SUBCONTRACTS AND SUBCONTRACTORS
By: Brian S. Case, Esq.
PART A. General Background and Contractual Framework of Subcontractors and Subcontracting
§ 35.01 Scope of Chapter
This chapter shall examine the use of subcontracts and subcontractors in the development and construction process in California. This chapter is divided into three parts. It will begin by explaining the traditional role and use of trade subcontractors in performing and executing the construction work undertaken in the development process as well as the principal industry forms and their use in the industry for the purposes of subcontracting. After some discussion and exploration of significant contract provisions inherent in most subcontract forms, this chapter will then examine the specifics of the legal relationships between the players to the development/construction process; subcontractors, owners, general contractors, lenders and design professionals.
In this chapter particular focus will be placed on how the statutory scheme and case law will treat the various parties to the development/construction process as it relates to specific disputes in which the parties may find themselves placed. Particular attention has been paid to organizing this chapter to discuss the legal treatment given to the subcontracting process, depending on whether the subcontractor is contracting with the developer, owner, general contractor, or others.
§ 35.02 Subcontractor’s Role in the Construction and Development Process
[1]–Traditional Roles
The construction of improvements to real property has traditionally been performed at the trade level by subcontractors. Although owners of construction/development projects have almost always employed professionals such as architects/engineers, construction managers, and, traditionally, utilized the services of general contractors, the actual work has been performed at the trade level primarily by subcontractors. +[ See 1, STEIN CONSTRUCTION LAW 3.01 [1], [b],[iii] (Matthew Bender 1991)]+
The use and employment of trade subcontractors for the undertaking of the actual construction work is undoubtedly an outcropping of necessity. As construction methods and techniques/projects became more and more complex, the persons performing the hands-on construction work were required to possess more and more expertise and greater levels of sophistication. To meet these demands, contractors became more and more specialized forming not only specific trades within the construction industry but even sub-specialties within each trade.
In order to maintain order and cohesion in the development\construction process which often requires a dozen or more such trade subcontractors, it has become imperative that the legal instruments and relationships between the parties be of equal sophistication. What follows is a detailed discussion of the current instruments and legal relationships that have evolved from the use of subcontracting in the development/construction process.
[2]–Trade Contractor and Suppliers Compared
It is important to distinguish between subcontractors who undertake the actual performance of the work already contracted to be performed by another and suppliers who, by definition or design, undertake no work but merely provide materials to be incorporated into the work by the trade subcontractors. Unlike true subcontractors, material suppliers do not require licensing since they generally do not significantly provide jobsite services. +[ Bus.& Prof. Code Section 7052]+ Whether a particular entity will be considered a subcontractor or supplier will depend for the most part upon the nature of the circumstances. +[Thisen v. County of Los Angeles (1960) 54 Cal.2d 170, 352 P.2d 529, 5 Cal. Rptr. 161]+ This subject as it relates to Mechanics Liens is treated more fully under Chapter 63. As will be discussed in great detail below, owners and general contractors may, from time-to-time, contract not only with trade subcontractors but also with suppliers of materials for direct incorporation into the work by either the general contractor’s forces or other trade subcontractors.
In the traditional development/construction setting, most often the materials to be incorporated into the work are purchased by the particular subcontractor performing the particular trade for which the materials are needed. Normally this allows the subcontractor who probably purchases large quantities of materials for use on other projects to take advantage of price savings resulting from the purchase of large annual quantities.
However, in addition to the traditional setting, there may be instances where the owner or general contractor has chosen to purchase directly itself the materials to be installed by a subcontractor. From a practical matter, there may be a number of reasons why an owner or general contractor may choose to contract directly with the material supplier rather than rely upon a subcontractor to procure the materials that are going to be used and consumed in the development project. For example, an owner or general contractor may decide to contract directly with a material supplier if the owner or general contractor has an established account with that supplier and is able to obtain preferred rates. Another reason may be where, because of the particular schedule involved in the construction project, the owner or general contractor is better equipped for handling the materials that are necessary for the trade subcontractor to meet the needed delivery schedule for the work.+[For a more detailed discussion of the importance and significance of scheduling see § 35.07 below.]+ No matter what the reason for any particular entity’s decision to undertake the contract with the material suppliers, it should be pointed out that it is unlawful to do so for the purpose of obtaining money back from the supplier as a “kickback”. +[Cal. Pen. Code Section 532e]+
However, just because an owner or general contractor contracts directly with a supplier, does not mean that the supplier is a subcontractor. Instead, the material supplier who contracts directly with the owner or general contractor and who performs no services toward installation of its materials remains merely a supplier and will be treated as such under most any applicable legal scrutiny. +[Thisen v. County of Los Angeles (1960) 54 Cal.2d 170, 352 P.2d 529, 5 Cal. Rptr. 161]+ As will be discussed later, the industry has developed distinct legal forms of contracts for use to purchase materials rather than subcontracting services.+[See Section 35.03 [3] Discussion of Industry Forms and Contract Terms]+
[3]–Subcontractors Modern Role as Contractor or Design- Build
[a]–As a Contractor
As discussed above, traditionally trade subcontractors have been utilized as the primary means of subcontracting out the work to be completed in the development\construction process. +[See 1, STEIN CONSTRUCTION LAW 3.01 [1], [b],[iii] (Matthew Bender 1991)]+ This traditional approach, in modern times, still accounts for the substantial majority of construction development projects in California. Under this role the subcontractor puts into place the work as called for in the plans and specifications that are provided it from the design professionals employed by the owner. For example, an electrical trade subcontractor is usually given a set of electrical plans and technical specifications designed by an electrical engineer and reviewed by the project architect. In other words, it is the design professional’s duty to design the work to be performed +[SEE 1, STEIN CONSTRUCTION LAW, 5.04 (Matthew Bender 1991)]+ and the trade subcontractor’s duty to construct it as designed +[Cf. Kurland v. United Pacific Insurance Company (1967) 251 Cal.App.2d 112, 59 Cal.Rptr. 258 (contractor not liable for defective system where it followed the plans and specifications given by the designer)]+.
[b]–Subcontractor As a Design-Build Contractor
In modern times, in addition to the use of trade subcontractors in the traditional manner, owners and contractors have also called upon subcontractors to facilitate additional functions in the development process. One such function includes the use of subcontractors in a design-build capacity.+[See Wyner v. Buxton (1979) 97 Cal. App. 3d 166, 158 Cal. Rptr. 587.]+ Subcontractors who are asked to design parts of their work are to some degree taking on some of the duties previously held by the architects and engineers which therefore limits the liability protections previously afforded them when the work they install does not operate fully due to design errors. +[See 1, STEIN CONSTRUCTION LAW 5.01 (Matthew Bender 1991)]+ Although the details of the design build process are too complicated for a complete treatment here, design-build issues related to subcontractors are explored in Sections 35.04 [2] and 35.06 [4] only as it relates to licensing issues and contracting terms.
§ 35.03 Methods and Parties to Subcontracting
[1]–General Background
There are many methods and variations of contracting for the services of trade subcontractors to perform the actual construction work undertaken in a development/construction project. +[See 1 STEIN CONSTRUCTION LAW 3.01 (Matthew Bender 1991)]+ In Part B below, we will discuss the issues concerning contracting and how the industry has responded to disputes between the trade subcontractor and the general contractor. In Part C below, we then discuss the legal issues surrounding the relationship between the subcontractor or the owner or other third parties under both a scenario where the owner has contracted directly with the subcontractor as well as general common law analysis of the legal relationship between a subcontractor and owner or other third party where they are not in direct privity.
No matter who has been selected to contract with the trade subcontractors, as a result of the substantial majority of the work being undertaken by trade subcontractors, the construction industry has developed a number of approaches in structuring the legal relationship between the parties to a construction project.
Generally speaking, a typical construction project, if there is such a thing, would include a hierarchy of players to the development process as follows:
- Owner Architect/Engineer
- General Contractor
- Subcontractor (various trades)
- Sub-subcontractor or supplier
- Supplier
Of course, as discussed above there may be a variety of variations on this organizational framework.
In most instances the parties will execute express contracts or legal instruments between each of the various levels of these players. Even where there is an absence of an express agreement however, the law will often imply certain rights and responsibilities between these players and these implications are discussed throughout this chapter.+[See e.g.Higgins v. Desert Braemer, Inc. (1963) 219 cal.App. 2d 744, 33 Cal.Rptr. 527 (recovery for reasonable value of work and labor even though no formal written contract)]+
[2]–Legal Instruments of Subcontracting
In order to formalize the legal relationships between the above parties, the players in most instances will utilize a formal subcontract form under which the terms and conditions of the contractors are delineated in great detail either expressly or by reference to other documents. Since subcontracting has probably been used as far back as the construction of the Great Egyptian Pyramids, there has developed a variety of industry forms which have addressed the terms and conditions of a subcontractors performance. Of course, since some industry associations are stronger than others a particular forms treatment of any specific issue may be shaded by the perspective of the specific industry group which has developed the form being utilized. The details of these forms, the prospective they come from, and the treatment of particular noteworthy issues by express terms and conditions are discussed in subsection [3] below.
To the extent the owner or general contractor is contracting directly with a material supplier, it is likely that a purchase order form will be utilized rather than a subcontracting form. A fair example of a material supplier purchase order form can be found in the Associated General Contractor of California, forms AGCC-6 and AGCC-7 (See Appendix following) . Many contractors in California have standardized their subcontracting forms to apply to both subcontractors and material suppliers but a supplier should be wary of executing any such standardized form since it will undoubtedly contain numerous superfluous provisions which will only complicate any disputes. For the most part, suppliers contracts will be subjected to the California Commercial Code which controls claims and disputes among sellers and buyers to a large degree.+[See Cal.Commercial Code Section 9310]+ Again, the typical industry forms relating to both subcontractors and suppliers are discussed in greater detail below.
From a very basic level, the typical essential legal instruments of subcontracting include, but are not limited to, the following:
-
- A contract form (or purchase order for suppliers) to guide the particular terms and conditions under which the subcontracting work (or materials) are to be performed and which reference the scope of work to be completed;
- Change order forms to memorialize any additions or deletions of work that were originally not contemplated under the scope of work from which the subcontractors price quote is derived;
- Submittal forms and clarification documents which transmit questions concerning the project and planned or suggested methods of construction to be employed by the subcontractor; and
- Other contract documents such as plans, technical specifications or general conditions that are typically incorporated by reference into the agreement.
Each of these basic legal instruments and their interrelationship to each other as well as the potential issues and disputes which may arise on a project are discussed in the following sections.
§ 35.04 Discussion of Industry Forms and Contract Terms
As mentioned above, the various trade and professional organizations in the construction industry have developed a variety of standardized contract forms for use in the construction industry. Because these forms will be influenced by the particular industry which created the form it is important to be familiar with the types of industry forms and how they will be interpreted for or against the particular players to the subcontracting process. What follows is a detailed discussion of each of these industry forms as well as particularly noteworthy provisions and their legal treatment.
[1]–American Institute of Architects (AIA)
Probably the oldest and best known industry form for subcontracting is the American Institute of Architect’s Standard Subcontract (AIA-Form A401).+[See Appendix 1 to this Chapter for a complete copy of this form.]+
To begin with it is important to note that the AIA forms were drafted by design professionals such as architects and engineers. For this reason it is suggested that the user must question whether the forms are drafted such that they may in some ways favor the position of the architect and its primary client the owner. Although the AIA 401 subcontract form is drafted from the perspective of the architect and its owner, it may be less offensive to the average subcontractor than the forms developed by the associations made up of primarily general contractors such as the AGCC. However since both associations have fairly recently updated their respective forms (presumably to make them more fairly drafted for the entire industry), this conclusion remains to be seen. With a little work both forms can relatively easily be customized to meet each parties reasonable self interests. It cannot be over emphasized and almost every form contract drafter recommends proper counsel be sought before using any particular form.
Because the AIA forms are the best known, their Standard form Subcontract has been widely used as a contracting form for subcontractors. In looking through the A-401, it is important to note that as with most of the AIA forms in addition to the Standard Form Subcontract one must also look to the General Conditions that are usually incorporated into the standard form.+[See Appendix for a complete copy of the AIA General Conditions which are set forth in AIA DOCUMENT 201]+ The General Conditions A-201 document substantially describes the in-depth legal relations and consequences between the Owner, General contractor and Subcontractor for purposes of subcontracting under an AIA form subcontract.
