Letter from the Editor
by James J. Sienicki
Welcome to the summer edition of our Under Construction newsletter. In this issue, we highlight several hot topic items affecting the construction industry such as what happens when the construction contract is not signed and the work is underway, as well as the purposes for and uses of performance bonds, payment bonds and Subguard insurance, as well as the differences between Subguard and performance bonds or payment bonds.
New legislation and court cases affecting the construction industry are constantly changing the way of conducting business. All of these articles can be valuable to anyone interested in keeping up with these ever-evolving issues. We hope we are able to inform and enlighten you. Please let us know if you want us to address a specific construction issue in a future newsletter. Have a fun and safe summer!
Arizona Court of Appeals Interprets Stricter Requirements for Payment Bond Claimants
by Jason Ebe
Arizona has long protected the rights of subcontractors and material suppliers to seek recovery from the payment bond surety on public bonded projects. Arizona’s Little Miller Act, A.R.S. § 34-223, provides that claimants have up to one year following the last provision of labor or materials to sue the bond principal and surety for payment. However, the statute requires that any such claimant having a direct relationship, not with the bond principal (typically the general contractor), but rather with a subcontractor of the contractor furnishing the payment bond, must provide two notices to protect its bond rights. First, the claimant must serve the bond principal a written preliminary 20-day notice as provided for in A.R.S. § 33-992.01 (in other words, the same preliminary notice the claimant would serve on the contractor, owner and perhaps lender to protect its mechanics’ lien rights). Second, the claimant must provide a notice to the bond principal within 90 days from the date on which the claimant performed the last of the claimant’s labor or furnished or supplied the last of the material for which such claim is made, stating with substantial accuracy the amount claimed and the name of the party to whom the material was furnished or supplied or for whom the labor was done or performed.
No controversy exists regarding what the notices must state or to whom they need to be delivered. However, in the April 30, 2015 decision of Cemex Construction Materials South, LLC v. Falcone Brothers & Associates, Inc., the Arizona Court of Appeals addressed the statutory requirement of method of delivery. The statute states, after the description of the second notice, that “such notice shall be served by registered or certified mail, postage prepaid.” In this case, the bonding company argued that the registered or certified mail requirement applied to both notices, the preliminary 20-day notice and the post 90-day notice. The supplier Cemex, on the other hand, argued that because the preliminary notice requirement followed A.R.S. § 32-992.01, that the same statute should apply to the delivery method, which, for lien notices, can also be sent by first-class mail with a certificate of mailing, in lieu of registered or certified mail. The Court interpreted A.R.S. § 34-223 to require both notices to be served by registered or certified mail in order for the payment bond claim to be effective.
This decision shocked many subcontractors, suppliers and lien services that historically have sent all preliminary notices only by first-class mail, regardless of whether it applied to a licensed project or a bonded project. Indeed, a brief by Amicus Curiae (Friend of the Court) Arizona Rock Products Association in the case argued that the “industry has relied upon first class mail in conjunction with sending all preliminary 20-day notices for more than 30 years, since 1984, [and] the Court’s ruling could undermine all of the notices that have been sent in reliance upon this industry practice that are currently pending.” The Court stated “[w]e acknowledge that this opinion may have a negative practice on an apparently longstanding industry practice. But it is well-settled that we cannot legislate, and that our province is to construe the law as written.”
Since this above provision of the Little Miller Act is incorporated in Title 41 (state projects) and into A.R.S. § 33-1003 (payment bond in lieu of lien rights), the Cemex decision calls into question the enforceability of every such pending payment bond claim (in Arizona) in which service of the preliminary notice was not by registered or certified mail. However, all hope is not lost. The Court recognized that proof of actual receipt by the bond principal may overcome the failure of proper mailing. However, as that proof is very likely to be contested, the best practice for all contractors, subcontractors and suppliers on any Arizona projects in which they may want to pursue a bond claim is to serve preliminary notices by registered or certified mail, and not by first-class mail.
Arizona State Legislature Expands Prompt Payment to Design Professionals on Public Works Projects
by Jason Ebe
Arizona law has long protected the rights of contractors, subcontractors and suppliers to prompt payment. However, all such protections have not extended to design professionals. For example, in 2013, the Arizona Court of Appeals held in the case of RSP Architects, Ltd. v. Five Star Development Resort Communities, LLC, that Arizona’s private prompt pay statute, A.R.S. § 32-1129, did not apply to the benefit of the architects. In response to a push to extend statutory prompt payment protections to design professionals, the Arizona State Legislature passed legislation, approved by the Governor on April 13, 2015 and to be effective on July 3, 2015, to extend prompt payment protections to design professionals on public works projects. House Bill 2336 is known and may be cited as “the Arizona Design Professional Prompt Pay Act.”
