Thu, 28 Jul 2011 11:00:33 -0800

By Robert Sturgeon

Parties to construction arbitrations who are disappointed with the arbitrator's award are often doubly-disappointed to learn that they have very little chance of successfully appealing in a court to overturn the arbitrator's decision. Because arbitration is intended to be a final and complete alternative dispute resolution process, judicial review of the arbitrator's award is quite limited. Ordinarily a court may not review the merits of the dispute, or overturn an arbitration award on ground that the arbitrator made legal errors or erred in applying the law to the facts. In general, a court is authorized to overturn an arbitration award only where (i) the award was procured by corruption or fraud; (ii) there was corruption or misconduct by the arbitrator, (iii) the arbitrator exceeded his or her powers, (iv) the arbitrator refused to postpone the hearing despite there being good cause to do so and that prejudices the parties, or (v) the arbitrator failed to disclose potential grounds on which he or she could be disqualified or refused to disqualify himself when there was cause to do so. See, e.g., Cal. Civ. Proc. Code 1286.2.

To expand the scope of judicial review beyond these parameters and obtain something akin to an ordinary right of appeal, parties have attempted to "contract around" the statutory provisions, and have included language in their arbitration agreements providing for appeal or judicial review of the substance of the arbitrator's decision. In a recent decision, the California Court of Appeal held that to be enforceable, an agreement for expanded scope of judicial review of the arbitrator's award must be explicit and unambiguous, and language in the arbitration agreement stating that the arbitrator must render an award "in accordance with substantive California law" is not sufficient. Gravillis v. Coldwell Banker Residential Brokerage Company, 182 Cal. App. 4th 503 (2010).

In Gravillis, the plaintiff had purchased a home using a standard form California purchase agreement which included a clause requiring arbitration of any disputes arising out of the agreement. The arbitration clause stated that the arbitrator "shall render an award in accordance with substantive California law." 182 Cal. App. 4th at 508. Before he moved into the home, plaintiff discovered it had extensive structural damage which left it essentially uninhabitable. Plaintiff filed a lawsuit in court against his real estate brokers for failing to disclose the structural defects. Based on the arbitration clause in the purchase agreement, the trial court ordered the case to arbitration. After a hearing, the arbitrator issued an award in favor of the plaintiff and awarded him damages and costs. The brokers petitioned the court to vacate the award, contending that the arbitrator had made substantive legal errors by (i) finding the brokers had breached a fiduciary duty to plaintiff, (ii) awarding the plaintiff "benefit of the bargain damages" rather than "out of pocket expense" damages; and (iii) awarding the plaintiff his costs incurred in the arbitration. The trial court denied the brokers' petition, and the brokers appealed. On appeal, the brokers asserted they were not subject to the general rule or non-reviewability, but were entitled to have the award overturned on the merits based on the arbitrator's legal errors because the arbitration agreement stated that the arbitrator was required to render an award "in accordance with substantive California law."

The Court of Appeal first emphasized the reasoning underlying the general rule -- because parties to arbitration have a right to expect the arbitration will be a final and binding resolution of their dispute, as a general matter, "the merits of the controversy between the parties [in arbitration] are not subject to judicial review," and the "courts will not review the validity of the arbitrator's reasoning." 182 Cal. App. 4th at 514. The brokers argued that because the arbitrator had made legal errors which were "not in accord with substantive California law," the arbitrator had "exceeded his powers" within the meaning of Code of Civil Procedure § 1286.2, and therefore the award could be vacated under the statutory provisions. The Court of Appeal rejected this contention, explaining that an arbitrator exceeds his or her powers when the arbitrator acts without subject matter jurisdiction, decides an issue that was not submitted to arbitration, upholds an illegal contract, issues an award that violates a statutory right or well-defined public policy, or selects a remedy that is not authorized by law or rationally related to the contract. 182 Cal. App. 4th at 511. The court held that the language requiring the award be "in accordance with substantive California law" was not sufficient to convert ordinary legal errors of the sort alleged by the brokers into acts in excess of the arbitrator's powers.

The court further explained that while California law allows parties to cases governed by the California Arbitration Act to contract for expanded judicial review, because a main purpose of arbitration is to avoid the judicial process, the bar for allowing expanded judicial review of the award is high. First, the arbitration agreement must be governed by the California Arbitration Act rather than the Federal Arbitration Act ("FAA") -- federal law does not allow parties to contract for an expanded scope of judicial review. 182 Cal. App. 4th at 518; Hall Street Associates LLC v. Mattel, Inc. (2008) 552 U.S. 576. Thus, for example, if the agreement states elsewhere that it is governed by the FAA, it will not qualify for expanded judicial review. Second, "to take themselves out of the general rule that the merits of the award are not subject to judicial review, the parties must clearly agree that legal errors are an excess of arbitral authority that is reviewable by the courts." 182 Cal. App. 4th at 516 (quoting Cable Connection, 44 Cal. 4th at 1361). Hence, an arbitration agreement which states that "[t]he arbitrators shall not have the power to commit errors of law or legal reasoning, and the award may be vacated or corrected on appeal to a court of competent jurisdiction for any such error" is sufficient to allow for judicial review of the substance of the award under California law. Cable Connection, Inc. v. DIRECTV, Inc., 44 Cal. 4th 1334, 1342 n. 3 (2008).

However, language in an arbitration agreement requiring that the arbitrator render an award "in accordance with substantive California law" does not meet that standard. That language does not expressly deprive the arbitrator of the power to commit legal error, nor does it expressly and unambiguously authorize a court to review the award for legal or other substantive error. Id. at 518-519. PRACTICE TIP: Contractors and developers seeking expanded judicial review of the award should include language in their contracts stating that the arbitrators do not have the power to commit errors of law, that the award can be vacated for such errors, and that arbitration is to be governed by the California Arbitration Act.

Authored By:

Robert Sturgeon

"Good Faith" In Prompt Payment Disputes

Sheppard Mullin — Fri, 24 Jun 2011 08:51:43 -0800

By Candace L. Matson

In California, the payment of contractors is governed by so-called "prompt payment statutes" which are sprinkled through various legislative codes, and which impose sanctions on the paying party for non-compliance. Progress payments by general contractors to their subcontractors on private and most public works of improvement are governed by section 7108.5 of the Business & Professions Code. Retention payments to subcontractors on public works of improvement are governed by section 7107 of the Public Contracts Code, and on private works of improvement by section 3260 of the Civil Code. In some cases the statutes permit withholding of payments only where there is a "good faith" dispute. But what constitutes "good faith"?

All of these statutes provide that monies must be released to subcontractors within a certain time except under special circumstances, i.e., where a dispute is involved or where the parties agree to an alternative payment scheme. Thus, where there is a "good faith dispute over all or any portion of the amount due on a progress payment," the general may withhold up to 150 percent of the disputed amount. Bus. & Prof. Code § 7108.5(c) (emphasis supplied). On a public project, "if a bona fide dispute exists between the subcontractor and the original contractor" the latter may withhold from retention up to 150 percent of the estimated value of the disputed amount. Cal. Pub. Cont. Code § 7107(e) (emphasis supplied). And on a private project, if "a bona fide dispute exists between a subcontractor and the original contractor, the original contractor may withhold from that subcontractor with whom the dispute exists its portion of the retention proceeds . . . [not to] exceed 150 percent of the estimated value of the disputed amount." Cal. Civ. Code § 3260(e) (emphasis supplied). Hence, a key factor as to when monies may be withheld from a subcontractor without exposing the general contractor to sanctions is whether there is a bona fide or good faith dispute between the parties.

The case of Alpha Mechanical, Heating & Air Conditioning, Inc. v. Travelers Casualty & Surety Company of America, 133 Cal. App. 4th 1319 (4th Dist. 2005) was the first to expressly examine what constitutes a "good faith dispute" on a private work of improvement under Bus. & Prof. Code § 7108.5 and Civ. Code 3260. In that case, the court observed that "the phrase 'good faith' does have a distinct meaning and purpose in the law" (id., at 1339) and "suggests a moral quality; its absence is equated with dishonesty, deceit or unfaithfulness to duty," Guntert v. City of Stockton, 43 Cal. App. 3d. 203, 211 (1974) (citation omitted), or "that state of mind denoting honesty of purpose, freedom from intention to defraud, and, generally speaking, means being faithful to one's duty or obligation." People v. Nunn, 46 Cal. 2d 460, 468 (1956). The court noted the comments of another authority: "Good faith, or its absence, involves a factual inquiry into the plaintiff's subjective state of mind. [Citations] Did he or she believe the action was valid? What was his or her intent or purpose in pursuing it?" Knight v. City of Capitola, 4 Cal. App. 4th 918, 932 (1992).

In Alpha Mechanical, the general contractor did not make final payment because it alleged that the subcontractor did not correct work deemed defective by the owner and damaged the work of other trades - necessitating repair work for which the general would have to pay if the subcontractor did not. The appellate court found no evidence in the record suggesting that the general contractor "lack[ed] good faith in its belief that the dispute over the damage caused by Alpha justified withholding the remaining sums due it." Id., 133 Cal. App. 4th at 1340. Hence, the general contractor was not subject to penalties under either Bus. & Prof. Code § 7108.5 or Civ. Code 3260.

Alpha Mechanical involved a classic dispute over work performed under the contract. However, no such dispute was involved in the more recent case of Martin Brothers Construction, Inc. v. Thompson Pacific Construction, Inc., 179 Cal. App. 4th 1401 (3d Dist. 2009), involving a public work of improvement. Martin Brothers involved a dispute over changed work, specifically over additional compensation that the subcontractor contended was owed over and above the agreed contract price for work that was allegedly outside the scope of the contract. The subcontractor sought to recover penalties under Public Contract Code section 7107 for the general's failure to release retention. The appellate court in Martin Brothers held that the reference to "dispute" in section 7107 encompassed any dispute, so long as the dispute was bona fide. Hence, even though there was no dispute over the amount of retention owed under the contract, the court found the general was justified in withholding retention while the change order dispute was pending.[1] The court's holding in Martin Brothers was surprising to many observers because it allowed the general contractor to withhold undisputed sums solely due to a dispute over whether additional sums were owed. Alpha Mechanical and Martin Brothers constitute a very broad reading of what can constitute a bona fide dispute and suggest that nearly any dispute, so long as it is genuinely believed to exist, can enable a general contractor to withhold undisputed amounts owing from a subcontractor.

That approach was flatly rejected this year in FEI Enterprises, Inc. v. Yoon, B209862 (2d Dist. 2011), certified for partial publication. In the published portion of this opinion, the appellate court addressed the good faith dispute exception to the prompt payment requirement set forth in section 7108.5 of the Business & Professions Code (which the court noted contains similar language to that found in sections 7107 and 10262.5 of the Public Contract Code and section 3260 of the Civil Code). The court rejected the subjective standard invoked by the Alpha Mechanical court, stating "that decision did not make a proper analysis of the meaning of the term "good faith dispute" as it is used in section 7108.5." It explained that the court in Alpha Mechanical essentially converted the "good faith dispute" language into a "good faith belief" standard. This court found such a standard to be "unwarranted and unwise." Instead, unless the factual circumstances dictate otherwise, an objective, "reasonable person" standard should be used to determine whether a payment from a contractor to a subcontractor is subject to a "good faith dispute" under the prompt payment statute.