Beyond the A-201 general conditions the most significant clauses of the AIA 401 form are as follows:
[a]–Incorporation by Reference clause-
Incorporation by reference provisions are designed to enlarge the standard provisions of a contract form. In a subcontract setting these usually take the form of incorporating into the subcontract terms the plans, specifications and other documents that are unique to the project and are infeasible to retype into each new subcontract form. Under California law, when terms of a contract are referred to by incorporation by reference, the terms of the contract and those that are referred to must be considered as one instrument.+[Hollbrook v. Fazio (1948) 84 Cal.App 2d 700, 191 P.2d 123]+ There is no legal limitation to the ability to enlarge upon contractual terms through incorporation by reference unless the referred to terms are not available or known by the contractee.+[Richards v. Merrill Lynch, Pierce, Fenner & Smith, Inc. (1976) 64 Cal.App 3d 899, 135 Cal.Rptr. 26]+
The incorporation by reference provision of the A-401 subcontract form can be found in Article 1.1 of the A-401 document. This article provides:
ARTICLE 1. THE SUBCONTRACT DOCUMENTS
1.1 The Subcontract Documents consist of (1) this Agreement; (2) the Prime Contract, consisting of the Agreement between the Owner and Contractor and the other Contract Documents enumerated therein, including Conditions of the Contract (General, Supplementary, and other Conditions), Drawings, Specifications, Addenda issued prior to execution of the Agreement between the Owner and Contractor, and Modifications issued subsequent to the execution of the Agreement between the Owner and Contractor, whether before or after the execution of this Agreement, and other Contract Documents, if any, listed in the Owner-Contractor Agreement; (3) other documents listed in Article 16 of this Agreement; and (4) Modifications to this Subcontract issued after execution of this Agreement. These form the Subcontract, and are fully a part of the Subcontract as if attached to this Agreement or repeated herein.+[AIA Form A-401 reprinted with permission]+
A similar provision for all sub-subcontracts that the subcontractor enters into with others is also required of the subcontractor under Article 2.2.
[b]–Flow Down Provisions
This provision is closely related to the incorporation by reference provision. Although the incorporation by reference provision enlarges the standard subcontract terms to include the same terms as that of the general contract, the “flow-down” provision provides the vehicle for interpreting how the court is to interpret the provisions that are incorporated by reference.+[1, STEIN Construction Law, 5.02[4],[b] (1991 Mathew Bender)]+ In the AIA A-401 form this provision is found in Article 2.1 as follows:
” . . . to the extent that provisions of the Prime Contract apply to the Work of the Subcontractor, the Contractor shall assume toward the Subcontractor all obligations and responsibilities that the Owner, under the Prime Contract, assumes toward the Contractor, and the Subcontractor shall assume toward the Contractor all obligations and responsibilities which the Contractor, under the Prime Contract, assumes toward the Owner and the Architect. The Contractor shall have the benefit of all rights, remedies, and redress against the Subcontractor which the Owner, under the Prime Contract, has against the Contractor, and the Subcontractor shall have the benefit of all rights, remedies, and redress against the Contractor which the Contractor, under the Prime Contract, has against the Owner, insofar as applicable to this Subcontract. Where a provision of the Prime Contract is inconsistent with a provision of this Agreement, this Agreement shall govern.+[AIA Form A-401 reprinted with permission]+
From the general contractors point of view, it is essential that it be bound to the owner to no greater extent than its subcontractors are bound to it. This is because in most cases the contractor has not added any dollars in its bid to the owner above that which was bid to it by the subcontractor. If the general contractor is forced to do something by the owner based upon a provision in the general contract it is essential to the general contractor that the subcontractor be bound in a similar fashion. Otherwise the general contractor will be forced to spend time and money that it did not put in its bid to the owner.
From the subcontractors point of view, it is reasonable to be expected to perform all of the requirements that it based its bid upon so the essential issue for the subcontractor is that such provisions are clearly spelled out in the contract and that the subcontract not contain, either directly or indirectly by incorporation, any additional terms that could empower an unscrupulous general contractor or owner to use such flow-down provisions unreasonably. One such provision which does not exist in the AIA A-401 Subcontract is a “jail house” clause where the contract provides for the contractor (and therefore subcontractor) to perform all work directed by the owner to be performed even if extra, and that the contractor waives its right to stop work or rescind and limits its rights in a dispute to damages after full performance. These type of provisions are enforced under California law.+[B.C. Richter Contracting Co. v. Continental Cas. Co. (1964) 230 Cal.App 2d 491, 41 Cal.Rptr. 98]+ Under a general contract with such a clause combined with a flow-down provision in the subcontract, the subcontractor may ultimately be expected to finance the performance of a disputed extra work claim during the performance of the work. This could prove very costly to a subcontractor. Since the AIA subcontract does not contain such a provision the reader may wish to refer to the discussion under the AGCC Form Subcontract which contains a version of such a clause for further discussion.
From the owners point of view, it is primarily interested in getting the work done as it expected so to the extent the subcontract form contains a flow-down provision it is doubly protected and therefore would want to encourage such provisions in the general contractors subcontract forms. This is especially true since under current California authority, an owner is likely to be considered an intended third party beneficiary of the general contractors subcontract agreements. [Gilbert Financial Corp. v. Steelform Contracting Co. (1978) 82 Cal.App. 3d 65, 145 Cal.Rptr. 448] In the event the general contractor has abandoned the job or becomes financially insolvent the owner may be able to at least look to the subcontractor to perform as required.
[c]–Payment Provisions
The AIA A-401 contains the typical payment provisions that one would find in standard subcontracts with only a few exceptions. The A-401 contains the standard retention clauses and provide for periodic progress payments. The progress payment section is quite detailed and provides protection for both the general contractor and subcontractor as follows:
ARTICLE 11. PROGRESS PAYMENTS
11.3 Provided an application for payment is received by the Contractor no later than the _____________ day of the month, the Contractor shall include the Subcontractor’s Work covered by that application in the next Application for Payment which the Contractor is entitled to submit to the Architect. The Contractor shall pay the Subcontractor each progress payment within three working days after the Contractor receives payment from the Owner. If the Architect does not issue a Certificate for Payment or the Contractor does not receive payment for any cause which is not the fault of the Subcontractor, the Contractor shall pay the Subcontractor, on demand, a progress payment computed as provided in Paragraphs 11.7 and 11.8.
11.4 If an application for payment is received by the Contractor after the application date fixed above, the Subcontractor’s Work covered by it shall be included by the Contractor in the next Application for Payment submitted to the Architect.
11.5 Each application for payment shall be based upon the most recent schedule of values submitted by the Subcontractor in accordance with the Subcontract Documents. The schedule of values shall allocate the entire Subcontract Sum among the various portions of the Subcontractor’s Work and be prepared in such form and supported by such data to substantiate its accuracy as the Contractor may require. This schedule, unless objected to by the Contractor, shall be used as a basis for reviewing the Subcontractor’s applications for payment.+[AIA Form A-401 reprinted with permission]+
Under Article 11.3 the subcontractor is required to provide the written application to the general contractor on a date certain otherwise the general contractor has no obligation to pay the subcontractor. The subcontractor is protected under the provision since if the general contractor does not receive payment from the owner and that nonpayment is not related to the fault of the subcontractor the general contractor must still pay the subcontractor.
Finally, Article 11.5 indicates that the contractor and subcontractor will establish a schedule of values for estimating the progress payments that the subcontractor qualifies for based upon the percentage of completion. This is a good practice for all of the parties to the construction/development process since it eliminates or reduces the potential disputes relating to estimating the value of any given project at a particular time. It should also minimize the risks of a billing practice frowned upon by most owners known as “front-end loading”. Front-end loading occurs where a contractor attempts to seek payment during the early portion of performance in a value that exceeds the true value of the work actually performed.+[Construction Dictionary by the National Association of Women in Construction (1985, 6th ed.)]+ If all of the parties to the project have agreed to the value of work in some detail ahead of time, there is less likelihood that during the time pressures of decisions during the work someone would be able to sneak in a value greatly exceeding the true value.
The provisions for final payment under the A-401 agreement are also relatively reasonable from the perspective of all parties. Article 12 provides:
ARTICLE 12. FINAL PAYMENT
12.1 Final payment, constituting the entire unpaid balance of the Subcontract Sum, shall be made by the Contractor to the Subcontractor when the Subcontractor’s Work is fully performed in accordance with the requirements of the Contract Documents, the Architect has issued a Certificate of Payment covering the Subcontractor’s completed Work and the Contractor has received payment from the Owner. If, for any cause which is not the fault of the Subcontractor, a Certificate for Payment is not issued or the Contractor does not receive timely payment or does not pay the Subcontractor within three working days after receipt of payment from the Owner, final payment to the Subcontractor shall be made upon demand. (Insert provisions for earlier final payment to the Subcontractor, if applicable.)
12.2 Before issuance of the final payment, the Subcontractor, if required, shall submit evidence satisfactory to the Contractor that all payrolls, bills for materials and equipment, and all known indebtedness connected with the Subcontractor’s Work have been satisfied.+[AIA Form A-401 reprinted with permission]+
To begin with this Final Payment provision allows the general contractor to await payment from the owner before the contractor must pay the subcontractor and after the subcontractor has provided appropriate evidence of payment to all suppliers and employees. However if the reason there is a delay in the owners payment that is not the fault of the subcontractor the general contractor must pay the subcontractor. Further analysis of disputes surrounding final payment are discussed in this Chapter under Part B.
Finally, the A-401 also contains a payment provision that is not all that customary in subcontracts in California but is imminently fair to subcontractors. This provision is found in Article 4.7 as follows:
4.7 REMEDIES FOR NONPAYMENT
4.7.1 If the Contractor does not pay the Subcontractor through no fault of the Subcontractor, within seven days from the time payment should be made as provided in this Agreement, the Subcontractor may, without prejudice to other available remedies, upon seven additional days’ written notice to the Contractor, stop the Work of this Subcontract until payment of the amount owing has been received. The Subcontract Sum shall, by appropriate adjustment, be increased by the amount of the Subcontractor’s reasonable costs of shutdown, delay, and start-up.
This provision provides for a contractual right of the subcontractor to stop performance if it has not received payment within the appropriate time period. Normally a subcontractor is limited in its ability to cease performance in the face of nonpayment. Absent a “jail-house” clause discussed above, a contractor in California may not abandon performance of a contract without legal excuse,+[Bus.& Prof. Code § 7107]+ and could be terminated for default if it constituted a breach. Generally, a contractor under California law, absent such a clause, must prove that the lack of payment constituted a material breach.+[Integrated, Inc. v. Alec Fergusson Electrical Contractor (1967) 250 Cal. App. 2d 287, 58 Cal. Rptr. 503; See also 1 Witkin, Summary California Law, Contracts 793 (9th ed., 1987)]+ The question of whether a lack of payment is in fact a material breach in a given situation is a question of fact that the contractor must weigh very carefully along with competent counsel.+[Integrated, Inc. v. Alec Fergusson Electrical Contractor (1967) 250 Cal. App. 2d 287, 58 Cal. Rptr. 503; See also 1 Witkin, Summary California Law, Contracts 793 (9th ed., 1987)]+ This is because lack of grounds to stop work or rescind may cause problems for the contractor both from a licensing perspective as well as a financial risk since the work remaining to be completed will eventually be given to another contractor who may have no incentive to do it for the same price originally agreed to by the subcontractor. It has not been expressly decided whether there is a distinction for these purposes between a contractor who indicates it is rescinding the contract and one that indicates it is merely suspending performance until the breach is cured. Either way there appears to be extreme risk if the contractor is not certain of the materiality issue.
There is authority however that where the parties have contractually agreed to a party’s right to stop work the contractor may in fact stop work and need not prove the materiality of the payment withheld.+[Big Boy Drilling Corp. v. Etheridge (1941) 44 Cal.App. 2d 114, 111 P.2d 953]+ Therefore the A-401 provision in Article 4.7.1 will be of tremendous assistance to any Subcontractor faced with an unscrupulous general contractor. It should be cautioned however that Article 4.7.1 will probably be construed to qualify the subcontractor to suspend further work and not to terminate or rescind since as will be discussed a separate remedy for termination is found in a different provision. [Big Boy Drilling Corp. v. Etheridge (1941) 44 Cal.App. 2d 114, 111 P.2d 953]
[d]–Termination of Contract Clause
Another noteworthy provision of the A-401 Subcontract form is the provisions describing terminations. The termination provisions of a contract are always important since they contain the parties agreement of when and how the contract may be terminated during performance. The A-401 document describes these circumstances as follows:
7.1 TERMINATION BY THE SUBCONTRACTOR
7.1.1 The Subcontractor may terminate the Subcontract for the same reasons and under the same circumstances and procedures with respect to the Contractor as the Contractor may terminate with respect to the Owner under the Prime Contract, or for nonpayment of amounts due under this Subcontract for 60 days or longer. In the event of such termination by the Subcontractor for any reason which is not the fault of the Subcontractor, Sub-subcontractors or their agents or employees or other persons performing the portions of the Work under contract with the Subcontractor, the Subcontractor shall be entitled to recover from the Contractor payment for Work executed and for proven loss with respect to materials, equipment, tools, and construction equipment and machinery, including reasonable overhead, profit, and damages.+[AIA Form A-401 reprinted with permission]+
7.2 TERMINATION BY THE CONTRACTOR
7.2.1 If the Subcontractor persistently or repeatedly fails or neglects to carry out the Work in accordance with the Subcontract Documents or otherwise to perform in accordance with this Agreement and fails within seven days after receipt of written notice to commence and continue correction of such default or neglect with diligence and promptness, the Contractor may, after seven days following receipt by the Subcontractor of an additional written notice and without prejudice to any other remedy the Contractor may have, terminate the Subcontractor and finish the Subcontractor’s Work by whatever method the Contractor may deem expedient. If the unpaid balance of the Subcontract Sum exceeds the expense of finishing the Subcontractor’s Work, such excess shall be paid to the Subcontractor, but if such expense exceeds such unpaid balance, the Subcontractor shall pay the difference to the Contractor.+[AIA Form A-401 reprinted with permission]+
The above termination provisions make it clear that the subcontractor and general contractor may terminate their performance under certain circumstances. A detailed discussion of the potential disputes concerning termination provisions is contained in Part B of this chapter.