Specifically, A.R.S. § 34-221, which applies to construction contracts with cities, towns and other public entities (but not the State or the Arizona Department of Transportation (ADOT)), has been amended to provide that the contractor’s prompt payment obligations to its subcontractors and suppliers now extends to its design professionals and the contractor’s subcontractors must similarly promptly pay their design professionals. In other words, payment is due to the design professional within seven days of receipt of payment by the contractor or subcontractor, as applicable, and the design professional is entitled to prompt pay interest of one percent per month (simple, not compounded) on late payments. As written, the amendment does not appear to affect contracts directly between a public entity and its design professional, but rather only design professionals subcontracted to the prime contractor or subcontractors.
For contracts involving the State, A.R.S. § 41-2577 was amended in similar fashion, in that a design professional contracted with the contractor or a subcontractor is now entitled to the same entitlement to prompt payment as a subcontractor, that is, payment within seven days of receipt of payment by the contractor or subcontractor, as applicable. In contrast to the Title 34 revision, A.R.S. § 41-2577(A) does address direct payments by the State to a contractor, but the revisions to this statute do not include language that the State must similarly promptly pay its design professionals, so the effective breadth of the amended A.R.S. § 41-2577 for State projects appears to be the same as A.R.S. § 34-221.
For projects involving the ADOT, A.R.S. § 28-411 was revised to require ADOT to pay a design professional an agreed amount or the reasonable value of services furnished pursuant to a limited notice to proceed from an authorized ADOT agent before the execution of a contract or contract modification. The statute does not otherwise grant any more expansive prompt payment rights to design professionals and does not grant any of the prompt payment rights described above in A.R.S. § 34-211 or A.R.S. § 41-2577.
Possible next steps that may be taken by design professionals towards extending their prompt payment protections include legislation to amend the statutes pertaining to a public entity’s direct contract with a design professional to provide for prompt payment by the public entity to the design professional, and/or legislation to amend the private prompt pay statute, A.R.S. § 32-1129, to address and perhaps legislatively overrule the RSP Architects decision. In the meantime, design professionals may continue to enforce their right to prompt payment by inclusion of proper contractual language. In other words, whether or not there is a statute that requires prompt payment of design professionals, they can nevertheless protect themselves by negotiating language into their contracts requiring prompt review and approval of billings, payment of those amounts due and notification of the bases of any payments withheld. For example, it will likely be enforceable in Arizona for the parties to write into a contract for design professional services the equivalent requirements of the private prompt payment statute, to be applicable to the design professional’s services. There is certainly no statute barring such language. But you must ask to receive.
Changes to Arizona Purchaser Dwelling Act Affect Sellers and Construction Professionals
by Jill Casson Owen
In its last session, the Arizona legislature amended the statutes governing Purchaser Dwelling Actions, A.R.S. 12-1361 et seq., and Homeowner Association Dwelling Actions, A.R.S. 33-2001 et seq., relating to claims against Sellers for alleged construction defects in homes. Some of the changes codify current Arizona case law, and in a couple instances, legislate a different outcome in the future. The changes benefit construction professionals by (i) specifying what constitutes a construction defect, (ii) requiring notice of reasonable detail of all alleged defects and (iii) establishing a Seller's right to repair or replace all such alleged defects prior to a purchaser filing any action that alleges construction defects. Other changes benefit purchasers by broadening the definition of “Seller,” lengthening the tolling period for statutes of limitations and repose, and prohibiting a Seller from requiring a release in exchange for repair or replacement. Additional changes amend scope, application, process and time periods. The statutory changes, which are described in more detail below, take effect July 3, 2015.
Changes in Scope or Application
Definition of Seller. The definition of “Seller,” was revised to include “construction professionals,” and broadly defined “construction professionals” to include subcontractors and suppliers. This change (i) codifies existing case law holding that a purchaser could bring a breach of warranty action against a builder even though the purchaser has no privity of contract (direct contract) with the builder, and (ii) statutorily overrules a 2013 Court of Appeals decision holding that lack of contractual privity precludes homeowners from asserting claims against subcontractors for breach of warranty of workmanship and habitability. Now, purchasers have the statutory right to sue subcontractors, suppliers and other parties defined as “Seller” directly for alleged construction defects.
Definition of construction defect and material deficiency. The legislature added a definition for “construction defect” which is defined as a “material deficiency” in the design, construction, manufacture, repair, alteration, remodeling or landscaping of a dwelling that is the result of one of the following: violations of construction codes, the use of defective material, products, components or equipment, or the failure to adhere to generally accepted workmanship standards in the community. The amendments added a definition for “material deficiency” which is a deficiency that actually impairs structural integrity, functionality or the appearance of a dwelling unit, or that is reasonably likely to cause such impairment in the foreseeable future if not repaired or replaced. This new definition means that minor issues that cause no impairment are not considered construction defects.
Effect of ADR provisions. Previously, because the article did not apply if the sales contract or community documents included reasonable alternative dispute resolution (ADR) provisions, a Seller could “opt out” of the statutes by including ADR provisions in the contract or community documents. This exception has been stricken. The ADR provisions still apply, and they become applicable after the repair and replacement process has been completed. This change now legislates a different result in the future for those contractors who have, in the past, successfully sought dismissal of purchaser dwelling actions based on the argument that the ADR clause in a construction contract divested the superior court of subject matter jurisdiction. The Seller’s election to enforce the ADR provisions does not negate, abridge or otherwise reduce Seller's right to repair or replace.
