Ernest C. Brown: Last October, California Governor Jerry Brown approved a major new
change to California's labor code.
It's Section 218.7.
For all California construction contracts signed after January 1, 2018, general contractors
will be directly responsible for the wages owed to workers of their subcontractors at
any tier.
This is a substantial change to California labor law.
In the past, only a first-tier subcontractor had contract rights of action against the
general.
The mechanic's lien stopped notice and bond laws only provided indirect rights of action
against the property, the amounts owed the contractor or surety.
And those rights have pretty quick time limits and rigorous procedural protections.
The new law was designed to crack down on subs who pay workers off the books, withhold
benefits and properly categorized employees as independent contractors, or otherwise,
shortchange their paychecks.
My name is Ernest Brown, and for the last 38 years, I've been a construction lawyer
in California and a licensed professional civil engineer.
I've worked on a lot of the largest projects in California including Santa Ana's John Wayne
Airport, which is about 300 million at that time, and the Carquinez Bridge, which connects
Highway 80 between San Francisco and Sacramento.
Joining me today is Paul Rodriguez.
Paul is the regional managing director of Aon Corporation based in Los Angeles, heading
up their construction group.
Aon is a leading global professional firm providing a broad range of risk, health and
retirement solutions, but they have particular strengths in the construction industry.
And Paul, thank you for being here today.
Paul Rodriguez: Thanks, Ernest.
Ernest C. Brown: I wanted to start with a brief overview of the changes to Section 218.7,
this new section of the labor code.
The California Labor Commissioner is empowered now to bring an action under specified statute
or a civil action to enforce the liability of a contractor to pay their subcontractors,
employees.
The third party owed fringe or other benefits of a joint labor-management cooperation committee,
can also bring a civil action to enforce the liability against the direct contractor under
these provisions.
Generally, the contractor will not be liable for penalties, but they will generally for
interest, and in some instances, they also are reliable for attorney's fees or expert
witnesses.
Unfortunately, if they win, they don't get theirs.
It's not supposed to be enforced for a political subdivision of the state of California or
their employees.
We interpret this to mean it applies to private, not public works.
However, the language of the statute is not especially clear.
We think it may also exempt, or I should say in this case, apply to federal projects.
It follows the use of the term direct contractor, which is used in mechanic's lien law, Section
8018 and 8046, in place of what most contractors call the general contractor.
So it applies to a contractor in direct privity with the owner.
There's also a substantial new burden on private work subcontractors.
The subcontractor must now provide specific information regarding the subcontractors and
the third party's work on the project including payroll records.
Under Section I, the subcontractor needs to provide the project name, subcontractor's
address, the lower-tier subcontractor's information, the direct contractor they're working for,
and the start date duration of the project as well as the expected labor hours for the
job.
If there's a dispute about getting these records, it allows the general contractor to withhold
payment under certain circumstances.
This is well beyond the current requirement that a subcontractor provide information on
any unpaid labors, which is required under mechanic's lien law Section 8104.
This is similar to certified payrolls on state and local public works and federal jobs.
The bill would provide that these obligations and remedies are an addition to any other
remedy provided by law.
Perhaps the most important and frightening aspect of this new law is the statute of limitations.
The general contractor can be sued for up to a year after completion of the project
or cessation of labor.
The law does allow contractors to insert indemnity contract into their agreements with sub contracts,
and they can also require a bond of subcontractors for these obligations at any tier.
So Labor Code 2018.7 provides a great deal of financial risk to their contractors and
their sureties that we did not have before January 1st of this year.
Paul, what are the sureties in the insurance industry saying about this bill?
Paul Rodriguez: Well, Ernest, that you're exactly right.
There's certainly a watchful eye and concern around the ramifications of this new law to
not only their construction and general construction clients but their subcontract clients.
And this bill extends into the developer and home builder industries as well.
So, it touches a number of areas where the surety industry as well as the insurance industry
has exposure.
To begin with, they look at this law and trying to mitigate the risk as best as you can, because
ultimately, what was intended for a smaller group of constituents, with a specific set
of concerns, has broader ramifications and unintended consequences.