[d]–Dispute Resolution Provisions
The A-401 agreement provides that the dispute resolution forum shall be arbitration under the rules of the Construction Industry Arbitration Rules of the American Arbitration Association.+[AIA Form A-401, Article 6.1]+ It is important to also note the drafting of the arbitration clause such that the Architect can not be made a party to the arbitration proceeding even if he is intimately involved in the dispute.+[AIA Form A-401, Article 6.1]+
[2]–Associated General Contractors of California (AGCC)
The second most widely used form for subcontracting was developed by the industry association made up of mostly general contractors. The Associated General Contractors is a national association of contractors and associates which is typically organized by state affiliates. The California affiliate boasts one of the largest memberships of contractors in the Associated General Contractors nationally. Although the AGCC is made up of primarily general contractors, the association also contains a number of subcontractor members and associates. Since the AGCC is made up of primarily general contractors, one may question whether the AGCC subcontract forms that are discussed below are in some instances structured to favor the general contractor over the subcontractor in certain instances. Although this should be kept in mind in deciding which form to use depending upon what prospective the reader is coming from, it is again submitted that with certain basic modification the AGCC form subcontract can be fairly utilized by both general and sub contractors. Of course proper legal advice should be sought to accomplish such a goal and what follows is a discussion of particularly noteworthy terms to help focus the readers attention on significant issues in the AGCC subcontract.
As far as subcontract forms are concerned the AGCC has developed both a Long Form as well as a Short Form in order to provide the owner and contractor an alternative.+[Long Form Standard Subcontract(AGCC-3) and Short Form Standard Subcontract(AGCC-4)]+ Obviously the Long Form contains greater references to the legal relations and in this authors view is a safer instrument from the general contractors point of view. The subcontractor is well advised to seek legal advise for modifications of either form.
[a]–Flow-Down and Incorporation by Reference Clauses
Similar to the discussion contained in the section focusing upon the AIA provisions, the AGCC standard subcontract forms+[Long Form Standard Subcontract(AGCC-3) and Short Form Standard Subcontract(AGCC-4)]+ contain Flow-down and incorporation by reference clauses. These clauses in the AGCC-3 and AGCC-4 forms are contained in the following provisions:
LONG FORM STANDARD SUBCONTRACT
SECTION 1. ENTIRE CONTRACT
. . . The Contract Documents are incorporated in this Agreement by reference, and the Subcontractor and his subcontractors will be and are bound by the Contract Documents insofar as they relate in any way, directly or indirectly, to the work covered by this Agreement. Subcontractor agrees to be bound to Contractor in the same manner and to the same extent as Contractor that where, in the Contract Documents reference is made to Contractor, and the work or specifications therein pertains to Subcontractor’s trade, craft, or type of work, then such work of specification shall be interpreted to apply to Subcontractor instead of Contractor.
SHORT FORM STANDARD SUBCONTRACT
The work . . . shall be performed . . . in accordance with all plans, specifications and other contract documents attached to or incorporated into the prime contract . . .
. . .
Subcontractor and his subcontractors are bound by the prime contract and any contract documents incorporated therein . . .
It appears that the “flow-down” provisions of the AGCC-4 form are minimal at best. Without clear contract language as found in the longer form AGCC-3 a general contractor may wish to play it safe by utilizing the Long Form. Otherwise these provisions should accomplish the same ends as set forth in the previous discussion concerning these clauses under the AIA A-401 Subcontract.
[b]–Payment Provisions
The AGCC-3 and AGCC-4 agreements both contain typical payment provisions as far as retention and progress payment are concerned. These contracts call for a percentage retention and monthly progress payments. Both the progress payments and the final payment are due ten (10) days after the general contractor has received payment from the owner.+[But see this Chapter, Part B for a discussion of further payment issues]+
One noteworthy provision allows the general contractor to make joint payments to the subcontractors vendors, etc. For example:
SECTION 4. PAYMENT SCHEDULE
. . . Contractor, at his option, may make any payment due hereunder by check made payable jointly to Subcontractor and any of his subcontractors, suppliers, and materialmen who have performed work or furnished materials under this Agreement . . . .+[AGCC-3 Long Form Standard Subcontract, reprinted with permission]+
Under this provision the general contractor apparently has the contractual right to direct payment to the subcontractors vendors without there being any showing of risk to the project. Most subcontractors would want to eliminate such a provision since they may for one reason or another want to delay payment to a particular vendor or may even have reason not to pay them. With the general contractor having control over such an event the subcontractor may have to give up a bargaining leverage that it had not known it would need at the time of executing the subcontract.
The general contractor on the other hand wants to have some control over the unfortunate event of having liens placed upon the project because a subcontractor is not paying its bills on time. A potential middle approach might be to limit the clause to those instances where a vendor has raised claims of nonpayment but the language must clearly be expressed in order to adequately protect the general contractor. The normal indemnity provisions and the provisions calling for final payment after providing adequate evidence of payment of all vendors, etc may also be of help in this area.
[c]–Scope of Work Provisions
Although also discussed in greater detail in Part B below, a brief discussion of the “scope of work” provisions is necessary since a significant provision in the AGCC-3 form is contained therein. Section 2 of the form provides:
. . . In the event of any dispute between Contractor and Subcontractor over the scope of Subcontractor’s work under the Contract Documents, Subcontractor will not stop work but will prosecute the work diligently to completion, the dispute to be submitted for resolution in accordance with Section 17 below.
This clause can be referred to as a “jail-house” or “annihilation” clause since it can annihilate a subcontractor by keeping him or her a captive of the general contractor’s interpretation of the scope of work to be performed by the subcontractor. These types of clause have been upheld and interpreted to limit a subcontractors remedy for a dispute in the scope of work to damages for breach rather than rescission or termination which might otherwise be available.+[B.C. Richter Contracting Co. v. Continental Cas. Co. (1964) 230 Cal.App 2d 491, 41 Cal.Rptr. 98]+
This could prove extremely difficult or even fatal to a subcontractor that does not have the ability or desire to advance the costs of construction of the disputed work pending a final resolution either by settlement, arbitration or court litigation.
Scope of work disputes can involve a few hundred dollars or a few million dollars. Obviously the subcontractor will want some protection from having to advance construction costs that exceed a reasonable percentage of their original contract amount. If a subcontractor finds itself having signed such a clause, if the dispute is of such a great magnitude, or the parties have otherwise neglected their contractual duties, perhaps the subcontractor could avoid the “jail house” clause by declaring a cardinal change or abandonment.+[C. Norman Peterson Co. v. Container Corp. of America (1985) 172 Cal. App. 3d 628, 218 Cal. Rptr. 592.]
From the general contractors view, he or she will want to obtain some protection for the event that there should arise a reasonable dispute concerning a subcontractors scope of work. The general contractor will not want its project interrupted during the resolution of any such disputes and may therefore want to insist upon some form of clause that provides it protection without becoming a “jailer” of its subcontractor.
[d]–Bonding and Insurance Provisions
The AGCC-3 provisions for bonding are as follows:
SECTION 8. BONDING OF SUBCONTRACTOR
Concurrently with the execution of this Agreement, Subcontractor shall, if required by Contractor, execute a labor and material bond and performance bond, in an amount equal to one hundred percent (100%) of the Contract Price. Said bonds shall be executed by a corporate surety acceptable to Contractor and shall be in a form satisfactory to Contractor. Contractor shall pay the premium on said bonds unless otherwise provided herein or in the Contract Documents.+[AGCC-3 Long Form Standard Subcontract, reprinted with permission]+
The only significant issue related to the bonding provisions of the AGCC-3 Subcontract is that the general contractor is entitled to a surety bond in a form acceptable to it. The construction bond surety market is full of differing types and forms of contract bonds. These range from the admitted corporate surety to non admitted surplus lines bonds and personal sureties. The general contractor should carefully examine the form of the bond as well as the financial information on the surety if available. If the bond is being provided by the subcontractor pursuant to a public works, the bond probably has to be given to an admitted surety.+[See Pub. Contract Code § 7108.]+ The subcontractor should inquire from the general contractor ahead of time the acceptable form for a surety bond. As far as the entity responsible for payment of the premium on the bond, according to Section 8 of the AGCC-3 provision, it is to be paid by the general contractor unless noted otherwise. This is consistent with the statutory requirements for subcontractor bonds.+[Cal. Pub. Contract Code § 4108(c)(2).]+
[e]–Termination Provisions
Similar to the AIA form subcontract, both the AGCC-3 and AGCC-4 form subcontract agreements provide for specific termination provisions. A more detailed discussion of these forms can be found in Part B of this chapter but the form language is as follows.
The AGCC-3 provisions are:
14.1.2 Termination for Default. If Subcontractor fails to commence and satisfactorily continue correction of a default within forty-eight (48) hours after receipt by Subcontractor of the notice issued under Section 14.1.1., then the Contractor may terminate Subcontractor’s right to perform under this Agreement and use any materials, implements, equipment, appliances, or tools furnished by or belonging to Subcontractor to complete Subcontractor’s work without any further compensation to Subcontractor for such use. Contractor also may furnish those materials and equipment, and/or employ such workers or subcontractors as Contractor deems necessary to maintain the orderly progress of the work.
In such case, Subcontractor shall be entitled to no further payment until the balance of Subcontractor’s work has been completed. At that time, all of the costs incurred by Contractor in performing Subcontractor’s work, including a markup of fifteen percent (15%) for overhead and profit on such expenses, plus actual attorneys’ fees as provided above, shall be deducted from any monies due or to become due Subcontractor. Subcontractor shall be liable for the payment of any amount by which such expenses may exceed the unpaid balance of the Contract Price.
14.1.3 Termination for Convenience. Contractor may at any time and for any reason terminate Subcontractor’s services and work at Contractor’s convenience. Cancellation shall be by service of written notice to Subcontractor’s place of business.
Upon receipt of such notice, Subcontractor shall, unless the notice directs otherwise, immediately discontinue the work and placing of orders for materials, facilities, and supplies in connection with the performance of this Agreement, and shall, if requested, make every reasonable effort to procure cancellation of all existing orders or contracts upon terms satisfactory to Contractor, or at the option of Contractor, give Contractor the right to assume those obligations directly, including all benefits to be derived therefrom. Subcontractor shall thereafter do only such work as may be necessary to preserve and protect the work already in progress and to protect material and equipment on the job site or in transit thereto.
Upon such termination, Subcontractor shall be entitled to payment in accordance with Section 4 only as follows: (1) the actual cost of the work completed in conformity with this Agreement; plus, (2) such other costs actually incurred by Subcontractor as are permitted by the prime contract and approved by the Owner; plus (3) fifteen percent (15%) of the cost of the work referred to in Subparagraph (1) above for overhead and profit. There shall be deducted from such sums as provided in this subparagraph the amount of any payments made to Subcontractor prior to the date of the termination of this Agreement. Subcontractor shall not be entitled to any claim or claim of lien against Contractor or Owner for any additional compensation or damages in the event of such termination and payment.+[AGCC-3 Long Form Standard Subcontract, reprinted with permission]+
The AGCC-4 Short Form Standard Subcontract provides:
SECTION 10. TERMINATION
(i) Should Subcontractor fail to rectify any contractual deficiencies, including failure to pay its creditors, within three (3) working days from receipt of Contractor’s written notice, Contractor shall have the right to take whatever steps he deems necessary to correct said deficiencies and charge the cost thereof to Subcontractor, who shall be liable for the full cost of Contractor’s corrective action, including reasonable overhead, profit, and attorneys’ fees. (ii) Contractor may at any time and for any reason terminate Subcontractor’s services hereunder at Contractor’s convenience; in the event of termination for convenience, Subcontractor shall recover only the actual cost of work completed to the date of termination plus fifteen percent (15%) of the actual cost of the work for overhead and profit. Subcontractor shall not be entitled to any claim or lien against Contractor or Owner for any additional compensation or damages in the event of such termination.