Right to Repair or Replace
Notice requirements. Purchasers may no longer send notices of defects that are representative samples. Instead, all alleged defects must be noticed in reasonable detail, all of which the Seller has an opportunity to repair or replace. The “reasonable detail” required in the notice of alleged construction defects has been expanded to include a description of the impairment to the dwelling. A Purchaser may, at any time including after a dwelling action has been initiated, amend the notice to include later-identified alleged construction defects, after which Seller’s right to repair or replace are applicable. If the matter is already in litigation, the court shall, upon request of the Seller, provide the Seller sufficient time to repair or replace the additional alleged construction defects. Notices of additional defects relate back to the original notice for purposes of tolling the statute of limitations and the statute of repose.
Notice of intent to repair. Sellers now have a statutory right, but not the obligation, to repair or replace alleged construction defects. The statutes formerly permitted Seller to make an offer to repair and the offer could be rejected by the purchaser; to the contrary, Seller is now permitted to send a notice of intent to repair or replace, which may not be rejected. Seller may exercise its right with respect to some, all or none of the alleged defects. A Purchaser may not file a dwelling action until the Seller has completed all intended repairs and replacements. Had this requirement been in effect then, there might have been a different outcome in a 2012 case where the defendant contractor had objected that the plaintiff homeowner had not responded in a timely manner and did not allow the defendant contractor to make repairs. In that case, the court ruled that since the plaintiff was not required to permit the contractor to make repairs, the lack of response was inconsequential and caused no prejudice. Under the revised statutes, the homeowner will be required to permit the repairs.
Monetary compensation; releases. A Seller may offer monetary compensation in addition to or in lieu of repair or replacement, however the Purchaser may reject such offer of monetary compensation. A Seller is not entitled to a release or waiver in exchange for repairs or replacement, however, the parties may negotiate for a release in exchange for monetary compensation or other consideration.
Third party repairs. Sellers may now be unable to perform their own repairs or replacement, because a Purchaser may request that the repairs and replacements be performed by someone other than the construction personnel involved in the construction or design of the dwelling. In such event, the Seller may select the alternate contractor, subject to Purchaser’s consent, which consent cannot be unreasonably withheld.
Changes in Applicable Time Frames
Previously, a Purchaser had to wait 90 days after giving Seller notice of defects before proceeding with any dwelling action, or, in the event Seller failed to respond to the notice only 60 days. Now, a Purchaser cannot proceed with an action while the repair and replacement process is pending. After receiving notice of defects from a Purchaser, a Seller has 60 days to respond, and an additional 35 days to commence repair or replacement after sending notice to the Purchaser of Seller’s intent to repair or replace. If a permit is required, the required time period becomes the later of 35 days or 10 days after receipt of the permit. Purchaser must wait an additional “commercially reasonable” period of time for Seller to complete its repairs and replacements. As before, if the Seller does not respond to Purchaser’s notice within 60 days, Purchaser may proceed with a dwelling action.
Failure to comply. If a Purchaser fails to comply with the statutes before bringing a dwelling action, the action shall be dismissed. If dismissed after expiration of the statutes of limitations and repose time periods, any subsequent actions are time-barred as to Seller and Seller’s construction personnel. If Seller does not comply with the requirements of the Purchaser Dwelling Act, and the failure is not due to Purchaser’s fault or force majeure, Purchaser may commence a dwelling action.
Tolling of statutes of limitations and repose. Previously the statute of limitations and statute of repose were tolled for only 90 days after a Purchaser sent a Seller notice of alleged defects, which meant that even if an offer to repair had been accepted, a Purchaser might need to file an action in advance of the expiration of the statutory expiration period. Now, the statutes of limitations and repose are tolled during the repair and replacement period plus an additional 30 days.
No award of fees and costs. A.R.S. § 12-1364, which provided for attorney fees, expert witness fees and costs to be awarded to the prevailing party, has been repealed in its entirety. The practical effect of this is that the recovery of attorneys’ fees, expert fees and costs will be in line with other existing Arizona law that allows for awarding of fees in more limited circumstances.
Admissible evidence. Previously, the notices and responses pursuant to the Purchaser Dwelling Action statutes were not admissible in court. Now, the parties’ conduct, as well as repair and replacement efforts, are all fully admissible.
Changes in Homeowner Association Dwelling Actions
Detailed notice to homeowners. With respect to homeowners association dwelling actions, the notice to all members no longer must include the manner of funding an action, but now must include a statement that describes the nature of the action and the relief sought, the expenses and fees that the association anticipates will be incurred, directly or indirectly, in prosecuting the action, including attorney fees, consultant fees, expert witness fees and court costs. The notice must also describe the impacts on the values of the dwellings that are the subject of the action and on those dwellings that are not.