Hence, there are now two cases, in the third and fourth districts respectively, which apply a subjective standard to the question of whether a good faith dispute exists to excuse prompt payment and one case in the second district which applies an objective standard to the question. PRACTICE TIP: If your client's dispute arise in one of the aforementioned districts, you can expect the court will most likely follow the precedent set by its own district. If the dispute arose in another district, it will be difficult to predict how a court would rule; hence, it is prudent to be conservative in recommending strategy and predicting outcomes.

Authored By:

Candace L. Matson

[1] Martin Brothers also sought to recover penalties under Bus. & Prof. Code § 7108.5 for Thompson’s failure to make timely progress payments. The court found that the parties had agreed to an alternative payment scheme by the terms of their subcontract in which payment was expressly “not due until Subcontractor has furnished . . . applicable [lien] releases pursuant to Civil Code section 3262.” Since section 7108.5 allows parties to “opt out” of its requirements via written agreement, and since Martin Brothers had not timely submitted the required lien releases, the court held that Thompson did not violate the prompt payment statute in failing to make a progress payment under the time constraints of the statute. Id., 179 Cal. App. 4th at 1415. PRACTICE TIP: Subcontractors should take steps to assure that lien waivers, if required by the subcontract, are timely submitted with each invoice for progress payment.

Developers Must Pay Prevailing Wages for Privately Financed Public Infrastructure

Sheppard Mullin — Wed, 08 Jun 2011 10:57:36 -0800

By Bram Hanono and Greg Woodard

California Labor Code sections 1720 et seq. (the Prevailing Wage Law) ("PWL") require employers (including developers and contractors) engaged in public works projects to pay the prevailing wage to their employees if the project is "paid for in whole or in part out of public funds." The Second Appellate District Court of Appeal recently ruled that private developers must pay prevailing wages for the construction of all public improvements in connection with a development project if public funds are used to finance any part of the public improvements, even if the remaining public improvements are paid for with private funds. The California Supreme Court declined to hear the developer's appeal. Therefore, developers and contractors could face increased project costs as a result of this case.

Background & Summary

In Azusa Land Partners v. Department of Industrial Relations, 191 Cal.App.4th 1 (2010), the developer proposed a master planned 500+ acre development that included up to 1,200 homes, 50,000 square feet of commercial, and public infrastructure and improvements. To obtain the City of Azusa's approval, the developer agreed to public infrastructure and improvement work, including construction of a public school and park, freight under-crossings, sanitation district facilities, and street, bridge, storm drain, sewer, water, utilities, park and landscaping improvements. The public improvements were to be funded by Mello-Roos bonds which were approved for indebtedness of up to $120 million to be incurred by the Community Facilities District ("CFD"). The developer was required to construct the public improvements even if the actual costs exceeded the amount of bond funds sold by the CFD for the improvements. The total cost of the public improvements was approximately $146 million but the CFD only sold $71 million in bonds, leaving the developer on the hook for the remaining $75 million.

A third party requested an inquiry into whether the entire project was a "public work" subject to the PWL. "Public works" is broadly defined by the PWL and includes work "paid for in whole or in part out of public funds." The Department of Industrial Relations (the "Department"), which was charged with the review, determined that even though the project was only partly funded with public funds, the entire project was nevertheless a public work and subject to the PWL. However, the Department also found prevailing wage did not have to be paid on the entire project because the project met an exemption in the PWL (Labor Code section 1720(c)(2)) that required prevailing wage only for those public infrastructure improvements in the project required as a condition of regulatory approval. Accordingly, the developer had to pay prevailing wage for all those public improvements even though some were in fact privately funded due to the shortfall in CFD funding. The developer appealed, but the Department upheld its initial determination, meaning prevailing wage had to be paid for all of the public improvements.

The developer filed a petition for writ of mandate in superior court and the trial court denied the petition. On appeal, the developer argued it should only be required to pay prevailing wage for the public improvements actually financed with the Mello-Roos bond proceeds and not for privately funded infrastructure improvements for which no bond proceeds were received – the developer was seeking a more narrow interpretation under section 1720(c)(2) of the PWL.

The Court of Appeal disagreed with the developer. First, the court held that under the PWL, the entire project was a "public work" because the project was funded in part through public funds. Second, the court held that under the PWL, the Mello-Roos bond proceeds constituted public funds. Finally, the court rejected the developer's argument that even if the project was subject to the PWL, it should only be required to pay prevailing wage for the public improvements that were built with Mello-Roos bonds, and not any public improvements constructed at private expense. Instead, the Court of Appeal agreed with the Department and the trial court, interpreting the PWL to apply to all public improvements, regardless of whether or not they were paid for with Mello-Roos bonds.

On March 2, 2011, the California Supreme Court declined to hear the developer's appeal. As a result, the developer will be required to pay prevailing wage on the entire $146 million cost for the project's public improvements, including the $75 million in public improvements which it privately financed.

Comment

Going forward, developers and contractors may be required to pay prevailing wage on the entire build-out of public improvements, even if the development is mostly privately financed and privately owned. This means each party should carefully determine in their development and construction contracts whether prevailing wage rules apply and which party will pay the increased costs.

Authored By:

Bram Hanono & Gregory E. Woodard

The Year 2010 In Review: Safety and Personal Injury Developments

Sheppard Mullin — Thu, 28 Apr 2011 10:14:40 -0800

This article is the eighth, and final, in a series summarizing construction law developments for 2010.

By Candace Matson, Harold Hamersmith & Helen Lauderdale

Tverberg v. Fillner Construction, Inc., 49 Cal. 4th 518 (June 2010)

The peculiar risk doctrine is a judicially created exception to the common law rule that a person hiring an independent contractor to perform inherently dangerous work is generally not liable to third parties for injuries resulting from the work. Courts initially used the peculiar risk doctrine to impose upon landowners vicarious liability for the acts of their independent contractors when certain third parties – innocent bystanders or neighboring property owners – were injured by the contractors' work. It was not until courts expanded the doctrine to include another category of third parties, the employees of the independent contractors, that the Supreme Court stepped in to curtail the exception. In Privette v. Superior Court, 5 Cal. 4th 689 (1993), the Supreme Court held that a hirer of an independent contractor is not vicariously liable to the employees of the independent contractor for injuries caused by risks inherent in the work the contractor was hired to perform.

In Tverberg, the Supreme Court seized the opportunity to resolve a conflict within the Courts of Appeal regarding whether the hirer of an independent contract is vicariously liable to the contractor for the contractor's own injuries resulting from a risk inherent in the work. The Court of Appeal in Michael v. Denbeste Transportation, Inc., 137 Cal. App. 4th 1082 (2005) held that the hirer was not liable to the independent contractor for the contractor's own injuries, while the Court of Appeal in Tverberg reached the opposite conclusion. The Tverberg court reasoned that the justification for the Privette decision was the availability of workers compensation for the injured employee. Because workers compensation would not always be available to the independent contractor, the Court of Appeal in Tverberg concluded that the independent contractor could seek recovery for injuries from the hirer.

The California Supreme Court reversed the Court of Appeal and barred the independent contractor's claim against the hirer for injuries caused by the inherently dangerous jobsite conditions. The Supreme Court explained that the outcome in Privette and other decisions disallowing claims was not determined by the availability of workers compensation to the injured person. Instead, the analysis depended on the delegated responsibility for maintaining jobsite safety. A hired independent contractor who is injured by risks inherent in the hired work, after having assumed responsibility for all safety precautions reasonably necessary to perform the work safely, is not an innocent third party deserving of compensation under the peculiar risk doctrine. The doctrine of peculiar risk does not apply when the injured independent contractor seeks to hold a hirer vicariously liable for injuries caused by risks inherent in the work over which the independent contractor has been granted control.

Miranda v. Bomel Construction Co., 187 Cal. App. 4th 1326 (4th Dist. July 2010)

The plaintiff worked in an office next to a vacant lot, which for several months was used as the location of an uncovered stockpile for dirt excavated from a nearby construction project. Plaintiff contracted Valley Fever and filed a complaint for negligence against the general contractor that created the stockpile. The plaintiff alleged the contractor failed to cover the stockpile or otherwise contain dust from it, and that fungal spores carrying the pathogens that caused Valley Fever were released from the excavated soil that the contractor had negligently stored. The contractor successfully moved for summary judgment on the ground the plaintiff could not establish that the contractor had proximately caused the plaintiff's injury.

The Court of Appeal affirmed. While plaintiff produced ample evidence that the fungal spores that cause Valley Fever are contained in dirt throughout Southern California, can become airborne, and can be inhaled after dirt is excavated, plaintiff had no evidence that dirt from the stockpile contained the fungal spores or was the source of plaintiff's exposure to the disease. While plaintiff could speculate that the dirt stockpile was the source of the fungal spores that caused him to contract Valley Fever, he could not produce evidence that the stockpile (rather than all the other sources of airborne dust in Southern California) was a substantial factor in causing the disease.

Authored By:

Candace L. Matson, (213) 617-5489, is a partner in Sheppard Mullin's Los Angeles office where she specializes in construction law. Harold E. Hamersmith, (213) 617-4255, is a partner in the firm's Los Angeles office specializing in design and construction contracts, claims, and defects litigation, and public contract law. Helen J. Lauderdale, (213) 617-4138, is a special counsel specializing in construction litigation in Sheppard Mullin's Los Angeles office.

The Year 2010 In Review: Construction Insurance Issues

Sheppard Mullin — Wed, 20 Apr 2011 15:14:57 -0800

This article is the seventh in a series summarizing construction law developments for 2010.

By Candace Matson, Harold Hamersmith & Helen Lauderdale

Forecast Homes, Inc. v. Steadfast Insurance Co., 181 Cal. App. 4th 1466 (4th Dist. Jan. 2010), rev. denied, 2010 Cal. LEXIS 4356

A home developer, acting as a general contractor, hired subcontractors to build homes. The subcontracts all required the subcontractors to defend and hold the developer harmless against any liability arising out of their work and to add the developer to their commercial general liability policies as an additional insured. A construction defect litigation was brought against the developer, but not against the subcontractors. The developer tendered its defense to Steadfast Insurance Company, which insured many of the subcontractors and on whose policies the developer was an additional insured. The insurer refused the tender, maintaining that only the named insured subcontractors could satisfy the per occurrence self-insured retention ("SIR") amounts and none of the subcontractors had done so because they did not incur defense or indemnity costs in the litigation.

In a bench trial, the court concluded that the policies unambiguously allowed only the named insured, and not the developer, to satisfy the SIR obligation. The Court of Appeal affirmed, agreeing that the policy language of "you" and "your" means the named insured when read together with the provision that "you shall be responsible for payment of all damages and defense costs for each occurrence or offense until you have paid self-insured retention amounts and defense costs equal to the per occurrence amount shown in the endorsement." The words "or any insured" in the definition of the SIR, did not create ambiguity as to who may pay the SIR; rather it was intended to define what amounts and expenses qualify for the named insured's SIR payment. As to the public policy argument raised by the developer, the Court stressed that the subcontractors, not the developer, formed the insurance contracts and that the subcontractors may have wanted to control the exhaustion of the SIR. Further, the policy's restriction on who may pay the SIR did not render the developer's coverage illusory. In conclusion, it is not against public policy for a commercial general liability policy to provide that the additional insured may not pay the SIR in order to trigger coverage.