[f]–Dispute Resolution Provisions
The AGCC-3 and AGCC-4 forms both provide for disputes to resolved by Arbitration only if the general contract between the general and the owner calls for Arbitration.+[ AGCC-3 Section 17.1 and AGCC-4 Section 13]+ Otherwise all claims and disputes are to be decided by court litigation, not arbitration. For a detailed discussion of the consequences of failing to follow the contract terms for arbitration see Chapter 65.
[3]–Other AGCC Industry Forms Relating to Subcontracting
In addition to the Standard Subcontract forms the AGCC has also developed other contract forms which are related to subcontracting and for use in subcontracting. The applicable forms and a brief discussion of each form includes:
[a]–AGCC Standard Subcontract Change Order (Form AGCC-5)
This form can be used as a change order form when a subcontractors scope of work has been changed. It is important to point out the language of the form which a contractor should keep in mind when executing the document. The form has very significant language which states:
Execution of this Change Order by both parties constitutes a binding agreement that no adjustment in compensation or time of performance shall be made as a result of the foregoing change(s), except as provided herein. Contractor may require consent of the Subcontractor’s surety, if any, to the terms of this Change Order.
It appears to be the intent of this language to create an accord and satisfaction of all damages arising from performing the work included in the change order. A subcontractor who believes it may have other damages such as delay, impact or others should refuse to execute the document without striking the above language or otherwise timely reserving its right to these other damages.
Compare for example the language contained in the Standard Form Prime Contract Change Order contained in form AGCC-2. This form of change order provides:
Execution of this Change Order by both parties constitutes a binding agreement with regard to the direct costs relating to this change order. Contractor reserves the right to request additional compensation at a later date with regard to impact, ripple, or other indirect costs arising from or related to the work which is the subject of this change order. Owner may require consent of the Contractor’s surety, if any, to the terms of this Change Order.+[AGCC Standard Contract Change Order, reprinted with permission]+
Obviously when it comes to entering into change orders with the owner the general contractor does not want to give up any claims for delay, impact or other indirect damages. Therefore a prudent subcontractor will do the same.
[b]–AGCC Long Form Purchase Order (Form AGCC-6)
This form along with its counterpart Short Form Purchase Order (Form AGCC-7), is for use by a contractor or owner who is purchasing materials from a supplier. Rather than using a subcontract form which can be very cumbersome for a supplier these forms describe the terms and conditions under which the materials are to be provided. The significant provisions of the Long Form are as follows:
LONG FORM PURCHASE ORDER
3. CHANGES AND RIGHT TO TERMINATE.
(a) . . . Buyer may terminate or suspend at its convenience all or any portion of this order not shipped as of the date of termination or suspension of the order. In the event of any change or termination, there shall be an equitable price adjustment by Buyer. If Seller maintains that Buyer’s adjustment is not equitable, the price change shall be negotiated. In the event the parties cannot agree, the final determination shall be made in accordance with the dispute resolution provision of this Agreement. However, if unit prices have been designated as to materials maintained in the normal course of Seller’s business as standard stock, such unit prices shall control all price adjustments for quantity changes. No change or termination shall relieve Buyer or Seller of any of their obligations as to any material shipped prior to Seller’s receipt of the change, termination, or suspension order. Any claim for adjustment by Seller hereunder must be asserted in writing within ten (10) days from the date of the change or termination is ordered.
(b) If the Owner shall order the Buyer to change, adjust, substitute, add to, delete from, suspend, or terminate the work included in this order, Seller shall comply with Owner’s order and the price or time of performance hereunder shall only be adjusted as allowed by Owner. If requested by Owner, Seller agrees to be bound to and by the dispute resolution procedure of the Prime Contract.
13. ASSIGNMENTS, SETOFF. . . . Buyer may, at its option, setoff any amounts otherwise due from Buyer to Seller under this purchase order against any delinquent amounts or liabilities which are due to Buyer or its commonly controlled affiliates from Seller.+[AGCC Form AGCC-6, reprinted with permission.]+
According to the above purchase order language, it appears that the contractor may terminate the purchase of materials at any time. This could have significant effects upon a supplier. This is especially true where, although there are dispute resolutions provisions to obtain termination costs when the contractor initiates the termination, there may be no such measures where the owner has terminated.+[AGCC-6]+
[c]–Standard Form Prime Contract Between Owner and Contractor (AGCC-1)
Because an owner may from time to time choose to contract directly with a subcontractor, this form may be modified to apply between the owner and the subcontractor. A special provision referring to the contractor where ever it applies as meaning the subcontractor is appropriate.
[4]–Other Industry Subcontract Forms
In addition to the AIA and AGCC subcontract forms there are numerous other forms used by the industry for subcontracting. Many of these other forms are compilations of various terms and conditions of the clauses contained in the AIA and AGC forms while others have attempted to start from the beginning and have completely rewritten terms and conditions. The contractor or practitioner who looks to such forms would be well advised to carefully review the provisions with a licensed construction law attorney. Although there are no formalized subcontract forms developed by an association solely dedicated to the subcontractors perspective one association has published a guide to help subcontractors negotiate modifications to the AIA and AGCC forms.+[See the American Subcontractor Association (ASA) Guide entitled “Winning the Battle of Subcontract Forms” available directly from the ASA.]+
[5]–Pitfalls of Using Subcontract Forms Not Properly Drafted
There are extreme consequences for a failure to properly draft the contractual instruments of subcontractors. In addition to the issues raised in this Part relative to potential disputes among the parties there are other potential sanctions for a contractors failure to make certain statements in its contract forms. For example, Business and Professions Code Section 7030 provides:
Every person licensed pursuant to this chapter shall include the following statement in at least 10-point type on all written contracts with respect to which the person is a prime contractor:
“Contractors are required by law to be licensed and regulated by the Contractors’ State License Board. Any questions concerning a contractor may be referred to the Registrar, Contractors’ State License Board, Post Office Box 26000, Sacramento, California, 95826.” This section shall become operative July 1, 1991. +[Bus.& Prof. Code 7030]+
Business and Professions Code Section 7030.5 also requires the license number of all contractors to appear on any contract the licensee enters into.
In this instance if the contract fails to contain such a provision the contractor may be subjected to disciplinary sanctions. One court has held that this provision was not intended to prevent the contractor from pursuing recovery under the contract in the event of nonpayment unlike other provisions in the Code such as Business & Professions Code Section 7031.+[Gonzales v. Concord Gardens Mobile Home Park (1979) 90 Cal.App. 3d 871, 153 Cal Rptr. 559]+ Even though a violation of this section will not preclude a contractor from recovery in a court of law, the potential sanctions available to the license board such as suspension, revocation and fines should be enough to encourage compliance.+[Bus.& Prof. Code Section 7090]+
Additionally, if the contractor is a Home Improvement Contractor+[See Bus.& Prof. Code Section 7151.2]+ or a Swimming Pool Contractor+[See Bus.& Prof. Code Section 7165]+ then the contract must provide for a provision as follows:
NOTICE TO OWNER
Under California Mechanic’s Lien Law any contractor, subcontractor, laborer, supplier, or other person who helps to improve your property, but is not paid for his work or supplies, has a right to enforce a claim against your property. This means that after a court hearing, your property could be sold by a court officer and the proceeds of the sale used to satisfy the indebtedness. This can happen even if you have paid the contractor in full if the subcontractor, laborers, or other suppliers remain unpaid.
To preserve their right to file a claim or lien against your property, certain claimants such as subcontractors or material suppliers are required to provide you with a document entitled “Preliminary Notice.” General contractors and laborers for wages do not have to provide this notice. A Preliminary Notice is not a lien against your property. Its purpose is to notify you of persons who may have a right to file a lien against your property if they are not paid.
TO INSURE EXTRA PROTECTION FOR YOURSELF AND YOUR PROPERTY, YOU MAY WISH TO TAKE ONE OR MORE OF THE FOLLOWING STEPS:
1. Require that your contractor supply you with a payment and performance bond (not a license bond), which provides a guarantee that all work and proper payments will be completed. This payment and performance bond as well as a copy of the construction contract may be filed with the county recorder for your further protection.
2. Require that payments be made directly to subcontractors and material suppliers through a joint control company, approved by the Registrar of Contractors.
3. Before making payment on any complete phase of the project, require your contractor to provide you with unconditional lien releases signed by each material supplier, subcontractor, or laborer involved on that project phase. Anyone signing this release loses the right to file a claim against your property. TO PROTECT YOURSELF UNDER THIS OPTION YOU MUST BE CERTAIN THAT ALL MATERIAL SUPPLIERS, SUBCONTRACTORS, AND LABORERS HAVE SIGNED.
Read and acknowledged:
____________________ ____________________
____________________ ____________________
Signature Dated+[Bus.& Prof. Code Section 7018.5]+
Finally, Home Improvement Contractors including Swimming Pool Contractors must include in their contracts a number of detailed notices to the homeowner including, but not limited to the following:
1. A schedule of payments+[Bus.& Prof. Code section 7159]+
2. Release of lien entitlement information +[Bus.& Prof. Code section 7159]+
3. Statements concerning change order limitations+[Bus.& Prof. Code section 7159]+
4. Start of Construction requirements+[Bus.& Prof. Code section 7159]+
5. If it involves a single dwelling then also a completion date.+[Bus.& Prof. Code Section 7164]+
If the Home Improvement contract also qualifies as a Home Solicitation Contract under the California Civil Code+[Civil Code Section 1689.5 et.seq.]+ then additional requirements of the contract form include:
1. A specific notice of the owners right to cancel any such contract within either three (3) or seven (7) business days+[Civil Code Section 1689.7]+
2. The date the buyer entered into the agreement+[Civil Code Section 1689.7]+
The principal factors to consider in determining whether the additional requirements of the Home Solicitation act are applicable is (1) whether the negotiations for the work were initiated by the contractor or the buyer,+[Civ. Code Section 1689.5]+ and (2) whether the contract was not signed at the contractors trade premises.+[Louis Luskin & Sons v. Samovitz (1985) 166 Cal.App.3d 353, 212 Cal.Rptr. 612]+ In order to prove the negotiations were initiated by the buyer rather than the contractor, the contractor must have the contract signed by the buyer acknowledging that the negotiations were initiated by the buyer.+[Civ.code Section 1689.5]+
In the above instances, the sanctions for a contractors failure to provide for the proper contract terms in a Home Solicitation contract are severe since the contractor may be denied recovery for the reasonable value of services rendered under the defective contract.+[Louis Luskin & Sons v. Samovitz (1985) 166 Cal.App.3d 353, 212 Cal.Rptr. 612; But See Beley v. Municipal Court (1979) 1000 Cal.App.3d 5, 160 Cal.Rptr. 508 where the court allowed recovery under a quasi-contractual theory]+
§ 35.05 License issues of Subcontracting-Overview
[1]–General Background and Implications
In Chapter 30, a detailed discussion of the basic license requirements and regulations related to licensing of contractors is set forth. This section shall discuss some specific licensing issues related to subcontractors which are of particular concern to the players from the perspective of a subcontracting point of view.
The general notion of licensing is designed to protect the public from unscrupulous or unqualified subcontractors who may attempt to perform the actual work in the various trades that are required to perform a particular project. As a consequence of the California legislature’s desire to protect the general public from such perils, a substantial body of law has developed which deals with the implications of trade subcontractors who are not properly licensed. At the heart of that body of law is Business and Professions Code Section 7031 which provides:
(a) Except as provided in subdivision (d), no person engaged in the business of acting in the capacity of a contractor, may bring or maintain any action, or recover in law or equity in any action, in any court of this state for the collection of compensation for the performance of any act or contract for which a license is required by this chapter without alleging and proving that he or she was a duly licensed contractor at all times during the performance of that act or contract, regardless of the merits of the cause of action brought by the person, except that this prohibition shall not apply to contractors who are each individually licensed under this chapter but who fail to comply with Section 7029.
(b) A security interest taken to secure any payment for the performance of any act or contract for which a license is required by this chapter is unenforceable if the person performing the act or contract was not a duly licensed contractor at all times during the performance of the act or contract.
(c) Proof of licensure pursuant to this section shall be made by production of a verified certificate of licensure from the Contractors’ State License Board which establishes that the individual or entity bringing the action was duly licensed in the proper classification of contractors at all times during the performance of any act or contract covered by the action.
(d) The judicial doctrine of substantial compliance shall not apply to this section, except that a court may determine that there has been substantial compliance with licensure requirements, for purposes of this section, if it is shown at an evidentiary hearing that the person was a duly licensed contractor during any portion of the 90 days immediately preceding the performance of the act or contract for which compensation is sought, that the person’s category of licensure would have authorized the performance of that act or contract, and that the noncompliance with the licensure requirement was the result of (1) inadvertent clerical error, or (2) other error or delay not caused by the negligence of the person. Subdivision (d) of Section 143 does not apply to contractors subject to this subdivision.