Compliance with homeowner association documents. Changes to the statute stating that that an action may only be filed after the association has authorized the action pursuant to the homeowner association documents provide a clear indication that the statutory process does not pre-empt or supersede the homeowner association documents. In addition, the association has an affirmative duty to demonstrate compliance with the homeowner association documents. Prior to filing an action, the association is required to provide the same notice and afford Seller the same right to repair or replace as is required for a purchaser. A Seller now has express standing to assert the failure of an association to comply with the procedures prescribed in the homeowner association documents or the statutes.
 Lofts at Fillmore Condominium Ass'n v. Reliance Commercial Const., 218 Ariz. 574, 190 P.3d 733 (2008). [back]
 Yanni V. Tucker Plumbing, Inc., 233 Ariz. 364, 312 P.3d 1130 (2013). [back]
 See, for example, Smith v. Clouse Const. Co., LLC, 2012 WL 5333576. [back]
 Simms v. Nance Const., Inc., 2012 WL 2476354 (2012). [back]
Construction Bonds and Subguard Insurance
by Mark D. Johnson
In virtually all public projects (and in many private projects), the owner requires the general contractor to post a performance bond and a payment bond. Recently, in some cases, general contractors have obtained subcontractor default insurance or “Subguard” in lieu of or in addition to a performance bond or a payment bond. This article explains the purposes for, and use of, performance bonds, payment bonds and Subguard insurance and the differences between Subguard and performance bonds or payment bonds.
Construction bonds are not a form of insurance. A construction bond is a three-party agreement between a surety, principal and obligee. An insurance policy is a two-party agreement between an insurer and an insured. The bond is generally triggered when the principal defaults on its obligation to the obligee, and is declared in default. Unless the obligee somehow caused the default, the reason for the contractor’s default (e.g. principal's insolvency, abandoning the work, etc.) is usually irrelevant. In contrast, construction insurance coverage is typically triggered only by accidental events or occurrences.
A performance bond pays for pure economic loss, meaning the cost of completing the contractor’s obligation even if nothing is broken or destroyed. In contrast, construction insurance excludes coverage for completing construction contract obligations. Construction liability and property insurance policies generally provide no coverage for fixing or finishing defective or incomplete work or materials but instead usually cover only resulting physical damage to other items. For example, if a window was defectively installed, insurance does not typically cover the cost to replace the window. However, if the defectively installed window allowed water intrusion to damage drywall in the building, then insurance would typically provide coverage to repair the damaged drywall. In contrast, if triggered, a performance bond could provide coverage for the defectively installed window regardless of whether it caused damage to other elements of construction.
The principal on the bond is the party who requests the surety to issue the bond and whose obligations are guaranteed. For example, if a general contractor asks a surety to issue a bond to a project owner, the general contractor is the principal on the bond.
The obligee is the party that requires the principal to obtain the bond and who receives the benefit of the guarantee. If the bond is obtained by a general contractor for an owner, the owner is the obligee. A surety is the party who issues the bond that guarantees the obligations of the principal.
In addition, virtually all sureties require the principal on the construction bond (and sometimes the principal’s owners and officers) to guarantee and indemnify the surety for payments made under a bond. As a result, under most construction bonds, if the surety makes payment of a claim under a bond, these indemnitors will be liable to the surety for the amount of the payment.
Surety bond premiums are based on a percent of the maximum amount for which the surety might be liable which is typically the contract price. Premium percentages range from around one percent to five percent, with the most credit-worthy contractors paying the least. The payments required for the bonds are passed through to the owner in the contract price and for this reason, owners on some, typically smaller, private projects choose not to incur the cost of surety bonds and instead assume more risk in the event of a contractor default, in terms of its performance or its failure to make payments to its subcontractors and suppliers.
A performance bond ensures contract completion in the event of contractor default. Generally, if the contractor defaults, the surety must hire another contractor to complete the contract or compensate the owner for the financial loss incurred from the original contractor’s default. In contrast, a payment bond ensures suppliers and subcontractors are paid for their work and materials furnished to the project, should the principal on the payment bond default. The language of the performance and payment bonds and the applicable statutes must be carefully analyzed to determine if the claimant and the claimant’s claims are covered by the bond.
The surety’s obligations under a performance bond are not triggered until the contractor is in default and the owner has provided the surety with a declaration that the contractor is in default in accordance with the terms of the bond. The declaration of contractor default may include: copies of the contract, all change orders, an up-to-date summary of the contract accounting and a detailed explanation of the grounds for declaring the contractor in default together with supporting evidence. Although requests from the surety during the investigation may seem onerous, it is generally in the owner’s interest to promptly comply, because failure to comply may be grounds for the surety to claim that it is not liable under the bond due to the owner’s failure to cooperate.