Interstate Fire and Casualty Insurance Co. v. Cleveland Wrecking Co., 182 Cal. App. 4th 23 (1st Dist. Feb. 2010)

A general contactor entered into subcontracts with Delta and Cleveland, pursuant to which each subcontractor agreed (i) to indemnify the general contractor for liability arising out of its work and to (ii) procure general liability insurance to which the general contractor would be an additional insured. Only Delta complied with the latter obligation, obtaining a commercial general liability policy from Interstate Fire and Casualty Insurance Company. During the performance of work, one of Delta's employees was injured by falling debris dislodged by Cleveland's operations. The employee filed suit against Delta, Cleveland and the general contractor. The general contractor tendered defense of the lawsuit to both subcontractors and to Interstate. Cleveland rejected the tender, but Interstate, pursuant to the Interstate-Delta policy, accepted it. The general contractor settled with the Delta employee and Interstate paid the settlement and attorney's fees. Cleveland also entered into a settlement with the Delta employee and obtained a good faith settlement determination.

Interstate filed a suit for subrogation against Cleveland for breach of contract in failing to defend and indemnify the general contractor. Cleveland demurred, contending that the good faith settlement cut off the general contractor's ability to sue for indemnity or contribution. The trial court sustained the demurrer, observing that the general contractor sustained no damages as a result of the breach and so had no claim.

The Court of Appeal reversed. The Court held that Interstate, standing in the shoes of an insured, could pursue a cause of action against Cleveland for breach of express contractual indemnification clause notwithstanding a good faith settlement determination. Another issue raised in the demurrer was the comparative equitable position of Cleveland and Interstate. The Court noted, that as an element of subrogation, Interstate must be in an equitable position superior to Cleveland in order to obtain subrogation. Addressing that issue, the Court found that Interstate and Delta had fulfilled their contractual obligations, whereas Cleveland had not. Accordingly, Interstate was in a superior equitable position as compared to Cleveland. Because the insurer was in a superior equitable position it stated a cause of action against Cleveland.

PMA Capital Insurance Co. v. American Safety Indemnity Co., 695 F. Supp. 2d 1124 (E.D. Cal. March 2010)

PMA Capital Insurance Company sued coinsurer American Safety Indemnity Company ("ASIC") for equitable contribution on the grounds that the coinsurer had a concurrent duty to defend a mutual insured in an underlying construction defect case. The parties cross- moved for summary judgment. The primary issue in the case was the definition of the term "occurrence" in the liability policy issued by the coinsurer. The District Court held that the term "occurrence" included only negligent work done by the insured that caused property damage. PMA could not establish that the occurrence, i.e., the insured's negligent work, occurred during the ASIC policy periods. Without negligent work by the insured during the policy period, PMA did not meet the burden of demonstrating potential for coverage under the ASIC policy. Accordingly, the District Court granted ASIC's motion for summary judgment.

Scottsdale Insurance Co. v. Century Surety Co., 182 Cal. App. 4th 1023 (2d Dist. March 2010)

Two insurers shared multiple construction subcontractors as mutual insureds. Frequently, Century Surety Co. would decline to participate in the defense and indemnity of the mutual insureds. Scottsdale Insurance Co. filed suit seeking equitable contribution with respect to over 300 underlying actions involving the mutual insureds. In allocating responsibility between the insurers, the trial court applied the following standard: "where someone's wrong has made it difficult to provide exact numbers as to loss or damage, plaintiff does not bear the burden of exactitude." The trial court concluded that Scottsdale could recover one-half of the amounts it paid on approximately 80 underlying claims.

On appeal, the Court held that when multiple insurance companies have a duty to defend a mutual insured in a legal action and one declines to participate in the defense, an insurer seeking equitable contribution from the non-participating insurer must prove that it paid more than its "fair share" of the defense and indemnity costs for the common insured. The insurer seeking equitable contribution also bears the burden of producing the evidence necessary to calculate a "fair share." One insurer cannot recover equitable contribution from another insurer for any amount that would result in the first insurer paying less than its "fair share" even if that means that the otherwise liable second insurer will have paid nothing. Because the trial court applied an incorrect standard, the Court of Appeal reversed and remanded the case for an allocation determination.

Pennsylvania General Insurance Co. v. American Safety Indemnity Co., 185 Cal. App. 4th 1515 (4th Dist. June 2010), rev. denied, 2010 Cal. App. LEXIS 11011

A framing subcontractor was insured by Pennsylvania General Insurance Company under a commercial general liability policy while performing work on an apartment construction project ("Project"). At the conclusion of the policy period, and after the subcontractor's work was completed, the subcontractor was issued a new commercial general liability policy by American Safety Indemnity Company ("ASIC"). The subcontractor was then sued in a construction defect suit involving the Project. The subcontractor tendered its defense to both Pennsylvania General and ASIC. Pennsylvania General accepted the tender of the defense and paid the subcontractor's defense and settlement costs. ASIC denied the subcontractor's tender and did not participate in defending or indemnifying the subcontractor, claiming that the allegedly defective work did not occur during the ASIC policy period. Pennsylvania General sued ASIC for equitable contribution for a portion of the defense and indemnity costs. The key issue was whether the trigger for coverage occurred within the ASIC policy period. The trial court concluded it did not and entered summary judgment for ASIC.

The Court of Appeal reversed. The Court noted that when construing insurance policies, ambiguities in coverage clauses must be resolved broadly in favor of coverage. The Court held that ASIC's policy, read as a whole, was reasonably susceptible to the interpretation that resulting damage, and not causal conduct, was a defining characteristic of the "occurrence" that must take place during the policy period to trigger coverage. Accordingly, it was error to grant summary judgment in ASIC's favor.

Clarendon America Insurance Co. v. North American Capacity Insurance Co., 186 Cal. App. 4th 556 (4th Dist. June 2010), reh'g denied, 2010 Cal. LEXIS 9459

A homebuilder was insured by two insurance companies, Clarendon America Insurance Company and North American Capacity Insurance Company ("NAC"). Clarendon sued NAC seeking proportionate or equitable share of sums Clarendon expended to defend the homebuilder in a construction defect class action. NAC moved for summary judgment on the ground that its duty to defend the homebuilder never materialized as the homebuilder never paid a $25,000 "per claim" self-insured retention for each of the homes involved in the class action completed after the effective date of the NAC policy. The trial court granted NAC's motion. The Court of Appeal reversed because, in light of other terms of the NAC policy and the circumstances surrounding the issuance of the policy, the homebuilder may have had an objectively reasonable expectation that the self-insured retention would apply to the class action as a whole rather than to each of the homes constructed after the policy was issued. NAC failed to show the homebuilder had no reasonable expectation of coverage or defense as a matter of law.

Clarendon America Insurance Co. v. StarNet Ins. Co., 186 Cal. App. 4th 1397 (4th Dist. Oct. 2010), rev. granted, 2010 LEXIS 11395

The developer of a residential housing development was served by the homeowners association with a Calderon Notice commencing an alternative dispute process which was a prerequisite to filing a complaint for construction defects. The developer sued Clarendon seeking payment of defense costs incurred in defending against the Calderon Notice. Clarendon, in turn, sued StarNet (the developer was an additional insured on both insurer’s policies). StarNet argued that the Calderon ADR proceedings did not consitute a “suit” within the meaning of its policy. The trial court disagreed and the appellate court affirmed. The latter applied the “literal meaning” approach (as opposed to the “functional equivalent” approach) to determine what constitutes a proceeding which triggers the defense obligation, as mandated by the California supreme court in Foster-Gardner, Inc. v. National Union Fire Ins. Co., 18 Cal. 4th 857 (1998). The court found that the Calderon Notice and ADR process is mandatory and “one part - the first step – in a continuous litigation process.” Therefore, it met the definition of “suit” in the StarNet policy. [This case was granted review, but further action was deferred pending consideration of the Ameron case discussed below.]

Arrowood Indemnity Company v. Travelers Indemnity Company of Connecticut, 188 Cal. App. 4th 1452 (2d Dist. Oct. 2010)

A general contractor held two CGL policies for different periods. The contractor was sued for negligence allegedly committed during the second policy period and the second insurer provided both defense and indemnity. The jury found the contractor was negligent, but it was not clear from the verdict whether it found the negligence to have occurred during the first policy period, the second policy period or both. The second insurer sued the first insurer for equitable contribution. The appellate court characterized this as a case of first impression: where one insurance has participated in the defense and/or indemnity of an insured and the other has not, which bears the burden of proving the existence or nonexistence of coverage? The court held that under such circumstances, the participating insurer meets its burden of proof when it makes a showing of coverage under the other insurer’s policy. The burden then shifts to the nonparticipating insurer to prove that, in fact, there is no coverage.

Ameron International Corp. v. Insurance Co. of the State of Penn., 50 Cal. 4th 1370 (Nov. 2010)

The insured was a subcontractor who manufactured and installed concrete siphons for an aqueduct project being performed for the US Dept. of the Interior Bureau of Reclamation. Long after the siphons were installed, they were discovered to be defective, and the Bureau’s contracting officer (“CO”) sought to recover $40M from the subcontractor for the continuous and progressive deterioration of the materials. Under the Contract Disputes Act of 1978, the insured subcontractor had the option to challenge the CO’s decision either by appealing the decision to the US Department of Interior Board of Contract Appeals (“IBCA”) or by bringing an action in the US Court of Federal Claims. The insured chose the former forum, and following 22 days of “trial,” settled the CO’s claim for $10M. The insured sought to recover the settlement and its defense costs from its liability insurers. The trial court ruled as a matter of law that none of the policies provided coverage, and the appellate court affirmed since the policies only obligated defense of “any suit . . . seeking damages” and indemnity for “all sums which the insured is legally obligated to pay as damages,” but did not define either “suit” or “damages.” The courts applied the bright-line holding of Foster-Gardner, Inc. v. National Union Fire Ins. Co., 18 Cal. 4th 857 (1998) in which the court applied the “literal meaning” of the word “suit” to mean an action filed in a court of law. The California Supreme Court reversed, stating that its holding in Foster-Gardner, which concerned an administrative action designed to obtain a negotiated settlement of the insured’s liability for environmental pollution, was based on its concern that the order did not provide insurance companies with sufficient notice of the parameters of the action against the insured. In this instance, however, the Supreme Court found that the adjudicative IBCA proceeding did not raise the same concern in that a complaint filed in the IBCA gave “as much, if not more, notice to insurers” as would a complaint filed in court, and noting the similarities between a court and an IBCA proceeding (the latter being authorized to conduct trials, determine liability and award damages). This opinion is thus an expansion of an insurer’s obligation deriving from similar policy language to defend and indemnify its insured who participates in an adjudicative administrative proceeding.

Authored By:

Candace L. Matson, (213) 617-5489, is a partner in Sheppard Mullin's Los Angeles office where she specializes in construction law. Harold E. Hamersmith, (213) 617-4255, is a partner in the firm's Los Angeles office specializing in design and construction contracts, claims, and defects litigation, and public contract law. Helen J. Lauderdale, (213) 617-4138, is a special counsel specializing in construction litigation in Sheppard Mullin's Los Angeles office.

The Year 2010 In Review: Prevailing Wage & Employment Law

Sheppard Mullin — Thu, 14 Apr 2011 10:05:36 -0800

This article is the sixth in a series summarizing construction law developments for 2010.