(e) The exceptions to the prohibition against the application of the judicial doctrine of substantial compliance found in subdivision (d) shall have no retroactive effect. These exceptions to that prohibition shall only apply to an action or arbitration proceeding, at law or in equity, that is commenced after the effective date of this section.
For the purposes of collecting any monies owed under a subcontract agreement, it is essential that a subcontractor be properly licensed.+[Although Bus. & Prof. Code § 7031 talks in terms of an “action,” this section has been held applicable proceeding to enforce even an arbitration award. In Air Floor v. Regents (1978) 84 Cal App 3d 1004, 149 Cal Rptr 130, the court of appeal went at length into a discussion of applicability of Section 7031 where a contractor is attempting to enforce an arbitration award. In concluding that Bus. & Prof. Code § 7031 did apply to the proceeding to enforce an arbitration award, the court concluded that although the arbitration itself was no an action or proceeding from the meaning Section 7031, the contractor’s attempt to elicit the court’s action of the arbitration award by way of a confirmation of its award was such an action or proceeding contemplated by Bus. & Prof. Code § 7031 and the contractor, therefore, had to be properly licensed.]+
With this background of the general requirement of licensing and the implications if the contractor is not properly licensed we now turn to a discussion of particular details of the licensing laws that are applicable to subcontracting as well as potential exemptions from licensing in general.
[2]–Classifications of Licenses Related to Subcontracting
The California Business and Professions Code which regulates licensing of contractors divides the contractor’s status into three sections, including an engineering contractor (A license), a general contractor (B license), and specialty contractors (C license).+[In Chapter 37, there is a detailed discussion of specialty contracts relating to particular trades such as electrical and plumbing contracts.]+
Contractors who are, therefore, performing subcontracting work must generally+[In some instances on very large contracts, a contractor licensed solely as a general contractor may take a contract as a subcontractor to another general contractor. In such cases the B license classification is sufficient only if the subcontract scope of work requires the contractor to perform work that involves three or more unrelated trades or crafts. Cal. Code of reg. 834]+ be licensed as a C classification specialty contractor which is defined as follows:
(a) A specialty contractor whose operations as such are the performance of construction work requiring special skills and whose principal contracting business involves the use of specialized building trades or crafts.
(b) A specialty contractor includes a contractor whose operations include the business of servicing or testing fire extinguishing systems.
(c) A specialty contractor includes a contractor whose operations are concerned with the installation and laying of carpets, linoleum, and resilient floor coverings.+[Bus. & Prof. Code § 7058.]+
Additionally, the legislature has allowed the Contractors’ State License Board to enact administrative legislation to regulate contractors.+[The Contractors’ State License Board is the administrative arm of the California Department of Consumer Affairs charged with regulating and performing disciplinary functions over contractors covered by the Bus. and Prof. Code.]+ Title 16 of the California Code of Regulations (formerly California Administrative Code) has been enacted and restricts a contractor from performing work in another classification unless the contractor is also licensed in the proper classification or subclassification that the work calls for,+[Cal.Code of Reg. section 830(b), 834(c)]+ or the work is “essential and supplemental” to the work that the contractor is duly licensed.+[Bus.& Prof. Code Section 7059]+ The regulations enacted define incidental and supplemental as work that is essential to accomplish the work that the contractor is duly licensed to perform.+[Cal.Code of Reg. Section 831]+ This latter exception for licensing where the work is incidental and supplemental has been interpreted very rarely, but has been determined not to include plumbing work by a heating, ventilating and air conditioning contractor.+[Currie v. Stolowitz (1959) 169 Cal.App 2d 810, 338 P.2d 208]+
Therefore a subcontractor should take extreme care in making sure it is properly licensed under the appropriate specialty classification that the contract calls for. The California Code of Regulations defines a specialty contractor classification as follows:
Specialty contractors shall perform their trade using the art, experience, science, and skill necessary to satisfactorily organize, administer, construct, and complete projects under their classification, in accordance with the standards of their trade.
The specialty classifications are divided into the following subclassifications:
Boiler, Hot Water Heating, and Steam Fitting — C-4
Building Moving and Demolition — C-21
Cabinet and Mill Work — C-6
Concrete — C-8
Drywall — C-9
Earthwork and Paving — C-12
Electrical (general) — C-10
Electrical Sign — C-45
Fencing — C-13
Fire Protection — C-16
Flooring and Floor Covering — C-15
General Manufactured Housing — C-47
Glazing — C-18
Insulation and Acoustical — C-2
Landscaping — C-27
Lathing — C-26
Limited Specialty — C-61
Low Voltage Systems — C-7
Masonry — C-29
Metal Roofing — C-14
Ornamental Metal — C-23
Painting and Decorating — C-33
Parking and Highway Improvement — C-32
Pipeline — C-34
Plastering — C-35
Plumbing — C-36
Refrigeration — C-38
Roofing — C-39
Sanitation System — C-42
Sheet Metal — C-43
Solar — C-46
Steel, Reinforcing — C-50
Steel, Structural — C-51
Swimming Pool — C-53
Tile (Ceramic and Mosaic) — C-54
Warm-Air Heating, Ventilation, and Air Conditioning — C-20
Water Conditioning — C-55
Welding — C-60
Well Drilling — C-57+[Cal. Code Reg. § 832]+
The exact definitions of each of these specialty classifications by the California Code of Regulations are set forth in Appendix H to this chapter and are discussed in greater detail in Chapter 37.
[a]–Exemptions to Licensing Applicable to Subcontracting
There are various exemptions to the contractor licensing requirements that may be applicable to the subcontracting process. For example to the extent a subcontractor has on staff an individual who is an employee and is working for wages the individual is exempt from licensing.+[Business & Professions Code Section 7053]+ Of course what the definition of an employee may be is a significant question since to the degree an individual is an independent contractor the exemption will not apply. There are a number of factors which weigh upon the test of whether the individual is an employee including whether he or she had the ability to control decisions on time of employment, basis of compensation, and work product.+[Dahl-Beck Elec. Co. v. Rogge (1989) 275 Cal. App. 2d 1008, 80 Cal. Rptr. 440.]+
Other exemptions which may be important in the context of subcontracting are (1) the minor works exemption+[Business & Professions Code, Section 7048]+ (works less than $300.00), and the “owner-builder” exemption where one is performing construction services on its own property and does not intend to sell the property for one year+[Business & Professions Code, Section 7044]+
Because the penalties of performing construction services can be extreme the reader is cautioned to seek proper legal advice before deciding whether the particular activities it plans to undertake will qualify for a licensing exemption.
[b]–Other Licensing Issues Applicable to Subcontracting
In addition to the licensing requirements of contractors pursuant to Business and Professions Code Section 7031, there are other issues related to licensing that are applicable in particular to subcontracting. California Business and Professions Code Section 6737 et. seq. requires that any person or entity who attempts to perform design functions for plans and specifications applicable to development projects must be licensed as an engineer within the particular discipline that the designing activities are being conducted. There are special exemptions to the engineers licensing requirements for subcontractors in the electrical and mechanical trades. One such exemption applies to an electrical or mechanical contractor who has agreed to or are in fact is both designing and performing the construction of the work that they have designed. For example, the California Business and Professions Code provides:
For the purposes of this chapter a contractor licensed under Chapter 9 (commencing with Section 7000) of Division 3, is exempt from the provisions of this chapter relating to the practice of electrical or mechanical engineering so long as the services he holds himself out as able to perform or does perform, which services are subject to the provisions of this chapter, are performed on behalf of the contractor by, or under the responsible supervision of a registered electrical or mechanical engineer insofar as the electrical or mechanical engineer practices the branch of engineering for which he is registered.+[Bus. & Prof. Code § 6737.3.]+
A similar exemption is found in Business 7 Professions Code Section 6737.4 which provides:
This chapter does not prohibit a contractor, licensed under Chapter 9 (commencing with Section 7000) of Division 3, which engaged in the business of contracting for the installation of electrical or mechanical systems or facilities, from designing such systems or facilities in accordance with applicable construction codes and standards for work to be performed and supervised by such contractor within the classification for which his license is issued, or from preparing electrical or mechanical shop or field drawings for work which he has contracted to perform. Nothing in this section is intended to imply that a licensed contractor may design work which is to be installed by any other person.+[Bus. & Prof. Code § 6737.4.]
Under these sections, many owners and developers have utilized the design services of a subcontractor in lieu of the normal channels of proceeding through an electrical or mechanical engineer. Thus an electrical or mechanical subcontractor may design electrical or mechanical plans and specifications without an engineering license where it has under 6737.3 performed the work that is set forth in its design or under 6737.4 utilized the services of a registered engineer to supervise or oversee the design functions of the contractor.
PART B. Relationship Between Subcontractor and Prime Contractor
§ 35.06 Legal Effect of Bids to Perform Subcontracting
[1]–Contractual Precepts of Subcontractor Bids
Probably, the greatest risk a subcontractor undertakes in its business is providing its bid to perform the intended work for which he or she is bidding. Conversely the greatest risk a general contractor or owner takes in relation to the subcontractors is that by accepting a bid from a subcontractor the subcontractor will be able to complete the task for the price accepted. If a subcontractor offers to perform a given scope of work for a price that is later discovered to be wrong, and the subcontractor is bound to perform at the original quoted price, it could prove very risky for the contractor from an economic point of view. On the other hand if the owner or general contractor relies upon a subcontractors bid and is later told that the subcontractor cannot honor its bid there may be tremendous prejudice to them. For this reason, it is of vital importance that the legal effects of bids of subcontractors be known and understood.
Generally speaking, a contractor’s bid, in most instances, is, by its very nature, an “offer” in the legal sense in that it usually contains a specific price quote to perform a specific scope of work. This must be contrasted to an invitation to bid which are nothing more than a request for offers.+[Universal By-Products, Inc. v. Modesto (1974) 43 Cal. App. 3d 145, 117 Cal. Rptr. 525.]+
Under normal contract legal analysis, if an offer is not otherwise revoked, it must be accepted by the offeree with the intent to create the formation of a contract before a legal obligation can be binding.+[Drennan v. Star Paving Company (1958) 51 Cal. 2d 409, 333 P. 2d 757]+ In other words, normally an offer can be converted into a binding contract by acceptance; however, if the offer is revoked before acceptance, then no binding contract exists. +[Drennan v. Star Paving Company (1958) 51 Cal. 2d 409, 333 P. 2d 757]. However, as will be discussed below, subcontractor bidding carries with it many exceptions and nuances which modify the general rule at least as it appears on the surface.
[2]–Private Works/Doctrine of Promissory Estoppel
It is well established law in California that contrary to the general rule that an offer can be revoked before acceptance, a subcontractor’s bid to a general contractor is irrevocable where the general contractor has relied upon the subcontractor’s bid to its detriment.
In Drennan v. Star Paving Company,+[Drennan v. Star Paving Company (1958) 51 Cal. 2d 409, 333 P. 2d 757]+ the Supreme Court of California held that although bidding on private works is not regulated by any specific statutory scheme, there are other basic principles at play that must, from a legal position, prevent a subcontractor from withdrawing its bid to a general contractor. The exception to the general rule is known in the construction industry as the doctrine of promissory estoppel. Under this principle of law, binding legal relationships are created by the mere offer to construct a contract where another has relied upon that offer.+[Drennan v. Star Paving Company (1958) 51 Cal. 2d 409, 333 P. 2d 757]+ Thus, even where the subcontractor’s bid contains an error and even though the subcontractor has attempted to revoke its bid before the general contractor has “accepted” it, the subcontractor may be held to its original offer.+[Drennan v. Star Paving Company (1958) 51 Cal. 2d 409, 333 P. 2d 757]+ The application of the doctrine of promissory estoppel has particular validity to a general contractor’s use of a subcontractor’s bid in its proposal to an owner which is subsequently accepted or is binding upon the general contractor. In those instances, the normal circumstances for promissory estoppel, which include reliance by the general contractor and a detrimental effect such as the general contractor being bound to perform the work at a specified price which included the subcontractor’s bid, are applicable.
Just as the general rule of no contract without an acceptance is subject to the exception of the promissory estoppel doctrine, even the Star Paving case is not without exceptions. For example, where a prime contractor has actual knowledge or it is determined that the general contractor had some reason to know that a subcontractor’s bid contains an error, then the equitable doctrine of promissory estoppel may not be invoked. In Brunzell Construction Company v. G.J. Weisbrod+[Brunzell Construction Company v. G.J. Weisbrod (1955) 134 Cal. App. 2d 278, 285 P. 2d 989]+, the court of appeal decided that the subcontractor could avoid a mistake in its bid because the general contractor was imputed with knowledge of the mistake.