Upon receipt of a declaration of contractor default, the surety under a performance bond has a duty to investigate the alleged default and is entitled to a reasonable period of time to do so plus a reasonable period to remedy any default. If the investigation confirms the default and no legitimate defense, the surety has a duty to complete the work in the most cost effective way. Generally, the surety’s options are: assist the principal to remedy the default; contract with another contractor to finish the work; or pay the owner the amount for which the surety is liable up to the penal amount of the bond. Alternatively, the surety can have the owner put the remaining contract work out for bid and then pay the owner the amount to complete the remaining work, minus the amount remaining unpaid under the original contract. This last approach is sometimes the preferred option for many sureties.
Common defenses to performance bond claims include: that the contractor/principal is not in default; that the construction contract has been materially altered since the surety issued the bond; that the owner has acted to the prejudice of the surety; and/or that the claim is barred by the limitations period stated in the bond or applicable statute. A surety may assert that the contractor/principal is not in default because: the uncompleted work is outside the scope of the original contract; the owner consented to the alleged default; the owner improperly withheld progress payments or was in material breach; and/or the contractor could not work because necessary precedents were not provided (e.g., drawings and specifications were incomplete; or incomplete or defective precedent work or material to be supplied by the owner or others was not provided).
The surety bonds a specific contract and takes the risk that the contractor will not perform under that contract. A material or cardinal change to the contract without the surety’s consent may release the surety. A material change may occur if the contract scope has been substantially altered to change the nature of the contract or the owner has caused a significant delay to the original construction schedule.
Depending on the language of the payment bond and any applicable statute, a claimant under a payment bond may be required to have a direct contract with the principal of the payment bond and usually the claim must be for labor or material or both which was used or reasonably required for use in the performance of the bonded contract.
In some cases, an owner may ask a general contractor to provide or the general contractor may choose to provide Subcontractor Default Insurance or Subguard in place of or, in addition to, a payment bond or a performance bond. Subguard protects a general contractor from a subcontractor default. In 2012, Subguard was used by 40 of the top 50 builders. In 2012, greater than $50 billion dollars of work was covered by Subguard.
Subguard provides the general contractor with the ability to immediately respond to a subcontractor’s default because the general contractor determines when the subcontractor is in default and triggers potential coverage under the Subguard policy. Therefore, Subguard provides a general contractor with a mechanism to limit the impact of a subcontractor’s default and any resulting delay to project completion. The cost of coverage under a Subguard policy is typically equivalent to that of a payment or performance bond providing coverage of a similar amount. General contractors are responsible for gathering financial data regarding each subcontractor and providing it to the insurer under a Subguard policy.
Subguard policies only protect against subcontractor default. Subguard policies do not protect subcontractors or suppliers against the failure of owners, general contractors, or construction managers to make timely payments to subcontractors or suppliers. Unlike a performance bond where the surety has the primary obligation to step in and remedy a default (i.e., takeover the project, finance the principal, or pay the obligee), under Subguard, the insured general contractor assumes responsibility for taking over the project and managing the defaulting subcontractor’s obligations. Under Subguard, the insured general contractor pays the up-front costs of replacing the defaulting subcontractor and then seeks reimbursement for those costs from the carrier under the Subguard policy. Due to the requirement of this up-front cash expenditure, Subguard policies are typically used only by larger general contractors with significant resources and may not be appropriate for smaller contractors with more limited resources.
Disgorgement Penalty for Unlicensed Contractors in California
by Jeffrey M. Singletary
California has some of the toughest penalties in the country for unlicensed contractors. An unlicensed contractor is not just a contractor without a license, but could also be a contractor who is not correctly licensed or a contractor who has the correct license but whose qualifying individual – a responsible managing officer (RMO) or responsible managing employee (RME) – is not as involved in the operations of the contractor to maintain proper licensure.
An unlicensed contractor, for example, may be subject to both civil and criminal penalties such as one-year imprisonment and/or $10,000 fine for intentional use of another person’s license with intent to defraud or a civil penalty of $200/day per employee performing work for unlicensed contractor. In addition, California Business & Professions Code Section 7031 precludes an unlicensed contractor from maintaining a lawsuit to recover compensation for its work.
But perhaps the most onerous penalty of all is that an unlicensed contractor may be required to disgorge any compensation it has previously been paid for performing work requiring a license. California Business & Professions Code Section 7031(b) sets forth the rule that if a contractor is not properly licensed at any point during the construction project, the party who paid the contractor who was unlicensed is entitled to sue that contractor to recover all sums it paid to that unlicensed contractor in relation to the entire project.