By Candace Matson, Harold Hamersmith & Helen Lauderdale

Alameda County Joint Apprenticeship and Training Committee v. Roadway Electrical Works Inc., 186 Cal. App. 4th 185 (1st Dist. June 2010)

A general contractor and its electrical subcontractor working on the project to rebuild the Bay Bridge were sued by various electrical unions, electrical contractors, and electrical contractors' associations. The plaintiffs asserted claims for unfair and unlawful competition under Business and Professions Code Section 17200 claiming that that defendants were using unauthorized workers to perform work that called for certified electricians under Labor Code Section 3099. The defendants succeeded in obtaining the dismissal of the lawsuit by arguing that the plaintiffs' claims raised issues with respect to the proper classification of workers, that it was up to the Department of Industrial Relations ("DIR") in the first instance to determine the scope of work that must be performed by certified electricians, and that plaintiffs had failed to exhaust their administrative remedies with the DIR before filing suit.

The Court of Appeal reversed. Labor Code Section 3099 was enacted in 1999 to establish and validate minimum standards for training and competency for electricians. It requires all persons who perform work for electrical contractors with class C-10 licenses to be certified. Section 3099 was not enacted as part of prevailing wage legislation, but rather as public safety legislation to ensure that electrical work be performed safely by properly trained electricians. When the general contractor bid for and secured electrical work requiring a C-10 license, it was on notice that it was obligated to use certified electricians to perform the work. Because the requirement for C-10 licensees to employ certified electricians was not the result of any DIR determination, but rather was a statutory requirement, the plaintiffs' claims that alleged violation of the statute did not require that any type of administrative proceeding be exhausted before the claims could be presented in court.

Azusa Land Partners v. Department of Industrial Relations, 191 Cal. App. 4th 1 (2d Dist. Dec. 2010)

The private developer of a planned residential community reached an agreement with the City of Azusa regarding the public infrastructure that would be required as a condition of approval of the proposed planned community. The infrastructure included a school, park, streets, storm drains, sewers, utilities, and other improvements, all of which were estimated to cost $147 million to construct. Roughly one-half of the cost would be financed through Mello-Roos bonds; the other half was to be paid from private funds.

The developer unsuccessfully sought a determination from the DIR that the portion of the public improvements paid for through private funds need not be subject to the prevailing wage requirements of Labor Code Section 1720, et seq. The DIR's determination was upheld by the trial court, which in turn was affirmed by the Court of Appeal. The Court held that Mello-Roos bond proceeds are public funds under Section 1720 and that the obligation to pay prevailing wages applied to all of the public improvements required for approval of the development, even though some of the specific improvements might be entirely financed with private funds. The Court of Appeal rejected the developer's argument that each piece of infrastructure should be analyzed individually to determine if its construction was paid for with public funds. Instead, the Court held the public infrastructure works that were a condition of the development's approval must be analyzed as a whole; if public funds are used to pay a portion of the overall infrastructure costs, then prevailing wages must be paid in connection with the infrastructure costs, regardless of whether individual aspects of the infrastructure were privately funded.

Authored By:

Candace L. Matson is a partner in Sheppard Mullin's Los Angeles office where she specializes in construction law. Harold E. Hamersmith is a partner in the firm's Los Angeles office specializing in design and construction contracts, claims, and defects litigation, and public contract law. Helen J. Lauderdale is a special counsel specializing in construction litigation in Sheppard Mullin's Los Angeles office.

The Year 2010 In Review: Public Works Projects

Sheppard Mullin — Thu, 07 Apr 2011 10:21:19 -0800

This article is the fifth in a series summarizing construction law developments for 2010.

By Candace Matson, Harold Hamersmith & Helen Lauderdale

A. Bidding

Great West Contractors Inc. v. Irvine School District, 187 Cal. App. 4th 1425 (4th Dist. Aug. 2010)

In Great West Contractors, the Fourth District held that a public agency's rejection of a bid for a public works project on the basis that a corporate bidder did not list its officers' licenses is a question of bidder responsibility, not bid responsiveness, and therefore a due process hearing was required. The Court of Appeal said that the case is important for two reasons. First, it presents a challenging problem in public contracting law: how to distinguish a "non-responsive" bid from a de facto determination that the bidder is not a "responsible" bidder. Second, the case presents what the court called "an object lesson in how evidence that, at least on its face, tends to show favoritism – indeed, on this record, favoritism most foul – never got squarely presented to, or considered by, the trial court." The Court invited readers of the opinion to judge for themselves whether "stonewalling" might not be a better word than "delay" for describing the public agency's actions.

The School District sought bids for the renovation of two elementary schools. All bidders were pre-qualified. Plaintiff, Great West Contractors, submitted the lowest bid on each project. Nonetheless, its bid was rejected as non-responsive. In response to the question in the bid package, "Have you ever been licensed under a different name or license number?" Great West responded "No." The School District subsequently determined that Great West had in fact operated under different license numbers and its president was listed as an RME under a different license number, and on that basis the School District determined that Great West's bid was non-responsive and it was therefore rejected in its entirety. The way by which this came about is what provoked the court's "favoritism most foul" comment. The Court related that a competing bidder, for a reason never adequately explained by the public agency, had access to Great West's bid information within 24 hours of the opening of all bids. Thus, the competitor was able to present a bid challenge almost immediately to the School District based on the allegation that Great West had omitted to disclose some licenses with which it or its principals had been associated. And that competing bidder went on to be awarded one of the contracts. But when Great West tried to get a copy of that very same competitor's bid, the School District did not turn over that information until several weeks later – indeed, the information was deliberately not made available until after the critical first court hearing in the case. And then, when Great West finally did get the information on its competitors' bids, it discovered that its successful competitors had been guilty of the very same omission with regard to the disclosure of all associated licenses that was the ostensible reason that Great West's bid was summarily rejected in the first place.

Great West filed a petition for writ of mandate generally arguing that it should have received the contract award. After two hearings, the trial court held that Great West's bid was non-responsive, and even if Great West had a due process right to a hearing due to its non-responsiveness, any relief would be moot inasmuch as the work had already begun and Great West could no longer be awarded the contracts at issue. Additionally, the trial court entered judgment against Great West.

The Court of Appeal ruled first that, although the projects were already completed, the question presented on appeal – whether plaintiff's failure to list its officers' licenses constituted an issue of bid responsiveness or bidder responsibility – was not moot. The work was already complete, and the School District argued that therefore a court should not decide the propriety of its rejection of Great West's low bid. The Court of Appeal reasoned, however, that the non-responsive vs. non-responsible issue presented is "a classic example of an issue capable of repetition yet likely to evade review. Consider: in public contracts of a short lead-time nature, like the one here, an initial determination by the public agency that the lowest bid is 'non-responsive' allows for a summary rejection of that bid that may readily preclude effective judicial redress."

The Court of Appeal added that the issue is of great public concern. A school district is legally required to award contracts to the lowest responsible bidder. This statutory mandate may be bald-facedly circumvented if the school district need simply declare the bid non-responsive, then award the contract to the next (and perhaps favored) bidder.

The court then went on to address the merits of the case, discussing the difference between non-responsibility and non-responsiveness. The Court cited, inter alia, the Taylor Bus Service case which stated that responsibility is a "complex matter dependent, often, on information received outside the bidding process and requiring, in many cases, an application of settled judgment, whereas responsiveness is "less complex" and "can be determined from the face of the bid." The Court ultimately held that the allegation of falsity with respect to Great West's response to the bid question made it clear that the School District's rejection of its bid was an issue of non-responsibility, not non-responsiveness. The Court of Appeal reversed the judgment below, finding that the School District had erred in rejecting Great West's bid without allowing it a hearing on the issue of responsibility, and further finding that the trial court had incorrectly denied Great West the opportunity to amend its claim to seek damages (bid preparation costs) consistent with Kajima/Ray Wilson v. Los Angeles County Metropolitan Transportation Authority, 23 Cal. 4th 305 (2000).

Schram Construction Inc. v. Regents of University of California, 187 Cal. App. 4th 1040 (1st Dist. Sept. 2010)

The Regents of the University of California awarded a general contract to DPR Construction for the design and construction of a medical center. On the University's behalf, DPR solicited bids for the mechanical, plumbing and electrical work on the project. Subcontractors were invited to bid on six individual packages and three alternative combination packages. After learning which subcontractors had bid on each package, DPR and the University decided to award a contract on a certain combination package instead of two individual packages. Southland Industries was determined to be the lowest responsible bidder on the combination package. Plaintiff, Schram Construction, which had submitted bids on the two individual packages but not on the combination package, filed a petition for writ of mandate challenging the award of the contract to Southland. The trial court denied Schram's petition.

The Court of Appeal reversed, concluding that the University's bid package selection procedure violated Public Contract Code Section 10506.4(c) – which requires it to "adopt and publish procedures and required criteria that ensure that all selections are conducted in a fair and impartial manner" and to disclose to prospective bidders how the best value bid will be selected, including the bid selection procedure and the determinative factors in that decision -- where it selected the bid packages based on undisclosed criteria and in a manner that allowed it to predetermine the outcome of the bid selection. The Court held that section 10506.4 required publication of the bid package selection criteria and that publication was necessary to a fair and impartial bid selection. The Court was particularly concerned that the bid selection had turned on a criterion that had not even been disclosed to the bidders. In concluding that the contract with Southland must be set aside, the Court stated that the University's violations of the competitive bidding statutes were not merely "technical or non-substantive," and that they compromised the integrity of the selection process by failing to ensure procedural and substantive fairness.

Graffiti Protective Coatings, Inc., et al. v. City of Pico Rivera, 181 Cal.App. 4th 1207 (2d Dist. Feb. 2010)

Through competitive bidding, plaintiff had been awarded a public works contract to maintain a city's bus stops. Four years later, the City terminated the contract as allowed by its terms. Without inviting competitive bids in accordance with Public Contract Code sections 20161 - 20162, the City entered into a new contract with one of plaintiff's competitors. Plaintiff filed suit for a writ of mandate and declaratory relief to invalidate the new contract and to compel the City to award the contract through competitive bidding.

In response, the City filed a special motion to strike, contending that the action was a "strategic lawsuit against public participation" (SLAPP) (Code Civ. Proc., § 425.16(b)(1)). The trial court granted the motion, reasoning that the maintenance of the City's bus stops was an issue of public interest and plaintiff was not likely to prevail on the merits of its claims. Under the anti-SLAPP statute, the City was entitled to an award of attorneys' fees, which the trial court fixed at over $24,000.

In reversing the trial court's decision, the Court of Appeal held that, even if plaintiff's claims involve a public issue, they are not based on any statement, writing, or conduct by the City in furtherance of its right of free speech or its right to petition the government for the redress of grievances. Rather, plaintiff's claims are based on state and municipal laws requiring the City to award certain contracts through competitive bidding. Thus, the claims are not subject to the anti-SLAPP statute. It follows that plaintiff does not have to demonstrate a probability of success on the merits at the pleading stage, risking the dismissal of its claims and the payment of the City's attorneys' fees. If the court were to conclude otherwise, the anti-SLAPP statute would discourage attempts to compel public entities to comply with the law.

B. Methods of Proving Damages – Total Cost and Modified Total Cost Theories

Dillingham-Ray Wilson v. City of Los Angeles, 182 Cal. App. 4th 1396 (2d Dist. Mar. 2010)

In this case, the Court of Appeal reversed a decision of the trial court, which had precluded the contractor from proving damages by the method it proposed and had ruled that neither a total cost theory nor a modified total cost theory was permissible. The first sentence of the Court of Appeal's opinion stated: "The City of Los Angeles obtained millions of dollars worth of construction work that it does not want to pay for." It only went further downhill for the City after that.