However, the area of a general contractor’s imputed knowledge because it should have known of a mistake in a subcontractor’s bid is a very difficult area for the court to work with. One court might conclude the general contractor knew or should have known of the mistake and another court might not. Contrast, for example, the Brunzell+[Brunzell Construction Company v. G.J. Weisbrod (1955) 134 Cal. App. 2d 278, 285 P. 2d 989]+ decision with that in Norcross v. Winters.+[Norcross v. Winters (1962) 209 Cal. App. 2d 207, 25 Cal. Rptr. 821]+ In this later case, the California Court of Appeal held a subcontractor to an alleged mistake in its bid which amounted to almost 40 percent. The evidence before the trial court indicated that the subcontractor bid of $4,800 was contrasted to bids from other subcontractors for the project ranged from $7,490 to a little over $8,100. The court concluded that the difference between the defendant subcontractor’s bid and the other bids were not of such magnitude to impute knowledge of the mistake to the general contractor so the subcontractor would be required to perform the work at the original “offer” price.+[Norcross v. Winters (1962) 209 Cal. App. 2d 207, 25 Cal. Rptr. 821]+ The subcontractor’s alternative is to face a damage claim by the general contractor for the difference in cost between the subcontractor’s price and what it actually cost as performed by others. Similar conclusions were reached in C & K Engineering Contractors v. Amber Steel Company+[C & K Engineering Contractors v. Amber Steel Company (1978) 23 Cal. 3d 1, 587 P. 2d 1136, 151 Cal. Rptr. 323]+ where it was decided that a general contractor had reasonably relied on the subcontractor’s bid and the subcontractor was estopped from revoking it, and in Saliba-Kringlen Corp. v. Allen Engineering Company+[Saliba-Kringlen Corp. v. Allen Engineering Company (1971) 15 Cal. App. 3d 95, 92 Cal. Rptr. 799]+ where the court determined that a subcontractor’s attempt to extricate itself from its bid by giving notice to the general contractor before the owner accepted the quote from the general contractor was unreasonable and the subcontractor was required to honor its bid.
One final case worthy of mention is Architects and Contractors Estimating Service, Inc. v. Smith.+[Architects and Contractors Estimating Service, Inc. v. Smith (1985) 164 Cal. App. 3d 1001, 211 Cal. Rptr. 45]+ In this case, the court applied legal theories of fraud or mistake in holding that a contractor may avoid the legal obligations of its bid even though it was relied upon by the general contractor.+[Architects and Contractors Estimating Service, Inc. v. Smith (1985) 164 Cal. App. 3d 1001, 211 Cal. Rptr. 45]+ What factors did the court look to in deciding that the subcontractor could avoid its bid to the general contractor? First, the appellate court identified that the contractor involved had bid the project as its first project in the trade it had offered to perform. Furthermore, the court found, both with respect to the mistake and fraud counts, that the general contractor had encouraged the subcontractor to quote a price based upon assurances of a profit. Finally, the general contractor was aware of the inability of the subcontractor to perform the work at the price it bid and the court concluded that it would provide relief to the subcontractor to avoid its bid.+[Architects and Contractors Estimating Service, Inc. v. Smith (1985) 164 Cal. App. 3d 1001, 211 Cal. Rptr. 45]+ A careful reading of the court’s decision reveals that it is really nothing more than an application of the “knew or should have known” rule applied to a contract and couched in terms of avoidance by mistake or fraud. In other words, if there has been no formal acceptance before the subcontractor has revoked its bid, the court can refuse to apply the doctrine of promissory estoppel if the general contractor knew or should have known of a mistake. Similarly, even in those cases where a contract has been formed (acceptance communicated before withdrawal), the court can reach the same conclusion of avoiding the contract where the general contractor’s knowledge constitutes fraud or mistake.+[Architects and Contractors Estimating Service, Inc. v. Smith (1985) 164 Cal. App. 3d 1001, 211 Cal. Rptr. 45]+
Regardless of the theory utilized by the court, it seems clear that in order for there to be a finding of imputed knowledge on behalf of the general contractor, a subcontractor must be able to demonstrate a large or substantial variance from all of the other responsive bids. Of course, this area of the law is very fact driven and, therefore, susceptible to frequent litigation. To avoid such disputes, the subcontractor would be well advised to, therefore, take great care in its quoting of a bid to a general contractor.
[3]–Subcontractor’s Ability to Enforce Its Bid on Private Works
If a subcontractor is bound to a general contractor under the subcontractor’s bid even absent a formal acceptance, one would believe that a similar conclusion would be likely when the tables are turned vice versa. However, that is not the case under California law in a private works setting since a subcontractor generally does not place the necessary detrimental reliance upon a prime contractor’s use of a subcontractor’s bid in order to satisfy the requirements of the doctrine of equitable promissory estoppel.+[Klose v. Sequoia (1953) 118 Cal. App. 2d 636, 258 P. 2d 515.]+ A private works is defined as one in which there is not a public entity contracting for the work to be done.+[Cal. Civ. Code § 3100]+ In such a project, the general contractor is not presently required to contract with a subcontractor even if it uses that bid to obtain a contract with the owner.+[Klose v. Sequoia (1953) 118 Cal. App. 2d 636, 258 P. 2d 515.]+ This same conclusion was also voiced in a recent federal case employing California law.+[Electrical Construction and Maintenance Company v. Maeda Pacific Corp. (9th Cir. 1985) 764 F.2d 619.]+ There appears to be a narrow exception to this rule where the subcontractor can allege and prove that the general contractor “accepted” the subcontractor’s bid.+[Electrical Construction and Maintenance Company v. Maeda Pacific Corp. (9th Cir. 1985) 764 F.2d 619.]+ Acceptance can be expressed or implied and can be manifested in a variety of ways, including a prior course of conduct.+[Electrical Construction and Maintenance Company v. Maeda Pacific Corp. (9th Cir. 1985) 764 F.2d 619.]+ Caution should, therefore, be exercised by the owner and general contractor in communications with bidders, and subcontractors must be articulate in their bidding procedures if they want to attempt to clarify what the status of the parties dealings are in any given circumstances.
[4]–Application to Suppliers of Materials
In addition to the above principles, there are special rules concerning quotes of suppliers of material who are sought to be subcontracted with for a construction project. Commercial Code Section 2205 makes a merchant’s offer, known to be relied on by a licensed contractor, irrevocable for 10 days after the awarding of the contract to the prime contractor.+[California Commercial Code Section 2205]+ Under the code, the contractor must confirm in writing the offer within 48 hours after it is made.
Therefore, a supplier who has provided a quote to provide certain materials could be held to that quote even if it contained an error so long as the contractor or owner has confirmed the quote as required by the statute.+[Cal. Comm. Code § 2205]+ As a practical matter, it could be argued from the supplier’s point of view that if the supplier revoked its offer before it was confirmed in writing, then Section 2205+[Com. Code § 2205]+ would not apply. In other words, if the supplier revokes its bid before the statutory reliance steps are taken, then normal contract legal interpretation could be utilized to avoid its bid.
[5]–Public Works Statutory Bidding Obligations
The bidding process on public works differs substantially from normal contractual precepts of offers and acceptance in the private work arena. This is because on public projects there are statutory and customary bidding procedures which impose obligations on general contractors and subcontractors who are bidding to public owners. Many of these statutory procedures are now embodied in the California Public Contract Code and are applicable to most but not all public entities.
Similar to the promissory estoppel theory in public works, under the competitive bidding statutes for public works, the bids of contractors are considered irrevocable offers.+[M.F. Kemper Construction Company v. City of Los Angeles (1951) 37 Cal. 2d 696, 235 P. 2d 7.]+ Essentially, during the period that a public entity has to review all bids to determine which is the lowest responsible bid, the contractor may not revoke its bid unlike normal contract legal analysis.+[Menefee v. County of Fresno (1985) 163 Cal. App. 3d 1175, 219 Cal. Rptr. 99; City of Susanville v. Lee C. Hess Company (1955) 45 Cal.2d 684, 290 P. 2d 520.]+
Consequently, subcontractors can expect that their bids to a general contractor bidding on a public work will be similarly bound against them to the extent that the general contractor becomes the successful lowest responsible bidder to the owner.+[Drennan v. Star Paving Company (1958) 51 Cal. 2d 409, 333 P. 2d 757.]+ On the other hand, although normally a subcontractor on a private works project cannot enforce its bid against the general contractor this rule is modified on public works projects.+[Southern California Acoustics Company v. C.V. Holder, Inc. (1969) 71 Cal. 2d 719, 79 Cal. Rptr. 319]+ A subcontractor on a public works inherits certain rights which offset the burden of its bid being irrevocable pending the decision by the owner with respect to the acceptance of the general contractor’s bid.
Under California public works law, subcontractors who are listed on a general contractor’s bid to a public entity may invoke the benefits of the Public Contract Code. These statutes provide that a general contractor’s bid which is accepted by a public entity may not substitute any other subcontractor in the place of one who is listed on the general contractor’s bid absent very specific situations.+[Pub. Contract Code § 4104, et seq.]+ If the general contractor attempts to substitute a listed subcontractor on a public works, the public entity must disallow such substitution until a noticed hearing and findings are made under specific statutory rules. These rules include:
(1) When the subcontractor listed in the bid after having a reasonable opportunity to do so fails or refuses to execute a written contract, when that written contract, based upon general terms, conditions, plans, and specifications for the project involved or the terms of that subcontractor’s written bid, is presented to the subcontractor by the prime contractor.
(2) When the listed subcontractor becomes bankrupt or insolvent.
(3) When the listed subcontractor fails or refuses to perform his or her subcontract.
(4) When the listed subcontractor fails or refuses to meet the bond requirements of the prime contractor as set forth in Section 4108.
(5) When the prime contractor demonstrates to the awarding authority, or its duly authorized officer, subject to the further provisions set forth in Section 4107.5, that the name of the subcontractor was listed as the result of an inadvertent clerical error.
(6) When the listed subcontractor is not licensed pursuant to the Contractors License Law.
(7) When the awarding authority, or its duly authorized officer, determines that the work performed by the listed subcontractor is substantially unsatisfactory and not in substantial accordance with the plans and specifications, or that the subcontractor is substantially delaying or disrupting the progress of the work.+[Pub. Contract Code § 4107]+
Absent a reasonable conclusion of one of these specific exceptions, a subcontractor may enforce its bid against the successful general contractor and seek all resulting damages as a consequence of the general contractor’s failure to allow the subcontractor to perform its work.+[Southern California Acoustics Company v. C.V. Holder, Inc. (1969) 71 Cal. 2d 719, 79 Cal Rptr. 319.]+
Of course, even exceptions to general rules are not without their exceptions and practitioners in this area should carefully review the applicable authorities.+[Interior Systems, Inc. v. Dell E. Webb Corp. (1981) 121 Cal. App. 3d 312, 175 Cal. Rptr. 301 — Subcontractor could not invoke a damage claim under the Public Contract Code where it refused to sign a contract given to it by the general contractor.]+
A separate relief from error of a general contractor’s bid with respect to the listing of subcontractors is set forth in Public Contract Code Section 4107.5. As mentioned above, a subcontractor who has been listed in a general contractor’s bid to a public entity generally may enforce its subcontractor bid against the successful-bidding general contractor. Where, however, a general contractor has inadvertently listed the subcontractor in its bid to the public entity, the general contractor may be relieved of the duty to the listed subcontractor. Again, the time limitations and the ability of a general contractor to avoid such an alleged inadvertent clerical error are very restrictive.
Pursuant to Public Contract Code Section 4107.5, the general contractor must give notice to the public entity within two working days after the time the general contractor’s bid is open as well as provide a copy of such notice to the subcontractor claimed to have been inadvertently listed. Thereafter, the subcontractor who has allegedly been inadvertently listed may, and if it wishes to enforce its claims shall, within six working days of the general contractor’s bid opening, submit any written objections to the general contractor’s intentions to replace the subcontractor.+[Pub. Contract Code § 4107.5]+
Finally, the public entity must notice a public hearing on the matter and reach specific conclusions. The hearings involved in such a substitution and claim of inadvertent listing are very strictly limited, both in time and subject matter, and if a contractor or practitioner is faced with this problem, due care should be taken in immediately complying with the statutory responsibilities.
§ 35.07 Performance Issues Relating to Scope of Work
When it comes to performance of subcontracts, one of the greatest areas of dispute between subcontractors and owners or general contractors involves the area of “scope of work.” Normally, it is the goal of the general contractor in preparing its price quote to the owner to insure that it has covered the cost of every item of work to be performed under the plans and specifications for the project. Many times, however, it is difficult for the general contractor to ascertain under the pressures of last minute bidding activity whether it has, in fact, obtained quotes from subcontractors to cover every possible scope of work.