Subject to very limited exceptions, California courts have supported this harsh result and it is clear that this policy is now firmly entrenched in the law. Note the following examples:
In Wright v. Issak (2007) 149 Cal. App. 4th 1116, a contractor sued two homeowners for unpaid amounts in connection with a home remodeling project. The homeowners responded with a cross-complaint against the contractor seeking, among other things, the return of all amounts they had paid him on the ground he did not have a valid contractor's license. Although the contractor held a California contractor’s license, he grossly underreported his payroll to the State Compensation Insurance Fund, and never obtained workers compensation for his crew working on the home remodeling project. Both the trial court and court of appeal agreed with the homeowners that, under California Business & Professions Code section 7125.2, the contractor’s license was automatically suspended for his failure to obtain workers compensation insurance for his employees. Both courts rejected the contractor’s argument that such suspension could not take effect until the contractor received a notice of suspension from the registrar of contractors. Because the contractor failed to properly report his payroll and obtain insurance for his workers before, during and after the home remodeling project, the contractor was not properly licensed. The homeowners were entitled to recover all amounts paid to the contractor under Business & Professions Code section 7031(b).
In Goldstein v. Barak Construction (2008) 164 Cal. App. 4th 845, homeowners entered into a contract with Barak Construction to remodel their home in mid-June 2004. Barak began work on the project right away, but did not obtain a contractor’s license for the first time until mid-September 2004. Homeowners paid Barak $362,629.50 before Barak abandoned the incomplete project. Homeowners then filed suit under Business and Professions Code Section 7031(b), seeking a writ of attachment against Barak for the full amount paid, plus an amount for attorneys’ fees and costs. The trial court granted the writ of attachment. Though the court recognized the draconian nature of the disgorgement action, the Contractors’ License Law allows recovery of all compensation paid to the unlicensed contractor regardless of whether the amounts paid are ultimately retained by it. And the court of appeal rejected the contention that the amount of the attachment should be reduced by the amount earned by Barak after it became a licensed contractor. The court reiterated that to recover for work performed on a project, a contractor must be licensed at all times during which it performs the contractual work.
Finally, in White v. Cridlebaugh (2009) 178 Cal. App. 4th 506, plaintiffs and a contractor entered into a contract to build a new house. Within a few months after the contract was entered, the relationship soured. Plaintiffs terminated the contract and the contractor recorded a mechanics’ lien against the property. Litigation ensued between the plaintiffs and contractor. The RMO for the contractor was an individual named Robert Diani. At trial, Diani testified that in 2004 he had turned over all dealings and daily work of the business to Terry Cridlebaugh. Since that time Diani had been living in Peru. Cridlebaugh did not hold a contractor’s license. Based upon these facts, it was held that the contractor’s license was automatically suspended. Therefore, the contractor was barred from suing to recover for its work, and the contractor was required to repay all previous compensation it had received from the plaintiffs.
The results from these cases are clear. If a contractor is unlicensed at any point during its construction work on a project, the general rule is that not only will the contractor be unable to sue for any sum it contends it is owed for the work, but it may also be required to actually disgorge all sums it received in relation to the entire project, including for work performed while the license was properly in place. Despite this seemingly harsh result, the language and intent of these statutes are clear and will be enforced by the courts. Contractors and subcontractors are well advised not to perform any work on any construction project without a valid California contractor’s license in place at all times.
What Happens When the Construction Contract is Not Signed and the Work is Underway?
by Daniel R. Frost
Although it seems self-evident that participants to a construction project would not want to commence work without first obtaining signatures on a written contract, it happens all too frequently, even on big projects. At times, the parties simply fail to sign the contract out of inadvertence. Other times, the parties begin performance while exchanging drafts and never get to a final agreement on which document expresses the agreement. When that happens, and disputes arise regarding what terms and conditions, if any, bind the parties, frustration is inevitable. Beyond that, and more importantly, the parties are often held to terms and conditions and assumptions of risk they believe they neither bargained for nor agreed to regarding the project.
There are a couple of situations where this potential for added risk becomes evident. The first arises when the agreement is simply not executed. The second occurs when work is begun while the parties are still exchanging drafts, and the parties never come to an agreement regarding which writing will control. Under both sets of circumstances, the parties face liabilities that perhaps neither expected. Moreover, the parties may face additional legal costs while counsel argues over what terms, conditions and assumptions of risk control. Some cases from Colorado and elsewhere illustrate these risks.
No Signed Contract
At the outset, it should be pointed out that, notwithstanding the lack of a signed writing between the parties, an enforceable contract may exist. Common law contract principles allow for the formation of contracts without the signatures of the parties bound by them. E-21 Engineering, Inc. v. Steve Stock & Assoc., Inc., 252 P.3d 36 (Colo. App. 2010) (enforcing the terms of an unsigned subcontract supplied by a general contractor). Thus, if both parties mutually assent to the essential terms of the agreement, a contract may be legally enforced, despite the absence of a signature. Lease Colo-Tex Leasing, Inc. v. Neitzert, 746 P.2d 972, 973 (Colo. App. 1987).
In E-21 Engineering, for example, a general contractor sent a subcontractor a letter of intent and a subcontract that included an arbitration provision. However, neither party signed the subcontract before the subcontractor began work. The general contractor subsequently attempted to rescind the letter of intent and claimed that an enforceable agreement did not exist because neither party executed the subcontract. The subcontractor argued that rescinding the letter of intent amounted to a breach of contract and sought to have the arbitration provision enforced. The Colorado Court of Appeals agreed with the subcontractor, finding that the subcontract was enforceable despite not being signed and enforced the arbitration provision. The court explained that the lack of a signature did not invalidate an otherwise enforceable agreement; if the parties mutually agreed to the terms prior to performance, the terms of the agreement govern.