Dillingham-Ray Wilson (DRW) had been awarded a contract by the City to expand the digester capacity at the Hyperion Wastewater Treatment Plant. During the course of construction, the City issued over 300 change orders which contained more than 1,000 changes to the plans and specifications. On rare occasions, the City directed DRW to perform changes on a time and materials basis. But in most instances, the City requested an estimate of the cost of the work, told DRW to start the work, and agreed the parties would negotiate a lump-sum payment at a later date. The parties agreed on the compensation payable for some of the time and materials change orders and lump-sum change orders, but not all of the change orders were ultimately agreed. When DRW completed the job, it requested an equitable adjustment to compensate it for the work performed without a price, and for expenses and losses allegedly resulting from the City's interference and delays. The City refused, and it assessed liquidated damages against DRW for delays and did not release the retention funds from escrow.

DRW sued the City for breach of contract, and the City cross-complained against the DRW on various theories including under the False Claims Act. Based on Amelco Electric v. City of Thousand Oaks, 27 Cal. 4th 228 (2002) and Public Contract Code Section 7105(d)(2), the City filed motions in limine to preclude DRW from presenting a total cost claim and from proving its damages with engineering estimates rather than actual costs. It also barred DRW from proving its damages on a modified total cost theory.

The case proceeded to trial on DRW's claims for delay damages, wrongfully withheld retention and prompt pay penalties, and on the City's cross-complaint. After post-trial motions, judgment was entered in favor of DRW in a net amount exceeding $30 million. Both parties appealed.

The Court of Appeal reversed the rulings which had limited DRW's damages proof, finding that the contract was ambiguous regarding restrictions on the proof and measure of damages. It remanded the case for a further trial on the interpretation of the contract. The Court also held that PCC Section 7105 and applicable case law restrict only the measure of damages and not the method of proving damages. It ruled that if, following remand, the trial court or jury interprets the contract and concludes that it does not require DRW to document actual costs on the change orders, and if engineering estimates are the best evidence of damages available, then DRW can offer those estimates to prove its claims. The Court also found that there is no legal prohibition on using a modified total cost theory (total cost of performance, less the contract amount, less any unreasonable cost) to prove damages on a public works contract. Therefore, DRW would be allowed to use this method to prove its damages on remand if the contract does not require it to document its actual costs.

C. Change Orders

P & D Consultants, Inc. v. City of Carlsbad, 190 Cal. App. 4th 1332 (4th Dist. Dec. 2010)

The Fourth District Court of Appeal held that a contract with a public agency cannot be modified orally or through conduct of the parties when the contract provides that no amendments, modification, or waivers of contract terms were allowed without a written agreement signed by both parties.

This breach of contract action arose from a written agreement between P & D Consultants and the City of Carlsbad for services pertaining to a redesign of the City's municipal golf course. The contract provided that no amendments, modification, or waivers of contract terms were allowed without a written agreement signed by both parties. The parties executed several written amendments, which increased the contract price for extra work. Because the City typically took several weeks to execute each amendment, the City's project manager often authorized P & D to begin work prior to receiving the signed amendment. The parties disagreed on the scope of work and price for Amendment No. 5, but ultimately executed it for slightly less than half the value P & D believed it was due. P & D later sought more money from the City, apparently for work P & D thought should have been included in Amendment No. 5. The City refused to pay and P & D sued. The City cross-complained for deficient and incomplete work. The jury found the City liable for breach of contract and awarded P & D the full damages it requested, $109,093.81.

The City appealed, contending that as a matter of law, the jury's award for extra work could not stand because there was no written change order. The Court of Appeal held that the judgment for P & D must be reversed "because as a matter of law, it cannot recover for extra work without a written change order, as the parties' contract requires." The Court held that the trial court erred in finding that the contract could be modified orally or through conduct, and that it should not have allowed the case to go to the jury on the modification theory. The Court cited to Katsura v. City of San Buenaventura, (2007) 155 Cal. App. 4th 104, which held that contracts with public entities cannot be modified orally and that people dealing with public agencies are "presumed to know the law with respect to any agency's authority to contract." The Court stated that any oral authorization by the City's project manager was insufficient to bind the City, and that the plain language of the contract limited the City's power to contract to that set forth in the contract.

D. Public Agency's Failure to Disclose

Los Angeles Unified School District v. Great American Insurance Co., 49 Cal. 4th 739 (July 2010)

The Supreme Court held in this case that a contractor need not prove an affirmative fraudulent intent to conceal as part of a cause of action for non-disclosure of material facts or breach of the warranty of correctness of the plans. The Court framed the issue as "whether a contractor may also recover when the plans and specifications are correct, but the public authority failed to disclose information in its possession that materially affected the cost of performance." The Court expressly disapproved of the language used in the 1979 decision in Jasper Construction, Inv. v. Foothill Junior College District, 91 Cal. App. 3d 1, which had held that to recover for non-disclosure the contractor must show the public entity affirmatively misrepresented or intentionally concealed material facts that rendered the furnished information misleading.

The School District had ejected a contractor from a school construction project claiming material breach of contract. The School District solicited proposals from other contractors to correct defects and complete the project. Bidders were provided with copies of the original plans and also with a 118-page list of work that the District's representatives found to be defective or incomplete. The list contained language that was intended to hold the contractor responsible for all listed defects. Hayward Construction submitted a bid to perform the work on a time and materials basis with a guaranteed maximum price of $4.5 million. Shortly after starting work, Hayward notified the District that many defects had not been included on the correction list and could not have been discovered by simple observation, and that it therefore had significantly under-estimated the cost of the remedial work. Hayward alleged that the District had failed to disclose the full nature and extent of the defects in the existing construction, and had failed to disclose information that would have put Hayward on notice that some of its assumptions about the scope of the work required were faulty. For example, Hayward asserted that the District had failed to disclose a consultant's report that would have alerted Hayward to the defects in the stucco work and further asserted that the District was aware Hayward's intended method for curing stucco discoloration would not be effective. The trial court granted the School District judgment on the pleadings, rejecting Hayward's claims of breach of contract and breach of warranty, reasoning that under Jasper, Hayward could not recover because it had not alleged facts that would allow a conclusion that the District either actively concealed or intentionally omitted material information. The court entered judgment in favor of the School District in an amount exceeding $1.1 million.

The Court of Appeal reversed, holding that Hayward may maintain an action for breach of contract based on non-disclosure of material information if it could establish that the District knew material facts concerning the project that would affect Hayward's bid and failed to disclose those facts. The Supreme Court affirmed the decision of the Court of Appeal, though it concluded that the Court of Appeal's ruling was overbroad in suggesting that recovery may be had for any failure to disclose material information . The Supreme Court held that the contractor on a public works contract may be entitled to relief for a public entity's non-disclosure in the following limited circumstances: (1) the contractor submitted its bid or undertook to perform without material information that affected performance 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, such information; (3) any contract specifications or other information furnished by the public entity to the contractor misled the contractor or did not put it on notice to inquire; and (4) the public entity failed to provide the relevant information. The Court elaborated that the circumstances affecting recovery may include, but are not limited to, positive warranties or disclaimers made by either party, the information provided by the plans and specifications and related documents, the difficulty of detecting the condition in question, any time constraints the public entity imposed on proposed bidders, and any unwarranted assumptions made by the contractor. The 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.

E. MBE, WBE, and DVBE Preferences

Coral Construction, Inc. v. City and County of San Francisco, 50 Cal. 4th 315 (Aug. 2010)

In the latest decision arising out of the City and County of San Francisco's series of ordinances granting preferences in the award of public contracts, the California Supreme Court upheld the constitutionality of Article I, Section 31 of the California Constitution, which forbids a city awarding public contracts to discriminate or grant preferential treatment based on race or gender. The City, whose public contracting laws expressly violate Section 31, challenged its validity under the so-called political structure doctrine, a judicial interpretation of the federal equal protection clause. The Court concluded that Section 31 does not violate the political structure doctrine.

For the last 26 years, the City has preferentially awarded public contracts to minority-owned business enterprises (MBE's) and women-owned business enterprises (WBE's). The City's Board of Supervisors has mandated these preferences in a series of ordinances adopted over time, justifying each with legislative findings purporting to show continuing discrimination by the City against MBE's and WBE's. The details of the program have evolved, partly in response to changes in the law governing the validity of such preferences. The plaintiffs in this case, Coral Construction Inc. and Schram Construction Inc., challenged the 2003 version of the ordinance as unconstitutional under Section 31.

Section 31, which the voters approved as Proposition 209 in the November 1996 General Election, declared that the State, including its political subdivisions, "shall not discriminate against, or grant preferential treatment to, any individual or group on the basis of race, sex, color, ethnicity, or national origin in the operation of public employment, public education, or public contracting."

In rejecting the City's argument that Section 31 violates the political structure doctrine – an aspect of federal equal protection articulated in Washington v. Seattle School District No. 1, 458 U.S. 457 (1982), the Court emphasized that Section 31 prohibits race- and gender-conscious programs which the federal equal protection clause permits but does not require. The Court also rejected the City's contention that the ordinance was unaffected by Section 31 because it falls within an exception which applies in instances where action must be taken to establish or maintain eligibility for federal funding. The City, which receives federal funds for a variety of projects, argued that it was compelled to enforce its ordinance by specific federal regulations imposing affirmative action obligations on cities that receive funds. The Supreme Court held, as the Court of Appeal had held, that the City's argument lacks merit.

Finally, the City contended that the federal equal protection clause requires its ordinance as a remedy for the City's own discrimination. The Court of Appeal had reversed the Superior Court's decision relating to this argument and remanded the case for the limited purpose of adjudicating that issue. The Supreme Court held that the Court of Appeal ruled correctly in remanding the federal compulsion argument for further proceedings. The Court did offer guidance to the Superior Court in resolving the federal compulsion issue on demand. The Court said that to defeat plaintiff's motion for summary judgment, the City must show that triable issues of fact exist on each of the factual predicates for its federal compulsion claim, namely (1) that the City has purposefully or intentionally discriminated against MBE's and WBE's; (2) that the purpose of the City's 2003 ordinance is to provide a remedy for such discrimination; (3) that the ordinance is narrowly tailored to achieve that purpose; and that a race- and gender-conscious remedy is necessary as the only, or at least the most likely means of rectifying the resulting injury.

Authored By:

Candace L. Matson is a partner in Sheppard Mullin's Los Angeles office where she specializes in construction law. Harold E. Hamersmith is a partner in the firm's Los Angeles office specializing in design and construction contracts, claims, and defects litigation, and public contract law. Helen J. Lauderdale is a special counsel specializing in construction litigation in Sheppard Mullin's Los Angeles office.

The Year 2010 In Review: Prompt Payment Statutes

Sheppard Mullin — Wed, 30 Mar 2011 14:15:01 -0800

This article is the fourth in a series summarizing construction law developments for 2010.

By Candace Matson, Harold Hamersmith & Helen Lauderdale

Yassin v. Solis, 184 Cal. App. 4th 524 (2d Dist. May 2010)

Homeowners entered into an agreement with a contractor for home improvement work. The agreement called for the contractor to be paid fixed amounts upon reaching specific milestones on the project, with the final payment of $7,500 due once the work was complete and a certificate of occupancy issued. The homeowners became dissatisfied with the contractor's work, terminated him from the project, and hired another to complete the work.

The contractor filed suit to recover amounts he claimed were owed, including the $7,500 due upon completion. The homeowners cross-complained to recover amounts they spent to correct the contractor's deficient work. The trial court awarded the contractor nothing and awarded the homeowners $50,000, plus $36,000 in attorneys' fees under Civil Code Section 3260(g), which governs payment of retention proceeds. The trial court reasoned that the homeowners were entitled to recover attorneys' fees because they were the prevailing party on the contractor's claim for the last payment of $7,500, which the court determined to be retention.