For example, a general contractor who is bidding upon a commercial building project which includes the installation of large air conditioning equipment will solicit bids from both mechanical contractors and electrical contractors to fulfill their various function for the commercial building project. There may be a scope of work issue concerning who is to do what as between the general contractor, mechanical contractor, and electrical contractor as follows. The mechanical contractor may feel that although it is installing the air conditioning equipment on the building’s roof and that air conditioning equipment requires electrical connections to run the pumps and chiller for the air conditioning unit, the function of those electrical connections should be the electrical subcontractor’s scope rather than the mechanical subcontractor’s. The electrical contractor may, on the other hand, feel that although it is obligated to run the electrical conduit lines to the mechanical air conditioning equipment, it does not want to take the responsibility of the electrical connection to the mechanical equipment since that is work on the mechanical contractor’s equipment. The issue may ultimately become a contract interpretation issue and the court will be called upon to construe the particular language identifying the scope of work.+[Brinderson-Newberg Jt. Venture v. Pacific Erectors, Inc. (9th Cir., 1992) 690 F. Supp. 89]+
It is ultimately up to the general contractor to insure that one or the other subcontractors has included the connections in its quote or that the general contractor has included the price to do so by its own forces. If not, it is possible that a dispute in the scope of work will exist between each of these players. While this example may not involve a tremendous amount of money, there are many other scope of work disputes that can involve substantial monetary amounts such that the general contractor and subcontractor will each resist having to perform the disputed scope of work. It is within this context that the substantial majority of disputes involving scope of work are involved. It is important for both subcontractors as well as general contractors to be aware of what steps can be taken to avoid or prevent scope of work disputes as well as how the courts will respond to the various positions in the event of a scope of work dispute.
[1]–Proper Care of Scope Issues and Contract Measures
There are specific measures which can be taken by both general contractors and subcontractors in the contracting process to help avoid and prevent scope of work disputes. From the subcontractor’s point of view, it is essential that in the subcontractor’s proposal, the subcontractor delineate all items which it intends to perform for the price it is quoting and to exclude all items that it intends not to perform. It is best to attach a copy of the proposal to the subcontract form but absent such careful drafting, a court might be able to consider an unattached proposal as evidence of a subjective intention.+[Western Med., Inc. v. Albers (1985) 266 Cal. App. 3d 383, 212 Cal. Rptr. 434]+ One way of handling such explicit quotations include provisions in the subcontractor’s quote which delineate all sections of the specifications that the subcontractor’s quote includes as well as a separate provision which lists all items that the subcontractor intends to exclude in its quote. The court may also look to all of the documents, the surrounding circumstances, and the subsequent conduct of the parties to determine true intent.+[Interfoam Corp. v. Mitchell (9th Cir., 1978) 575 F. 2d 1270]+
Because there is a great potential for scope of work disputes beyond the specifications, it may also be prudent for a subcontractor to provide a separate statement that any items that are not contained within the included list of items are hereby expressly excluded. If a subcontractor’s bid does not list specific exclusions, a court could construe or interpret the contract to, in fact, include the items if they are normally included in the particular trades custom and usage.+[Civ. Code § 1645; but see Hinckley v. Bechtel Corp. (1979) 41 Cal. App. 3d 206, 116 Cal. Rptr. 33 — if contract is fully integrated, custom and usage evidence is not admissible for proof of intent although it may be considered for purposes of deciding whether a contractee has properly performed under the contract.]+
From the general contractor’s point of view, it is essential that he or she insure that the subcontractor has included all items that normally would be included in that trade. Most contracts have terms and conditions which specify such a result; however, in order to avoid disputes downstream, the prudent general contractor will also carefully review the subcontractor’s quote in comparison to other subcontractor quotes who have bid that particular trade as well as the overall plans and specifications for the project.
Conversely, the general contractor may wish to include statements in the contract which require the subcontractor to perform all items of work which are reasonably related to the trade in which the subcontractors performing its work unless they are otherwise expressly excluded under the proposals/contract.
Also, it may be wise for the general contractor to include a contractual provision in its subcontract which obligates each and every subcontractor to perform work which the subcontractor contends is outside the scope of its work to the extent that there is a bona fide dispute and that the subcontractor may reserve its right to a claim for the costs associated with the extra scope of work. These clauses are generally upheld and prevent the subcontractor from rescinding or stopping work.+[B.C. Richter Contracting Co. v. Continental Casualty Co. (1964) 230 Cal. App. 2d 491, 41 Cal. Rptr. 98]+ The purpose for this sort of provision is to insure that the project continues to be completed in an orderly and timely fashion and so that the progress of the work is not interrupted by scope of work disputes. Essentially, this is a risk allocation provision which places the risk of scope of work disputes at the foot of the subcontractor. This mechanism allows the subcontractor to pursue a claim for extra work in the event the subcontractor can demonstrate that its price clearly did not include that scope of work.
Subcontractors may hesitate to agree to such a provision and accept that risk of loss. Even where a subcontractor agrees to accept such a provision and associated risk, the subcontractor should be able to argue that provision only applies to scope of work disputes where there is a bona fide dispute between the general contractor and subcontractor. Where there is a lack of bona fide dispute as to the scope of work, then the subcontractor should be able to argue that such a provision cannot be invoked in bad faith or that under extreme circumstances the clause is unconsiderable.+[Civ. Code § 1670.5]+ In one of the few court decisions to consider the unconscionable defense argument, a California court looked at both the procedural element of unconscionable provisions that are contained in the preprinted contract forms as well as the substantive elements of being beyond what is reasonable under the circumstances.+[A & M Produce Co. v. FMC Corp. (1982) 135 Cal. App. 3d 473, 186 Cal. Rptr. 114]+ These provisions are subject to great intellectual debate and are susceptible to unscrupulous use by general contractors but are generally designed as a provision of last resort since the best clarity and opportunity to avoid such disputes may be found in the proposal/quote stage as discussed above.
Most contracts include specific areas for designating the scope of work that the particular subcontractor is agreeing to perform and again it is essential that very specific inclusions and exclusions be contained within these sections similar to the proposal stage. For example, the American Institute of Architects’ Standard Subcontract Agreement (AIA A-401) provides:
ARTICLE 8. THE WORK OF THIS SUBCONTRACT
8.1 The Subcontractor shall execute the following portion of the Work described in the Subcontract Documents, including all labor, materials, equipment, services, and other items required to complete such portion of the Work, except to the extent specifically indicated in the Subcontract Documents to be the responsibility of others. (Insert a precise description of the Work of this Subcontract, referring where appropriate to numbers of Drawings, sections of Specifications, and pages of Addenda, Modifications, and accepted Alternates.)+[AIA Form A-401, reprinted with permission]+
Similarly, the Associated General Contractors’ Long Form Subcontract provides:
SECTION 2. SCOPE
Subcontractor agrees to furnish all labor, materials, equipment, and other facilities required to perform the work to complete:
It is at these portions of the contract that both a general contractor and subcontractor will want to be as specific as possible so as to avoid the problems of having a court, after the fact, try to interpret their original intent.
[2]–Legal Interpretation Rules of Scope of Work
Disputes
Generally speaking, scope of work disputes will be treated by the courts of California similar to other disputes involving the interpretation of contracts.+[Civ. Code § 1635.]+ Essentially, a contract must be interpreted so as to give effect to the mutual intention of the parties as it existed at the time of the contract+[Civ. Code § 1636]+ and to the extent that there are several writings comprising the contractual agreements between the parties, the court must consider all of the contracts taken together.+[Civ. Code § 1642.]+
Another possible aid in interpretation is if the court is able to determine who was the drafter of the agreement that has given rise to an ambiguity in determining the scope of work, any uncertainty or ambiguity will be construed against the person who drafted the agreement.+[Civ. Code § 1654.]+ Also, courts will imply stipulations and incidents necessary to carry out or into effect the implied obligations in order to reach a reasonable interpretation of the contractual documents+[Civ. Code §§ 1655, 1656]+ and may even be allowed to consider evidence by reference to the circumstances under which the contract is made.+[Civ. Code § 1647.]+
There are limitations, however, on the court’s power to interpret written agreements and it is the general rule that courts should ascertain the intention of the parties of a written contract by and from the writing alone if possible.+[Civ. Code § 1639.]+ Furthermore, if the written agreement has an integration clause or is otherwise a fully integrated agreement, under California law, courts have limited ability to entertain parole evidence of terms of the agreement.+[Gerdlund v. Electronic Dispensers International (1987) 190 Cal. App. 3d 263, 235 Cal. Rptr. 279, 282.]+
The test of admissibility of extrinsic evidence to explain the meaning of a written instrument is . . . whether the offer of evidence is relevant to prove a meaning to which the language of the instrument is reasonably susceptible.+[Gerdlund v. Electronic Dispensers International (1987) 190 Cal. App. 3d 263, 235 Cal. Rptr. 279, 282.]+
A very recent example of what can happen to contractors and subcontractors who have failed to make clear written expressions of their intent of the scope of work is set forth in Brinderson-Newberg Joint Venture v. Pacific Erectors, Inc. [Brinderson-Newberg Joint Venture v. Pacific Erectors, Inc. (9th Cir. 1992) D.A.R. 10042, 690 F. Supp. 891.] In that very recent case, the Ninth Circuit Court of Appeal was asked to construe the “scope of work dispute” between the general contractor, made up of a joint venture between Brinderson Constructors, Inc. and Gust K. Newberg and a subcontractor, Pacific Erectors, Inc. and its surety company.
Essentially, the scope of work dispute involved the meaning of the contract which provided that the subcontractor, Pacific Erectors, Inc., was to “erect complete and make a complete installation” of a flue gas system (FGS). The subcontractor introduced parole evidence to interpret the meaning of the above language to mean that it merely had to perform the structural and miscellaneous steel work for the FGS project. The general contractor, on the other hand, denied making any such representations to the subcontractor and insisted that the subcontractor had agreed to erect and install the entire FGS facility. In determining whether the trial court should have considered the parole evidence offered by the subcontractor as a tool in interpreting the contract language, the Ninth Circuit answered:
The precise issue is whether the terms “erect complete” and “make a complete installation,” when read in context with the rest of the contract, are reasonably susceptible of the meaning Pacific attempts to advance through its parole evidence. If the court finds after considering this preliminary evidence that the language of the contract is not reasonably susceptible of [the proffered] interpretation and is unambiguous, extrinsic evidence cannot be received for the purpose of varying the terms of the contract. [Citations omitted.] +[Brinderson-Newberg Joint Venture v. Pacific Erectors, Inc. (9th Cir. 1992) D.A.R. 10042, 690 F. Supp. 891.]+
In finally concluding that the subcontractor’s offered interpretation of the contract was could not be accepted and that therefore the subcontractor was required to perform the entire scope of work, the Ninth Circuit held:
Pacific’s proffered interpretation stretches the contractual language beyond reasonable limits and violates most applicable rules of contract construction. Therefore, we find (1) that the district court erred in allowing the jury to hear parole evidence supporting Pacific’s proffered interpretation, and (2) that as a matter of law, Pacific’s work under the contract included the field assembly, picking and settling, and bolting and welding of the FGS components into permanent position. +[Brinderson-Newberg Joint Venture v. Pacific Erectors, Inc. (9th Cir. 1992) D.A.R. 10042, 690 F. Supp. 891.]+
However, the Ninth Circuit’s decision against the subcontractor on the scope of work issue did not end there. The subcontractor, Pacific, had also sued for fraud and misrepresentation on behalf of the general contractor in attempting to hold the subcontractor to an interpretation of the scope of work that the subcontractor did not agree. The Ninth Circuit again concluded that in order for parole evidence of fraud or misrepresentation to be admissible under California law, “it must tend to establish some independent fact or representation, some fraud in the procurement of the instrument, or some breach of confidence concerning its use, and not a promise directly at variance with the promise of the writing.”+[Brinderson-Newberg Joint Venture v. Pacific Erectors, Inc. (9th Cir. 1992) D.A.R. 10042, 690 F. Supp. 891, citing Bank of America National Trust v. Pendergrass (1935) 4 Cal. 2d 258, 48 P. 2d 659, 661.]+ The court went on to note:
As with the “meaning exception to the parole evidence rule discussed above, the purposes of the rule will be undermined unless there is some limit to the fraud/ misrepresentation exception. Thus, California holds parties responsible for signing integrated contracts and will allow parole evidence fraud only to the extent it does not contradict the integrated contract.
As can be seen from the above analysis, great caution should be taken by both subcontractors and general contractors alike in memorializing the exact scope of work that each intends to be undertaken for the price that has been agreed upon. The Ninth Circuit’s conclusions could have easily gone the other way in support of the subcontractor’s interpretation had the contract or scope of work language contained language which was closer to the subcontractor’s proffered meaning rather than the general contractor’s. In other words, especially in integrated contract situations, the courts will arrive at a reasonable interpretation of the scope of work language that is utilized in the contractual documents and will be limited in their ability to construe outside or parole evidence of the meaning which one party or the other attached to the language.