The E-21 Engineering case teaches that a court may enforce in whole the terms of an unsigned document exchanged by the parties prior to performance. It further implies that if the court finds that the parties mutually agreed to a set of written terms immediately prior to commencement, the parties are bound to those terms, even if the writing is unsigned. Moreover, that unsigned writing could be as imprecise as a general letter of intent or even a memo expressing the barest outline of a contract. As long as the essential terms of an agreement are in writing, courts will supply missing terms by custom, implication or presumption. Winston Financial Group, Inc. v. Fults Management Incorporated, 872 P.2d 1356 (Colo. App. 1994).
E-21 Engineering also teaches that commencing performance without a signed contract can result in a party being held to terms to which it had not necessarily agreed. In other words, commencing performance without a written contract can be considered acceptance of unilaterally proposed contract terms. George Pridemore & Son., Inc. v. Traylor Brothers, Inc., 311 S.W.2d 396 (Ky. App. 1958); Am. Aluminum Products Co., Inc. v. Binswanger Glass Co., 194 Ga. App. 703, 391 S.E.2d 688 (1990).
In Pridemore, for example, a subcontractor submitted a bid for certain HVAC work with the express understanding that air conditioning would be omitted from the scope of the work. Before the subcontractor commenced performance, however, the general contractor issued a purchase order to the subcontractor that clearly and unambiguously included air conditioning work. The subcontractor did not sign the purchase order, but commenced work on the project without objecting to the purchase order’s terms. A dispute arose when the air conditioning was not installed and the subcontractor sued the general contractor, alleging that no valid contract existed because the parties had not mutually assented to the terms of the agreement. The court disagreed with the subcontractor and held that the subcontractor assented to the terms of the general contractor’s purchase order by commencing performance with knowledge of the terms contained therein.
Similarly, in Binswanger Glass, the Georgia Court of Appeals found that a general contractor’s purchase order containing terms at variance with a subcontractor’s initial proposal was a rejection and a counteroffer, not an acceptance. The court then found that the subcontractor accepted the counteroffer by commencing performance. Therefore, because the subcontractor did not object to the terms of the contractor’s purchase order before commencing performance, the general contractor’s purchase order constituted the binding contract between the parties. Indeed, an attempt to accept a bid on terms materially different than the original bid is simply a counteroffer, not an acceptance. Haselden-Langley Constructors, Inc. v. D.E. Farr & Associates, Inc., 676 P.2d 709 (Colo. Ct. App. 1983).
Commencing work prior to signing a contract can be hazardous, even when the parties have the best of intentions, as can be seen from the above-mentioned cases. The much better practice is to have a signed, written agreement in place before performance begins.
The Federal and Nevada False Claims Acts
by Craig S. Denney and Carrie L. Parker
Contractors are no strangers to the courts of justice. Litigation between contractors and owners frequently occurs when a project does not get completed on time or the work does not comply with the Contract Documents. The disputes are typically litigated as breach of contract lawsuits. Contractors, however, who do business with the State of Nevada or the Federal Government should be aware that an inaccurate billing or claim, or worse, padding an invoice or claim, can carry serious consequences. Even if the State of Nevada or the Federal Government doesn’t catch the inflated bills, there is also a possibility that an employee or former employee might report the inaccurate bills to the State or the Federal government.
The Nevada False Claims Act is codified in NRS Chapter 357 and is known as the whistleblower statute. It is intended to be a tool to fight fraud against state and local governments and is modeled after the Federal False Claims Act (31 U.S.C. §§ 3729-3733). Both Acts reward whistleblowers who report fraud committed against the government. While many cases brought under the Acts involve Medicare or Medicaid fraud, the laws apply to any type of false or fraudulent claim submitted to the government for payment or approval including construction claims. The case may be brought by a whistleblower or by the government. E.g., NRS 357.070 (“[T]he Attorney General “shall investigate diligently any alleged liability pursuant to this chapter and may bring a civil action pursuant to this chapter against the person liable.”)
Cases brought under both the Federal and Nevada Acts can result in judgment in the amount of up to three times the amount of damages plus a civil penalty of $5,500 to $11,000 per false claim. 31 U.S.C. § 3729(a)(1); NRS 357.040(2). Both laws require a knowledge component, which could be shown by having actual knowledge, acting “in deliberate ignorance of whether the information is true or false” or acting “in reckless disregard of the truth or falsity of the information.” 31 U.S.C. § 3729(b)(1); NRS 357.040(3).
While most people think False Claims Act liability applies to situations where a person knowingly presents a false claim or knowingly presents a false record that is material to a false claim, the False Claims Act also prohibits reverse false claims and conspiracy. 31 U.S.C. § 3729(a)(1)(C); NRS 357.040(1)(i).
