Written by Murtaugh Law

California Labor Code § 218.7 (AB 1701): How does this new law impact general contractors, subcontractors and project owners?

On October 14, 2017, Assembly Bill (AB) 1701 was signed into law as California Labor Code § 218.7. This law imposes potentially significant liability on general contractors for their subcontractors’ failure to pay wages, fringe, or other benefits to laborers. The following is a brief overview of AB 1701’s application:

• Applies to construction contracts “for the erection, construction, alteration, or repair of a building, structure, or other private work” entered on or after January 1, 2018.

• Makes general contractors (or direct contractors) liable for subcontractors’ failure to pay wage, fringe, or other benefit payments or contributions (at any tier) including subcontractors’ failure to pay any interest incurred on such wages, fringe, or other benefits, but does not extend to penalties or liquidated damages.

• Extends claim rights to unpaid wage, fringe benefit or other benefits for labor performed on the project to third parties on the claimants’ behalf (or example, Labor Commissioner, joint labor-management cooperation committees or union trust funds).

• For public works contractors that are required to comply with State prevailing wage laws, there is less operational impact. Unpaid subcontractor workers on public works projects already have a legal right to pursue the general contractor’s project payment bond for unpaid wages. The general contractor is ultimately responsible to reimburse the surety for any payments. However, the contractor must be mindful that under AB 1701 the worker now has a direct cause of action directly against the general contractor, even though those parties do not have a contract with each other.

• Procedurally, claimants have one year from the earlier of the following dates to file actions against the direct contractors, when:

1. A Notice of Completion of the direct contract is recorded;
2. A Notice of Cessation of the direct contract is recorded; or
3. The work covered by the direct contract is actually completed.

• Attorneys’ fees and costs, including expert witness fees, shall be awarded by the court to prevailing third party claimants and joint labor-management cooperation committee claimants in any actions under this section; however, if the contractor prevails in the action, there is no reciprocal attorneys’ fees and costs provision.

Impact on General Contractors

General Contractors can take several steps to shift the burden of this liability and protect themselves both contractually and operationally.

From a contract perspective

1. Broad contractual indemnity rights: General contractors can include broad indemnity provisions that include claims arising from the subcontractor’s failure to pay wages and fringe benefits to laborers on the project. General Contractors can also require subcontractors to include a similar provision in their own contracts with sub-subcontractors that would require lower tier subcontractors to also defend and indemnify the general contractor for claims arising from their respective employees’ work.

2. Audit: Include an audit provision requiring subcontractors and sub-subcontractors to provide payroll records (at minimum, information set forth in Labor Code section 226) and project award information, regularly and/or upon request, with specific deadlines for such production, as subdivision (f) does not specify what is untimely. Failure to timely provide the records could be grounds for termination.

3. Withholding and back-charges: Include withholding and back-charge provisions in contracts that would allow general contractors to withhold or charge back the subcontractors for disputed amounts, for claims brought against them, and for failure to comply with the audit, bond, and guarantee requirements.

4. Require payment bonds from Subcontractors: General contractors may require subcontractors, and their sub-subcontractors, to provide payment bonds. The inability or unwillingness to provide a bond may be indicative of a subcontractor’s financial distress.

5. Personal Guarantees: Depending on the size of the project and the subcontractor, require personal guarantees from a subcontractor’s owners, partners or key personnel.

From an operations and management perspective

1. Monitor subcontractor payroll records throughout the Project: Most private works contractors do not actively monitor subcontractor payroll records during a project. With the passage AB 1701, it is incumbent on general contractors to request these payroll records and review them throughout the project to make sure the subcontractor is paying the wages and fringe benefits to assess compliance and mitigate potential risks. Records similar to certified payroll reports required on prevailing wage projects should be required. While a subcontractor’s failure to provide these records will not serve to relieve the general contractor of any potential liability under this section, the failure will serve as grounds for the general contractor to withhold as “disputed,” all sums owed until the subcontractor provides the requested records or to terminate the non-compliant subcontractor.

2. Pay subcontractors timely for undisputed work: Nothing in this AB 1701 alters the general contractor’s obligation to timely pay its subcontractors on the project or otherwise face potential prompt payment penalties. Unless there is a sufficient basis to withhold funds as “disputed,” contractors should continue to timely pay their subcontractors.

3. Select financially secure, trustworthy subcontractors: It is critical that general contractors continue to be selective in choosing subcontractors and should engage subcontractors who have a proven track record or demonstrate financial solvency.

Impact on Owners

Owners must be cautious in selecting the general contractor and ensure the general contractor is cautious and selective in choosing subcontractors to perform work on the projects. Nothing in AB 1701 alters the owner’s obligation to timely pay the general contractor. Owners should continue to timely pay their general contractors or otherwise face potential prompt payment penalties.

Impact on Subcontractors

Subcontractors at every tier must keep and maintain accurate payroll records in order to: (1) provide such records upon the general contractor’s request, and thereby avoid payment withholds over “disputed” sums; and (2) have accurate documentation to defend against any potential claims.

Every contractor and project is different and a “one size fits all” approach to contracting in California’s constantly evolving construction and legal landscape is rarely feasible. If you would like to discuss the effect of AB 1701 or how to update your contracts to protect your company from the potentially significant impacts of this bill, please contact Lawrence A. Treglia, Jr., and/or Jeffery M. Suckiel at (949)794-4000.