So the sureties and the insurance companies have put together good guidance for the contractor
clients and have collaborated with them really again, because it's early days around this
new law looking at three specific areas where there is control to be able to get ahead of
these issues.
At the end of the day, the insurance companies and the sureties, first word of advice is,
you work with legal counsel whether inside or outside to make sure that your contracts
are right.
Ernest C. Brown: I think there's going to be a lot of work for lawyers and sureties
from this law without question.
Paul Rodriguez: Absolutely.
If you look at the areas within a contract that have to be reviewed and potentially modified,
you look at things like set-off rights, indemnity and defense provisions within a contract,
performance security requirements, and the bond forms potentially that are already required,
and making sure that they align with the statute of limitations.
In many cases, you see a 90-day period on a traditional bond form around claimant issues.
This goes out a year.
So things like that where a contractor can look at their contracts and try to make sure
that they're trying to really quantify the risk that they have and work to put good language
out there that protects their interests.
Secondly, it's around subcontractor pre-qualification and then processes around payroll verification,
whether making sure that certified payroll, or looking at things, like, what sort of documentation
you're acquiring from a union standpoint to make sure that you do have validation, that
payment has been made, and all benefits have been applied around a certain project.
This only heightens the need, and as we've seen in the construction industry over the
last 10 years, the need to ensure that you're properly pre-qualifying your subcontractors,
making sure you're using best-in-class subs, and really, not so much the first-tier subs
that in many cases are very large organizations, but as you go down a level or three levels,
making sure that you're dealing with reputable firms with good processes in place.
So, we expect that the questions that come in during a tender period or an RFQ, an RFP
about a potential firm, well, the questions around subcontractor usage and the quality
of the subs are going to be heightened, and frankly, their financial strength.
Because ultimately, many of these issues ultimately come down to the paying power of that subcontractor
with their employees.
Lastly, using tools such as surety bonds or other performance security mechanisms, whether
it's liquid to security and letters of credit or cash, looking at retention, and using those
as ways to potentially mitigate a potential concern, or other vehicles such as subcontractor
to fault insurance.
Again, a product that wasn't really intended to cover this type of risk, and looking, is
there a way to potentially modify the terms and conditions of that policy to provide some
coverage or some oversight and protection, again, in a catastrophic situation.
Lastly, around traditional risk transfer mechanisms in the insurance industry, a very challenging
solution to try to put together, because a traditional insurance product was not intended
to cover these types of obligations.
And frankly, because of the frequency or lack thereof and having scale around a specific
event, the ability to aggregate the risk properly and apply premium becomes a challenge.
And truly, to quantify what that risk looks like from an insurance perspective makes it
very difficult to "insure."
Ernest C. Brown: So, then, the underwriters are going to have a bit of a challenge as
well.
Paul Rodriguez: Absolutely.
Ernest C. Brown: It's great.
Well from the legal standpoint, what we see is it will take a while to develop a law in
this area.
We don't have any cases yet.
We don't have regulations.
But things like the extent of the fringe benefits, what does that cover?
How broadly does that go?
That has been a question.
As well as the extent that subcontractors employees, how about those offsite or manufacturing
facilities that may be creating something for this project or for others?
And finally, the issue of whether or not you can have just a completely new type of risk
emerge from this, because it's such a new statute.
Did you really know what may occur, what we'll call the unknowns with regard to the statute?
But I do conclude with something I've said to Paul and his company over the years and
our clients, just a very simple little list of things to think about in this area, write
a good contract that it takes into account this new risk of employee defaults on wages
and fringe benefits.
Handle problems promptly when you think that the subcontractors, the wages are not being
paid properly, or fringes are looking a little bit different than what you expect.
Handle it at the time it comes up.
Ensure the major risks, and that includes getting surety bonds where you think you need
them.
Certainly, the most important thing is, probably, select the best subcontractors and of any
tier as well, making sure that they're financially viable, solvent, and are going to obey the
law with regard to labor and employment rules.
Keep good records, which are going to be essential to basically be able to indemnify yourself
from these subcontractors as they evolve.
And frankly, the final one is, yell for help, and you've got a great surety opportunity
here to call Aon and our firm if you do have questions in this area.
So again, Paul, thanks for coming today and sitting down with us to talk about this new
issue.
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