A reverse false claim is when a person “[k]nowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the State or a political subdivision” (31 U.S.C. § 3729(a)(1)(G); NRS 357.040(1)(g)) or “[i]s a beneficiary of an inadvertent submission of a false claim and, after discovering the falsity of the claim, fails to disclose the falsity to the State or political subdivision within a reasonable time.” NRS 357.040(1)(h). An example would be discovering that a billing error had been made resulting in an overpayment from the government and failing to report it and repay it. As noted above, this could result in triple damages and a $5,500 to $11,000 penalty for each overpayment.
The conspiracy provision of both acts provides liability for conspiring to commit any of the acts set forth in 31 U.S.C. § 3729(a)(1) (A), (B), (D), (E), (F), or (G) or NRS 357.040(1), respectively. These laws do not require the person to have personally received any payment based on a false claim. In Nevada, “[a]n actionable civil conspiracy ‘consists of a combination of two or more persons who, by some concerted action, intend to accomplish an unlawful objective for the purpose of harming another, and damage results from the act or acts.’” Consolidated Generator-Nevada, Inc. v. Cummins Engine Co., 114 Nev. 1304971 P.2d 1251 (1998) (quoting Hilton Hotels v. Butch Lewis Productions, 109 Nev. 1043, 1048, 862 P.2d 1207, 1210 (1993) (citing Sutherland v. Gross, 105 Nev. 192, 196, 772 P.2d 1287, 1290 (1989))). Thus, a consultant who conspired with a contractor to defraud the government and personally did not receive any funds traceable to the government could nonetheless be liable under the Nevada False Claims Act.
The Nevada False Claims Act has been modeled after the Federal False Claims Act, and both of these laws have been strengthened within the last six years to crack down on fraud by government contractors. Contractors need to be vigilant and take steps to avoid overbilling and inflating claims. If an overpayment may have occurred, even inadvertently, contractors should also determine whether and how best to report the overpayment.
Utah Legislative Update
by Mark O. Morris
The 2015 Legislative Session in Utah came to a close earlier this year and the lien laws once again got a makeover, although not as significant as prior changes the past few years. Prior to this session, the biggest change affected the priority of liens. It remains the best practice to eliminate the risk of a worthless paper judgment by filing a pre-lien notice on Utah’s State Construction Registry (SCR). By doing so, claimants provide themselves with lien and bond rights that in most circumstances increase their chances of collecting on the judgment or forcing a settlement. Last year, changes were made so that a construction lien relates back to, and has a priority date as of the first pre-lien notice filed on the project. So, any trust deed or mortgage secured after the first pre-lien notice would be subordinate to all lien claimants. This may only be temporary, as a lender may take priority over the first pre-lien notice by paying those lien claimants in full for all construction work performed before the trust deed is recorded. Prior to last year, under the 2011 law, lien claimants who were paid in full by the lender up to the date of recording the trust deed were required by title companies to withdraw their pre-lien notices from the SCR. This created problems when that lien claimant continued to do work on the project, thus making it necessary for them to have to re-file a pre-lien for future work. Now, there is no longer a requirement to withdraw the SCR filing when the claimant is paid by a lender up to the date of the recording of the trust deed. This eliminates the hassle of having to re-file a pre-lien notice and possibly being subject to the five day late penalty. Thus, people filing pre-lien notices are not required to withdraw them, even if a bank or title company demands that they do so.
The most noteworthy changes in 2015 concern disposing of purportedly invalid or excessive liens. There has been a good deal of litigation in Utah over what constitutes a “wrongful lien,” and this change provides some help. Under House Bill 46, now law in Utah, if a lien claimant files a lien without a pre-lien notice or with a defective pre-lien notice, the owner has the ability to file a petition with the district court to nullify and void that lien. This is an expedited process to remove the lien in a matter of weeks. Prior to filing a petition to nullify a lien, an owner must provide a safe harbor notice to the lien claimant with an opportunity to withdraw the lien within 10 days of the notice. If they fail to withdraw the lien, then the owner may file the petition with the court and obtain an expedited hearing to determine the validity of the lien. The prevailing party is entitled to attorney fees and costs incurred in the petition action.
In addition, if a lien notice claims an amount that is excessive, there is a new procedure available for challenging this as well. For residential projects in which the amount at issue is less than $50,000, the parties can agree to an arbitration process. Candidly, imposing an arbitration process into the mix of resolving a lien dispute may not offer much relief to the parties, as they are required to share the expenses of the arbitrator and the rules of civil procedure and rules of evidence still apply. If a party disagrees with an arbitrator’s decision, a trial de novo in district court is available after the parties are given 60 days more to do additional discovery. While efforts to make lien dispute resolution more efficient should be applauded, it appears that one of this year’s changes only added more hoops to the resolution process. However, if the added hoops do in fact have the effect of further discouraging parties from engaging in a formal resolution process, then perhaps the goal of reducing disputes is closer to being met than originally appears.