The Court of Appeal overturned the award of attorneys' fees. The Court distinguished the type of installment payments agreed upon by the homeowners and contractor in this case with retention. Unlike installment payments, retention consists of amounts withheld from progress payments until after the project is complete and the lien period has expired as security for the contractor's performance and full payment of subcontractors and suppliers. Because the $7,500 payment the contractor sued to recover was not withheld from any prior progress payment, it was not retention. Instead it was simply an installment payment and, therefore, could not trigger the recovery of attorneys' fees under Civil Code Section 3260(g), which only covers the timely payment of retention. Without much discussion or analysis, the Court of Appeal endorsed the trial court's conclusion that attorney's fees are not recoverable under Civil Code Section 3260.1, which addresses the timely payment of progress payments.

Hinerfeld-Ward Inc. v. Lipian, 188 Cal. App. 4th 86 (2d Dist. Sept. 2010)

A contractor on a substantial, multi-year home remodeling project sued the homeowners for unpaid amounts claiming breach of an oral contract. The homeowners cross-complained for, among other things, negligence and fraud, and defended against the contractor's affirmative claims by citing Business and Professions Code Section 7159, which requires home improvement contracts to be in writing. At trial, the contractor obtained a judgment for $200,000 for earned but unpaid progress payments and was awarded 2% per month on the unpaid amount, plus another $200,000 in attorney's fees, under the prompt pay provisions of Civil Code Section 3260.1. Meanwhile, the homeowners were awarded $1,000 on their negligence claim against the contractor.

The appellate court affirmed the trial court. Citing Asdourian v. Araj, 38 Cal. 3d 276 (1985), the appellate court held that while oral home improvement contracts violate Business and Professions Code Section 7159 and are illegal, they are not automatically void. In deciding whether an oral home improvement contract should be enforced, courts must examine whether enforcing the contract will undermine the consumer protection purposes of the statute or whether declaring the contract unenforceable will result in an unjust windfall to the homeowners. Because the homeowners in Hinerfeld-Ward were well-educated and were assisted by an experienced architect throughout the project, the Court of Appeal found they were not in danger of being manipulated or abused by a contractor. Moreover, declaring the contract unenforceable would have resulted in a substantial windfall to the homeowners. Thus the Court ruled the oral contract was enforceable.

The appellate court – a different division of the Second District than the one that decided Yassin v. Solis – reached a decision at odds with the outcome of Yassin v. Solis regarding the recoverability of attorneys' fees in actions brought under Civil Code Section 3260.1. The homeowners challenged the imposition of both a 2% percent per month charge on unpaid amounts and attorney's fees. Section 3260.1 states that if progress payments are wrongfully withheld, the contractor is entitled to recover "the penalty" specified in Section 3260(g). Section 3260(g) provides for both the charge of 2% per month on the wrongly withheld amount plus an award of attorney's fees and costs to the prevailing party. Relying on legislative history that reflected an intention to allow the recovery of both the 2% charge and attorney's fees, the Court of Appeal rejected the homeowners' argument that an attorney's fees award was not part of "the penalty" that could be recovered under Section 3260.1.

Authored By:

Candace L. Matson is a partner in Sheppard Mullin's Los Angeles office where she specializes in construction law. Harold E. Hamersmith is a partner in the firm's Los Angeles office specializing in design and construction contracts, claims, and defects litigation, and public contract law. Helen J. Lauderdale is a special counsel specializing in construction litigation in Sheppard Mullin's Los Angeles office.

The Year 2010 In Review: Mechanic's Liens, Lis Pendens and Construction Bonds

Sheppard Mullin — Fri, 18 Mar 2011 11:46:17 -0800

This article is the third in a series summarizing construction law developments for 2010.

By Candace Matson, Harold Hamersmith & Helen Lauderdale

A. Mechanic’s Liens

1. New Requirement for Mechanic’s Liens (AB 457)

Effective January 1, 2011, Civil Code Section 3084 is amended to require that mechanic's lien claimants must give notice of certain information included in the lien claim to the property owner and accompany the notice with a proof of service affidavit.

B. Lis Pendens

1. Forsgren Associates, Inc. v. Pacific Golf Community Development LLC, 182 Cal. App. 4th 135 (4th Dist. Feb. 2010)

A general contractor on a project involving the construction of a golf course sued the owners of adjacent property to foreclose on a mechanic's lien recorded against both the golf course property and adjacent properties. Although the parcels were owned by different legal entities, the principal owner of the golf course development was also a member of the other owner entities. Part of the golf course contained a flood control channel which benefitted not only the golf course, but the surrounding land designated for the construction of homes. The trial court ruled that the general contractor was entitled to foreclose on the liens attached to the whole of the adjacent properties.

The Court of Appeal reversed the ruling as overbroad. The golf course was owned by a business entity separate and independent from the owners of the surrounding residential and commercial property. The Court held that the scope of the lien was limited to only those portions of adjacent properties that were beneficial to the convenient use and occupancy of the golf course. Only those limited portions of adjacent properties where sprinklers for the golf course had been installed and areas in which topsoil had been removed and vegetation planted could be subject to the lien.

2. Recording of Lis Pendens Now Mandatory (AB 457)

Effective January 1, 2011, Civil Code Section 3146 is amended to require that a lis pendens must be recorded within 20 days of filing a lien foreclosure action. Until and unless the lis pendens is recorded, an encumbrancer or purchaser will not be deemed to have constructive notice of the foreclosure suit as a matter of law.

C. Stop Notices

1. Force Framing, Inc. v. Chinatrust Bank (U.S.A.), 187 Cal. App. 4th 1368 (4th Dist. Aug. 2010)

The subcontractor served its preliminary notice on the bank erroneously listed in a preliminary information sheet furnished by the owner (East West Bank) and there was no evidence it had reason to know of the error. The subcontractor served the correct bank (Chinatrust) with a bonded stop notice and filed suit to enforce the stop notice. The bank sought summary judgment on the ground that the subcontractor had not served it with the preliminary notice required by Civil Code Section 3097 and that the subcontractor was charged with constructive knowledge of the bank as construction lender because the deed of trust it recorded was a matter of public record. The trial court agreed and granted summary judgment in the bank’s favor. The appellate court reversed on the ground that the subcontractor could have had a good faith belief in the identity of the construction lender, and that created a triable issue of fact which could not be resolved on summary judgment.

D. Performance and Payment Bonds

1. Mepco Services, Inc. v. Saddleback Valley Unified School District, 189 Cal. App. 4th 1027 (4th Dist. Nov. 2010) , modified, 2010 Cal. App. LEXIS 1978

A general contractor sued a school district to recover compensation for extra work and delay damages, in addition to its final progress payment and retention. The district countersued the general contractor for breach of contract, seeking liquidated damages for delay and also sued both the contractor and the surety on the performance bond, the procurement of which by the contractor was required under the prime contract. Following a jury trial, the trial court issued judgment in favor of the contractor on its action, and against the district on its countersuit, and the court awarded the contractor its attorneys’ fees, although the contract contained no attorneys’ fee provision. The appellate court held that the fees were properly awarded pursuant to the terms of the performance bond and Civil Code Section 1717. The bond provided that the district was entitled to recover its fees from the contractor and the surety, jointly and severally, if it was required to engage the services of an attorney to enforce the bond. The Court of Appeal observed that under Section 1717, the contractor and the surety were each, reciprocally, entitled to recover their fees in defending against the enforcement action. Also, under the circumstances of this case, the claims prosecuted and defended by the contractor involved an issue common to, and intertwined with, the district’s performance bond claim, i.e., which party had breached the contract. Therefore, the trial court did not err in awarding the contractor all its attorneys’ fees.

Authored By:

Candace L. Matson is a partner in Sheppard Mullin's Los Angeles office where she specializes in construction law. Harold E. Hamersmith is a partner in the firm's Los Angeles office specializing in design and construction contracts, claims, and defects litigation, and public contract law. Helen J. Lauderdale is a special counsel specializing in construction litigation in Sheppard Mullin's Los Angeles office.

The Year 2010 In Review: Contractor Licensing

Sheppard Mullin — Wed, 16 Mar 2011 15:08:32 -0800

This article is the second in a series summarizing construction law developments for 2010.

By Candace Matson, Harold Hamersmith & Helen Lauderdale

1. Loranger v. Jones, 184 Cal. App. 4th 847 (3d Dist. May 2010)

Jones, a licensed contractor, had a workers' compensation policy covering his employees. Jones unknowingly used an unlicensed subcontractor and knowingly permitted two minors without work permits, and another person without a contractor's license, to help perform work for Loranger. Loranger refused to pay the final invoice and Jones filed suit for breach of contract. Loranger cross-complained alleging defects and sought disgorgement of monies paid.

However, the Court of Appeal, affirming the trial court, held that Jones' license had not been automatically suspended under Business and Professions Code Section 7125.2 and accordingly, Jones was not subject to the sanctions of Section 7031 subdivisions (a) and (b). Loranger largely relied upon Wright v. Issak, 149 Cal. App. 4th 1116 (6th Dist. 2007) in arguing that Jones could not bring suit and was subject to disgorgement. However, the Court found Wright distinguishable because in that case the contractor intentionally reported zero payroll to avoid obtaining workers' compensation insurance. In the instant case, however, Jones had workers' compensation coverage when he began the project. At worst there may have been a lapse of coverage; however, without notice of a lapse of coverage from the registrar, there was no effective suspension of the contractor's license. The Court also expressly rejected a reading of Wright to find "any" underreporting of payroll tantamount to a failure to obtain workers' compensation coverage and thus an automatic suspension of a contractor's license.

2. In re Yehuda Sabban, 600 F.3d 1219 (9th Cir. BAP, April 2010)

A homeowner won a judgment against an unlicensed contractor under Business and Professions Code Sections 7031(b) (disgorgement for non-licensure) and 7160 (contract induced by falsity or fraud) in state court. After the trial, the contractor filed for bankruptcy under Chapter 7 of the Bankruptcy Code (liquidation of all non-exempt personal property to pay off creditors). The individual filed an adversary action to determine the dischargeability of the debt. He argued that both awards imposed a remedy for violations of statutes punishing the contractor for debts obtained by fraud and therefore, pursuant to 11 U.S.C. § 523(a)(2)(A), those debts were not dischargeable. The bankruptcy court partially rejected that argument, holding that the 7031(b) award was dischargeable and finding the smaller award under 7160 was non-dischargeable. The Ninth Circuit, in affirming the bankruptcy court ruling, held that the 7031(b) award was not traceable to fraud, and was not premised on fraud, and so it was dischargeable. Thus, an award against an unlicensed contractor under Business and Professions Code Section 7031(b) is dischargeable in bankruptcy.

3. Alatriste v. Cesar's Exterior Designs, Inc., 183 Cal. App. 4th 656 (4th Dist. April 2010)

A homeowner employed a landscaping contractor which it knew did not have a contractor's license at commencement of work. The contractor stopped work when the homeowner refused to make payments. The homeowner brought suit to recover the money he had already paid to the contractor. The contractor contended that the homeowner's claim was barred because he knew about the contractor's unlicensed status.

The Court of Appeal rejected the contractor's argument, stating that Business and Professions Code Section 7031(a) provides a complete defense to a claim for payment from an unlicensed contractor, even when the customer knew the contractor was unlicensed. The Court applied that rationale to the "sword provision" of 7031(b), holding that knowledge of unlicensed status does not provide a defense to a claim for disgorgement of payments made for unlicensed work. Furthermore, the Court rejected the contractor's argument that it was entitled to retain payment for work performed after it obtained a license, noting that 7031(b) provides for disgorgement if a contractor was unlicensed at any time during the performance of work. The homeowner was entitled to recover the total amount paid, including payment for materials.

4. UDC-Universal Development, L.P. v. CH2M Hill, 181 Cal. App. 4th 10 (6th Dist. Jan. 2010), rev. denied, 2010 Cal. LEXIS 4141

UDC-Universal Development, L.P. entered into two contracts with CH2M Hill, pursuant to which CH2M agreed to provide engineering and environmental planning services for UDC's condominium development. The contracts included an indemnity provision that covered all of UDC's losses to the extent that they arose from, or were connected to, any negligence or omission by CH2M. A duty to defend clause obligated CH2M to defend any suit, action or demand brought against UDC on any claim "covered herein" upon written request from UDC. After completion of the development, the homeowners association brought suit against UDC for "defective conditions" due in part to negligence attributable to CH2M. CH2M rejected UDC's tender of defense, and UDC cross-complained against CH2M for indemnity.

CH2M argued that UDC's indemnity claim was barred because UDC lacked a contractor's license when it entered into the contracts. However, the Court of Appeal held that the term "compensation" as used within Business and Professions Code Section 7031(a) means sums claimed as an agreed price or fee earned by performance, and not indemnification for claims related to a subcontractor's work. Accordingly, the Section 7031(a) bar on actions to recover compensation for work performed by an unlicensed contractor does not apply where the contractor is seeking indemnity for damages paid as a result of a subcontractor's defective work. Regardless of whether a developer is properly licensed, where a contract imposes on a subcontractor a duty to defend against any claim implicating the subcontractor's work, the duty arises as soon as a defense is tendered.

5. Licensing Now Available to LLCs (SB 392)

Effective January 1, 2011, section 7025 of the Business & Professions Code is amended to allow limited liability companies to obtain contractor licenses in California. The License Board is required to begin processing applications therefor not later than January 1, 2012. In order for an LLC to hold a license, it must file and maintain a surety bond in the amount of $100,000 for the benefit of employees to ensure payment of wages and fringe benefits (in addition to the contractor’s license bond required of all licensees.) Further, if the LLC is a signatory to a collective bargaining agreement, the new bond must cover fringe benefit trust fund contributions. Finally, a licensed LLC must maintain and furnish proof of specified insurance coverage in an amount between $1-5M, depending on the number of personnel of record.

Authored By:

Candace L. Matson is a partner in Sheppard Mullin's Los Angeles office where she specializes in construction law. Harold E. Hamersmith is a partner in the firm's Los Angeles office specializing in design and construction contracts, claims, and defects litigation, and public contract law. Helen J. Lauderdale is a special counsel specializing in construction litigation in Sheppard Mullin's Los Angeles office.

The Year 2010 In Review: Design And Construction Defects Litigation

Sheppard Mullin — Fri, 25 Feb 2011 12:11:25 -0800

This article is the first in a series summarizing construction law developments for 2010.

By Candace Matson, Harold Hamersmith & Helen Lauderdale

1. Centex Homes v. Financial Pacific Life Insurance Co., 2010 U.S. Dist. LEXIS 1995 (E.D. Cal. 2010)

After settling numerous homeowners' construction defect claims – and more than ten years after the homes were substantially completed – a home developer brought suit against one of the concrete fabrication subcontractors for the development seeking indemnity for amounts paid to the homeowners, as well as for damages for breach of the subcontractor's duties to procure specific insurance and to defend the developer against the homeowners' claims. The subcontractor brought a motion for summary adjudication on the ground the developer's claims were barred by the ten year statute of repose contained in Code of Civil Procedure Section 337.15.

The District Court agreed the developer's claim for indemnity was barred by Section 337.15. And it held that because the damages recoverable for breach of the subcontractor's duty to purchase insurance are identical to the damages recoverable through the developer's indemnity claim, the breach of duty to procure insurance claim also was time-barred. The District Court, however, allowed the claim for breach of the duty to defend to proceed. The categories of losses associated with such a claim (attorneys' fees and other defense costs) are distinct from the damages recoverable through claims governed by Section 337.15 (latent deficiency in the design and construction of the homes and injury to property arising out of the latent deficiencies).

2. UDC – Universal Development v. CH2M Hill, 181 Cal. App. 4th 10 (6th Dist. Jan. 2010)

Indemnification clauses in construction agreements often state that one party to the agreement – the "indemnitor" – will defend and indemnify the other party from particular types of claims. Of course, having a contract right to a defense is not the same as actually receiving a defense. Any indemnitor attempting to avoid paying for defense costs can simply deny the tender of defense with the hope that when the underlying claim is resolved the defense obligations will be forgotten. In the past, when parties entitled to a defense – the "indemnitees" – had long memories and pressed to recover defense costs, indemnitors attempted to justify denying the tender by claiming their defense obligations coincided with their indemnity obligations and neither arose until a final determination was made that the underlying claim was one for which indemnity was owed.

The California Supreme Court rejected this justification for denying an immediate defense obligation in Crawford v. Weather Shield, 44 Cal. 4th 541 (2008). And in UDC – Universal Development vs. CH2M Hill, 181 Cal. App. 4th 10 (2010), the Sixth District Court of Appeal followed the Supreme Court's lead, repeating that the right to a defense is separate and distinct from the right to indemnity under a typical indemnity clause, the right arises immediately upon assertion of a claim, and the right exists regardless of whether the claim is ultimately proven.

UDC was the developer of a condominium project. It contracted with CH2M Hill to provide engineering and environmental planning services for the project. Their agreement called for CH2M Hill to indemnify UDC for all claims "that arise out of or are in any way connected with any negligent act or omission" of CH2M Hill. It also required CH2M Hill to provide UDC with a defense to any action brought on any claim covered by the indemnity obligation. After the project was completed, the homeowners' association filed suit against UDC for defective conditions at the project due in part to negligent planning and design of open spaces and common areas. The complaint did not attribute negligence to any particular subcontractor but instead contained general allegations of deficient services by architects, engineers, and consultants.

UDC filed a cross-complaint for equitable, comparative, and express contractual indemnity against numerous subcontractors on the project, including CH2M Hill. It also tendered the defense of the homeowners' association's lawsuit to all cross-defendants. CH2M Hill declined the tender. UDC succeeded in settling all of the cross-claims except those asserted against CH2M Hill.

At trial, the parties agreed the jury would decide the factual issues of negligence and breach of contract and the court thereafter would apply the contract's indemnity provisions. The jury concluded CH2M Hill had not been negligent and had not breached its contract with UDC. With these favorable conclusions in hand, CH2M Hill argued to both the trial and appellate courts that it had no duty to defend UDC. According to CH2M Hill, such a duty could only arise after a finding that CH2M Hill had been negligent.

Both the trial and appellate courts rejected CH2M Hill's argument. Instead, they ruled that a duty to defend is separate from a duty to indemnify, and the duty to defend necessarily occurs before the duty to indemnify arises and before any negligence determination is made. CH2M Hill also unsuccessfully urged the courts that it owed no duty to defend the developer because the homeowners' association's complaint did not specifically allege that CH2M Hill was negligent. The appellate court concluded that the developer's right to a defense did not turn on whether the plaintiff named a particular subcontractor in its complaint. The plaintiff's general allegations of deficient design services by engineers for the project, together with the developer's cross-complaint for indemnity attributing responsibility to CH2M Hill for the plaintiff's damages, were sufficient to trigger CH2M Hill's duty to defend.

The UDC and Crawford decisions eliminate any lingering uncertainty about when the obligation to provide a defense arises: under a typically worded indemnity clause, the duty to defend requires immediate action by an indemnitor after the defense of a claim is tendered. But whether these decisions will alter real world conduct by indemnitors and result in their taking an active responsibility for the defense of claims from the outset is far less certain.

3. Great Lakes Construction, Inc. v. Jim Burman, et al., 186 Cal. App. 4th 1347 (3d Dist. July 2010)

After a homeowner posted unfavorable comments about two contractors on the internet, the contractors sued the homeowner for libel. The contractors' complaint prompted a predictable series of pleadings, starting with the homeowner's cross-complaint for breach of contract and negligence against the contractors and designers for substandard work, followed by the contractors' cross-complaint against one of its subcontractors for breach of contract and indemnity. In the ensuing litigation, the homeowner and subcontractor were represented by the same attorney. The contractors successfully moved to disqualify the lawyer for the homeowner and subcontractor based on the conflict that existed in the lawyer's joint representation of them. The Court of Appeal reversed. No legally protected interest of the contractors was violated by the joint representation of their opponents by a single lawyer; the lawyer owed the contractors no duty of loyalty. Therefore the contractors did not have standing to seek the lawyer's disqualification.

Authored By:

Candace L. Matson is a partner in Sheppard Mullin's Los Angeles office where she specializes in construction law. Harold E. Hamersmith is a partner in the firm's Los Angeles office specializing in design and construction contracts, claims, and defects litigation, and public contract law. Helen J. Lauderdale is a special counsel specializing in construction litigation in Sheppard Mullin's Los Angeles office.

Congress Increases False Claims Liability for Public Works Contractors

Sheppard Mullin — Wed, 26 Jan 2011 09:18:20 -0800

By Bram Hanono

The Fraud Enforcement and Recovery Act (FERA)[1] was signed into law in May 2009. Among other significant changes, FERA expanded the grounds for liability under the False Claims Act (FCA).[2] Public works contractors who work on projects funded with federal funds now stand an increased risk for potential liability under the FCA. The FCA now covers, for example, state and local agency projects where the public agency has received a grant of federal funds to build the project. And it includes projects only partially funded by federal money. Accordingly, federal, state, and local contractors should ensure that they have appropriate compliance systems and controls in place to deal with the enhanced FCA.

FERA's "Clarifications" to the FCA

One purpose of FERA was to provide clarifications to the FCA, which Congress felt had been made uncertain and watered down by recent court decisions. It does so by clarifying that the FCA covers claims for government money or property: (1) whether or not the claim was presented to a government employee or official; (2) whether or not the government has custody of the money or property; and (3) whether or not the contracting entity specifically intended to defraud the government. FERA accomplishes these expansions by amending the grounds for liability and altering (and adding) key definitions to the FCA.

As revised by FERA, the FCA may be enforced against any person or entity that "knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval."[3] This language amends the FCA[4] by eliminating the requirement that a claim must be presented to an officer or employee of the government or a member of the U.S. military to impose liability. Similarly, FERA revises the definition of "claim" to include:

any request or demand, whether under a contract or otherwise, for money or property and whether or not the United States has title to the money or property that . . . is made to a contractor, grantee, or other recipient, if the money or property is to be spent or used on the Government's behalf or to advance a Government program or interest . . . where the United States Government provides or has provided any portion of the money or property [or] will reimburse such contractor, grantee, or other recipient for any portion of the money or property[.][5]

The effect of this revision was to repudiate the decision in United States ex rel Totten v. Bombardier Corp.[6] In Totten, the D.C. Circuit held that the government had to prove a claim was "presented" to an officer or employee of the government for liability to attach. Now, a "claim" includes requests or demands to a grantee, such as a local public agency which is building a project.

Similarly, FERA's revised definition of "claim" clarifies the Fourth Circuit's holding in United States ex rel. DRC, Inc. v. Custer Battles, LLC[7], in which the Fourth Circuit held that liability under the FCA did not reach claims for payment of funds over which the U.S. had neither title or control. Now, the FCA reaches claims for payment of funds over which the U.S. has neither title or control, as long as the funds are "to be spent or used on the Government's behalf or to advance a Government program or interest." Notably, FERA provides no definition of what it means to "to advance a Government program or interest."

Finally, FERA's clarifications to the FCA effectively overturn the Supreme Court's decision in Allison Engine v. United States ex rel. Sanders.[8] In Allison Engine, the Supreme Court explained that a subcontractor violates the FCA if it submits a false statement to the prime contractor, intending for the statement to be used by the prime contractor to get the government to pay its claim. Now, FERA prescribes FCA liability where a person "knowingly makes, uses, or causes to be made or used, a fake record or statement material to a false or fraudulent claim."[9] This language amends the FCA[10] by eliminating the "to get" and "by the Government" language previously cited in Allison Engine as connoting an intent requirement.

FERA also added a materiality requirement to that section. "Material" is defined as "having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property."[11] Therefore, under the new provisions, liability exists if the subcontractor's statement has a natural tendency to influence, or is capable of influencing, payment or receipt of money. FERA makes it irrelevant whether the contractor intended that the government rely on the statement in payment of its claim. The FCA now has a much lower standard for bringing a lawsuit.

FERA Expands Liability for "Reverse False Claims"

Another important change to the FCA under FERA expands liability for "reverse false claims." A reverse false claim was previously characterized by the situation where a company used a false statement or record to avoid or decrease an obligation to pay money to the government in order to keep the funds. Now, liability for a reverse false claim exists whenever one "knowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the Government."[12] A false statement or record is no longer required for liability to attach.

Further, FERA expanded the definition of "obligation" to include "an established duty . . . arising from . . . the retention of any overpayment."[13] Under this definition, contractors have a duty to determine if any payment by the government or its agents includes an overpayment. If so, the contractor must refund the overpayment. Failure to identify and refund an overpayment may now result in a FCA violation. Contractors and other recipients of government funds must be alert to these obligations. It appears that fraudulent intent is no longer required to establish liability.

Conclusion

Overall, FERA increased the potential for liability under the FCA for government contractors or others who receive federal funds. Contractors that perform public works projects should train key personnel regarding the FCA and put a compliance system and controls in place to deal with the potential liability under the recently enhanced FCA.

Authored By:

Bram Hanono is an associate in Sheppard Mullin's Del Mar office (858) 720-7461.

[1] 123 Stat. 1617.

[2] 31 U.S.C. §§ 3729-3733.

[3] 31 U.S.C. § 3729(a)(1)(A).

[4] Former 31 U.S.C § 3729(a)(1).

[5] 31 U.S.C § 3729(b)(2).

[6] 380 F.3d 488 (DC. Cir. 2004).

[7] 562 F.3d 295 (4th Cir. 2009).

[8] 128 S. Ct. 2123 (2008).

[9] 31 U.S.C. § 3729(a)(1)(B).

[10] Former 31 U.S.C. § 3729(a)(2)

[11] 31 U.S.C § 3729(b)(4).

[12] 31 U.S.C. § 3729(a)(1)(G).

[13] 31 U.S.C. § 3729(b)(3).

Mechanic's Lien Update: Lien Claimants Must Now Give Owners "Notice of Mechanic's Lien"

Sheppard Mullin — Wed, 08 Dec 2010 10:32:16 -0800

By Edward Lozowicki & James Higgins

California contractors and material suppliers beware. Beginning on January 1, 2011, a mechanic’s lien claimant will be required to give notice of a mechanic’s lien to the property owner. The notice must contain specific information, be included on the lien claim and be accompanied by a proof of service affidavit. Failure to comply invalidates the lien as a matter of law. (Assembly Bill 457 (2009), amending California Civil Code Section 3084.)

Even though a mechanic’s lien is recorded, claimants were not previously required to give actual notice of such lien to the property owner. Beginning in 2011, the mechanic’s lien document ("Claim of Lien") must include not only the amount claimed, a description of labor and materials furnished, the name of the person who employed the lien claimant, and a description of the property, but also a “Notice of Mechanic’s Lien” and "Proof of Service Affidavit."

The “Notice of Mechanic’s Lien” is three paragraphs and generally notifies the property owner that: (1) the lien claimant must file a lawsuit no later than 90 days after the date the mechanic’s lien is recorded; (2) the lien may affect the owner’s ability to borrow against, refinance, or sell the property; and (3) suggests that the owner speak to the contractor, lawyer, or to consult with the Contractors’ State License board website. The “Notice of Mechanic’s Lien” must match the exact language of Section 3084. Lien claimants should ensure that their boilerplate forms have this new notice language.

The mechanic’s lien and “Notice of Mechanic’s Lien” must be served on the owner or reputed owner by registered, certified, or first-class mail, evidenced by a certificate of mailing. If the owner or reputed owner cannot be served by this method, then the notice may be given by one of these methods to the construction lender or to the original contractor. A "proof of service affidavit", showing the method of service, must be attached to the Claim of Lien in order to comply. Failure to serve the mechanic’s lien, including “Notice of Mechanic’s Lien” shall cause the lien to be unenforceable.

AB 457 adds another wrinkle to the mechanic’s lien law. Beginning in January 2011, once the lien foreclosure lawsuit is filed, the plaintiff shall also record a “notice of pendency of the proceedings,” or "lis pendens" in the county recorder’s office where the property is located. Under the previous version of Civil Code section 3146, the lis pendens was optional, but not required. Under the new law, the lis pendens must be recorded on or before 20 days after the filing of the foreclosure lawsuit. Only after the lis pendens is recorded will an encumbrancer or purchaser of the property have constructive notice of the pendency of the lawsuit.

The new “Notice of Mechanic’s Lien” law presents one more pitfall for lien claimants. With contractors and suppliers sometimes waiting until the last minute to record their mechanic’s liens, the additional notice of lien could get overlooked. Obviously, the next step is for potential lien claimants to update their form mechanic’s liens to comply with the statute right away.

Authored By:

Edward Lozowicki is a partner in the San Francisco office where he heads the Northern California Construction Group. James Higgins is an associate in the Group specializing in construction claims and litigation.

Architect-Engineer's Duty to Defend Is Immediate Under Construction Indemnity Clause

Sheppard Mullin — Wed, 27 Oct 2010 07:32:58 -0800

By Helen Lauderdale

Indemnification clauses in construction contracts often state that one party to the contract – the "indemnitor" – will defend and indemnify the other party from particular types of claims. On construction projects, the "indemnitors" are typically the contractor and architect/engineer ("A-E") who agree to defend and indemnify the owner – the "indemnitee." If the owner is sued for construction defects or personal injury which implicate the contractor or A-E, the owner usually tenders the lawsuit to them for defense and indemnity.

Of course, having a contract right to a defense is not the same as actually receiving a defense. For example, a contractor/indemnitor attempting to avoid paying for defense costs could simply deny the tender of defense from the owner with the hope that when the underlying claim is resolved the defense obligations will be forgotten. If the owner/indemnitee had long memory and pressed to recover defense costs, the contractor/indemnitor could try to justify denying the tender by claiming that its defense obligations coincided with its indemnity obligations and that neither arose until a final determination was made that the underlying claim was one for which indemnity was owed.

However, the California Court of Appeal rejected this justification for denying an immediate defense earlier this year, in UDC – Universal Development vs. CH2M Hill, 181 Cal.App.4th 10 (2010). The Court of Appeal followed the Supreme Court's lead, in Crawford v. Weather Shield, 44 Cal.4th 541 (2008), holding that the right to a defense is separate and distinct from the right to indemnity under a typical indemnity clause. The court said the right to a defense arises immediately upon assertion of a claim, and the right exists regardless of whether the claim is ultimately proven to be legitimate. The facts in UDC demonstrate that a refusal to defend can be risky – and costly.

UDC was the developer of a condominium project. It contracted with CH2M Hill to provide engineering and environmental planning services for the project. Their agreement called for CH2M Hill to indemnify UDC for all claims "that arise out of or are in any way connected with any negligent act or omission" of CH2M Hill. It also required CH2M Hill to provide UDC with a defense to any action brought on any claim covered by the indemnity obligation. After the project was completed, the homeowners' association filed suit against UDC for construction defects at the project due in part to negligent planning and design of open spaces and common areas. The complaint did not attribute negligence to any particular subcontractor but instead contained general allegations of deficient services by architects, engineers, and consultants.

UDC filed a cross-complaint for equitable, comparative, and express contractual indemnity against numerous subcontractors on the project, including CH2M Hill. It also tendered the defense of the homeowners' association's lawsuit to all cross-defendants. CH2M Hill declined the tender. UDC succeeded in settling all of the cross-claims except those asserted against CH2M Hill.

At trial, the parties agreed the jury would decide the factual issues of negligence and breach of contract and the court thereafter would apply the contract's indemnity provisions. The jury concluded CH2M Hill had not been negligent and had not breached its contract with UDC. With these favorable conclusions in hand, CH2M Hill argued to both the trial and appellate courts that it had no duty to defend UDC. According to CH2M Hill, such a duty could only arise after a finding that CH2M Hill had been negligent.

However, both the trial and appellate courts rejected CH2M Hill's argument. Instead, they ruled that a duty to defend is separate from a duty to indemnify, and the duty to defend necessarily occurs before the duty to indemnify arises and before any negligence determination is made. CH2M Hill also unsuccessfully urged the courts that it owed no duty to defend the developer because the homeowners' association's complaint did not specifically allege that CH2M Hill was negligent. The appellate court concluded that the developer's right to a defense did not turn on whether the plaintiff named a particular consultant or subcontractor in its complaint. The plaintiff's general allegations of negligent design services by engineers for the project, together with the developer's cross-complaint for indemnity attributing responsibility to CH2M Hill for the plaintiff's damages, were sufficient to trigger CH2M Hill's duty to defend.

The UDC and Crawford decisions eliminate any lingering uncertainty about when a contractor's or A-E's obligation to provide a defense arises: under a typically worded indemnity clause, the duty to defend requires action by a contractor or A-E when the defense of a claim is tendered. But whether these decisions will alter real world conduct by them or their insurance carriers and result in their taking an active responsibility for the defense of claims from the outset is far less certain.

Not so coincidentally, California just enacted a new law, sponsored by the American Council of Engineering Companies, which attempts to modify the UDC holding. The new statute applies to design professionals' contracts with public agencies executed after January 1, 2011. It declares that indemnity clauses in design contracts which indemnify the public agency, including the duty and cost to defend, are unenforceable except for claims that arise out of the designer's negligence, recklessness or willful misconduct. Private works contracts are not affected by this statute. Stats. 2009-10, Chpt. 510.

It's worth remembering that defense and indemnity rights are creatures of contract. If the contractor or A-E seeks to limit the obligation to provide a defense immediately upon the assertion of a claim, they can draft an enforceable contract clause that explicitly excludes such an obligation. Otherwise the contractor or A-E would face the risk of paying for the owner's defense costs even if the contractor or A-E was ultimately exonerated from any fault in causing the claim.

Authored By:

Helen J. Lauderdale is a special counsel specializing in construction litigation in Sheppard Mullin's Los Angeles office.

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

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

By Edward Lozowicki

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 B. 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.