§35.08 Performance Issues Concerning Scheduling and Delay Claims
Probably the greatest area of dispute among subcontractors and those who employ them centers around the concept of time and scheduling. This is because, as every one who has worked on a construction project knows, time means money.
Generally speaking, when a contractor bids a project, it has usually estimated that its performance will take a specified period of time for which it must allocate an economic value for the cost of the company’s overhead in performing such work. Often there may be a delay in the completion of the project as a consequence of one party or anothers acts or ommissions. The offending party may through such delays increase the costs of performance of the other. In every contract there is a duty of good faith and fair dealing to avoid hindering the other parties ability to enjoy the fruits of its cotract.+[Joanaco Projects, inc. v. Nixon & Tierney Construction Co. (1967) 248 Cal.App 2d 821, 57 Cal.Rptr. 48]+ This duty includes the duty to provide information and documents that are necessary to prosecute the work+[cf COAC, Inc. v. Kennedy Engineers (1977) 67 Cal. App. 3d 916, 136 Cal. Rptr. 890]+, the duty to provide access and suitable conditions+[1, Stein Construction Law 5.02[3][c] (1991, Matthew Bender)]+, and the duty to coordinate+[1, Stein Construction Law 5.02[3][b] (1991, Matthew Bender); but see L. K. Comstock Co. v. United Engineers and Contractors, Inc. (9th Cir., 1989) 880 F. 2d 219 — where general contractor found not liable to subcontractor who failed to attend job site scheduling meetings.]+ Thus a party should be able to recover damages for the delayed performance where time is of the issue.+[cf Coll v. Alcan Pac. Co. (1967) 251 Cal. App. 2d 442, 59 Cal. Rptr. 763.]+ Before discussing the exact issues suurounding the ability to recover such costs of delayed performance it is necessary to define terms.
[1]–Use of Terms
A starting point in understanding and resolving construction claims relating to delay and schedule performance is the use of terms upon which the parties can base discussions. Generally, delays can be broken down into excusable or unexcusable delays and compensable or non-compensable delays. Damages due to delay can be either liquidated damages or actual damages depending upon the circumstances and the contract terms.+[Aetna Casualty & Surety Company v. Board of Trustees of Rincon Valley Union School District (1963) 223 Cal. App 2d 337, 35 Cal.Rptr. 765]+
“Excusable delays” are delays which are not the fault or within the control of the the contractor who failed to complete timely. An “Excusable delay” may be either compensable or non-compensable depending upon its cause as discussed below.
“Unexcusable delays” are delays which according to the contract or the particular circumstances, were within the control of the contractor, and since the contractor is at fault for the delay, no adjustment in time or money is available. With no extension of time the contractor is deemed to have completed late and such an unexcusable delay will usually become the subject of owner claims against the contractor for delay.
“Non-compensable delays” are usually an excusable delay to the project schedule but are, according to contract or custom, within the parties’ contemplation and not the fault of either the contractor nor the owner. These include delays caused by unusually extreme weather, other acts of God, and even some forms of labor disputes. Essentially, these types of delay are beyond the control of all of the parties and, therefore neither the contractor or owner will be compensated or penalized. Although the contractor is not entitled to extra compensation for non-compensable delays, he or she is in most instances at least entitled to an extension of contract time for any delay in the completion. For example if a drywall contractor is delayed from completion due to an organized labor strike although he or she is not entitled to recover delay damages from the owner or general contractor, who are also not at fault, the contractor should also not be responsible for any liquidated damages since it is entitled to an extension of contract time.
“Compensable delays,” on the other hand, are delays to the construction schedule which are within the control of one of the parties or even a combination of forces. In these instances, the non offending party has undoubtedly incurred cost impacts to their extended performance due to an extended period of time that the project covers. Under this event the party is entitled to a recovery for the delayed performance directly caused by the failure to exercise their duty of good faith and fair dealing not to hinder the performance of the other.+[Joanaco Projects, inc. v. Nixon & Tierney Construction Co. (1967) 248 Cal.App 2d 821, 57 Cal.Rptr. 48]+ Compensable delays occur when any interference with the duties of a contractor or owner result in delay to the completion of the project.
“Acceleration” is essentially an event where the project has been delayed which would normally extend the time period of performing the tasks at hand, but for one reason or another, the time period is not extended. The contractor must under such circumstances accelerate the same amount of labor and work force into a shorter period of time. This can have cost of performance consequences that are different than pure delay costs and a contractor is entitled to recovery of all excess costs.+[Mobil Chem. Co. v. Blount Bros. (5th Cir., 1987) 809 F. 2d 1175.]+ An acceleration can be either directed or constructive. A directed acceleration is where, although the contractor has been delayed, the owner directs the contractor to perform the original scope of work in the original period of time notwithstanding the delay. A directed accelleration can also occur where although no delay has occured the owner directs an early completion date.
A constructive acceleration may be implied where, although the owner does not expressly direct the contractor to perform in a shorter period of time, the owner has made the contractor aware that it will require the contractor to complete within the original schedule which did not anticipate the alleged delays. An example of a constructive acceleration might be where the owner has refused to grant or recognize a time extension request by the contractor and the owner reminds the contractor of the penalties of a late completion.
A final term which must be defined is the notion of “float”. Normally a costruction project carries with it a particular schedule that each subcontractor must complete its work within. Say for example, a mechanical subcontractor must complete its work within nine (9) months of the project start date. Because of the subcontractors effeciencies and a generous contract schedule the subcontractor submits a detailed as-planned construction schedule that shows the subcontractor actually able to comlete its work within six (6) months thereby saving three (3) months of overhead costs. Suppose then that during the work, the owner or general contractor is not ready for the mechanical subcontractor to finish its work at month six but eventually the subcontractor is able to finish within the original nine month schedule. Is the subcontractor entitled to claim that since it planned to finish early the offending party is obligated to reimburse the subcontrcator for the added overhead costs? Or is the owner or general contractor entitled to use the float that was theoretically created by the subcontractor’s early planned finish date? These are questions which, as set forth below, are still to be answered by California courts.
[2]–Legal Rules for Determining Entitlement to Delay Damages by the Subcontractor
When a subcontractor encounters a delay to its performance through acts or omissions of the general contractor or owner, the first thing a contractor must ascertain is whether, as a matter of law, the contractor is entitled to damages for such delay. That is to say, although the delay may qualify as a “compensable delay,” is there any other legal impediment to payment of the costs of such delay?
Owners and general contractors have on some occasions attempted to contract away any liability for delay to the progress of a subcontractor. These provisions typically described as “No Damage For Delay Clauses” were at one time very frequently found in agency contracts between California public entities and a contractor and are still found in some private subcontract forms. An example of a no damage for delay provision which is still found in the AGCC-3 Standard Long Form Subcontract is as follows:
SECTION 5. TIME
. . . No claims for additional compensation or damages for delays, whether caused in whole or in part by any conduct on the part of Contractor, including, but not limited to, conduct amounting to a breach of this Agreement, or delays by other subcontractors or Owner, shall be recoverable from Contractor, and the above-mentioned extension of time for completion shall be the sole remedy of Subcontractor; provided, however, that in the event Contractor obtains additional compensation from Owner on account of such delays, Subcontractor shall be entitled to such portion of the additional compensation so received by Contractor from Owner as is equitable under all of the circumstances . . . .
Acknowledging the extreme unfairness of such provisions, on public works, the California Legislature enacted Public Contract Code Section 7102 which, as recently amended, provides:
Contract provisions in construction contracts of public agencies and subcontractors thereunder which limit the contractee’s liability to an extension of time for delay for which the contractee is responsible in which delay is unreasonable under the circumstances involved, and not within the contemplation of the parties, shall not be construed to preclude the recovery of damages by the contractor of subcontractor. No public agency may require the waiver, alteration, or limitation of the applicability of this section. Any such waiver, alteration, or limitation is void. This section shall not be construed to void any provision in a construction contract which requires notice of delays, provides for arbitration or other procedures for settlement or provides for liquidated damages.
Essentially, under Public Contract Code Section 7102, since a public entity can not avoid the obligations of its delay neither can a general contractor. Accordingly no damage for delay clauses are not enforceable on a public works project even if an AGCC subcontract form is used. It should be pointed out, however, that the above provision by its express terms does not limit any notice requirements that a subcontractor must give to either an owner or a general contractor and the lack of adequate notice and perfecting all administrative remedies may still be an impediment to recovery.
Notwithstanding Public Contract Code Section 7102, “No Damage For Delay” provisions may still be upheld by California courts in private work projects.+[K & F Construction v. Los Angeles City Unified School District (1981) 123 Cal. App. 3d 1063, 176 Cal. Rptr. 842]+. To the extent that such clauses are not precluded by Public Contract Code Section 7102 (such as non-public works), such a provision may be upheld against a contractor to limit a contractor’s remedy for delay by the other to only an extension of time.
Even where such clauses have been upheld, however, a contractor who has been delayed by the acts of another may still be able to argue that the “No Damage For Delay” provisions should be limited under certain circumstances. For example, in Hawley v. Orange County Flood Control District,+[Hawley v. Orange County Flood Control District (1963) 211 Cal. App. 2d 708, 27 Cal. Rptr. 478]+ the court strictly construed a “No Damage For Delay” provision against an owner who had delayed the progress of the project and so actively engaged in hindering the contractor’s progress that the delay became so unreasonable the court refused to apply a “No Damage For Delay” provision. Therefore, even in the private work context, a contractor who has been prevented by the owner from progressing with its work in an orderly fashion may seek damages for such delay even in some cases in the face of “No Damage For Delay” provisions.+[See also McGuire & Hester v. San Francisco (1952) 113 Cal. App. 2d 186, 247 P. 2d 934.]+
Although the above principals seem to be firmly decided, one issue which has not been directly taken up by California courts to date is to what extent will a contract provision be upheld where it does not exclude damages for delay, but merely “liquidates” the cost of such delay to a specific dollar amount for each day’s delay that the owner is responsible for under the circumstances. To the extent that such clauses are seen as “liquidated damage clauses”, it is possible that such clauses will be upheld even though the liquidated damage amount is not equal to the actual damage amount that a contractor incurs for each day of delay.+[See Pub. Contract Code § 7102.]+ A contra argument to such a position is that the contractor’s actual delay costs were unreasonable under the circumstances and, therefore, the liquidated damage provision is invalid.+[Civ. Code § 1671(b).]+ The issue is difficult at best and the contractor under the current code has the burden of proof.+[Civ. Code § 1671.]+
[3]–Quantifying a Subcontractor’s Damage for Delay
Once having ascertained that damages for delay may be available to a subcontractor who has been delayed by the owner or its agents, the subcontractor must then attempt to quantify the amount it is damaged due to such delay. There has been much debate and acrimony between contractors or their scholars and owners or their scholars as to a reasonable basis for calculating delay damages in a given context. Many jurisdictions+[Golf Landscaping, Inc. v. Century Constr. Co. (1985) 39 Wash. App. 895, 696 P. 2d 590; Nebraska Pub. Power Dist. v. Austin Power, Inc. (8th Cir., 1985) 773 F. 2d 960; PDM Plumbing & Heating, Inc. v. Findler (1982) 431 N.E. 2d 594]+ have applied damage calculations which are derived from a formula known as the “Eichleay Formula” which originated out of a government contract with a contractor known as the Eichleay Corp.+[60-2 BCA (ASBSC 1960).]+ Essentially, the Eichleay Formula attempts to quantify delay damages of a contractor by determining what percentage of a contractor’s total overhead, which has been incurred during the contract period in question, versus the percentage of that contract’s gross revenues in question, compared to the contractor’s total billing, multiplied by the number of days of the owner caused delay. In mathematical terms:
Contract Billing Total ÷ Total Billings for all Contracts During Contract Period x Total Overhead Incurred During this Contract Period = Total Allocable Overhead to this Contract (or Y). Y ÷ Number of Days Performed on the Project x Number of Days Delayed = Extended Overhead Claim.
Many modifications to such a basis of calculation for delay damages to a contractor have been approved throughout various jurisdictions known as “Modified Eichleay Formulas.” In California, most trial courts will follow Eichleay or Modified Eichleay Formulas for determining delay damages of a contractor unless the contractee can offer convincing proof that such formulas are unreasonable under the particular circumstances at hand.
Other theories to calculate damage due to delay include a “total cost method of comparing the costs incurred less amounts paid.” This basis of damage calculation has been criticized+[Huber, Hunt & Nichols, Inc. v. Moore (1977) 67 Cal. App. 3d 278]+, but has been approved by other courts.+[C. Norman Peterson Co. v. Container Corp. of America (1985) 172 Cal. App. 3d 628, 218 Cal. Rptr. 592; State v. Guy F. Atkinson (1986) 187 Cal. App. 3d 25, 231 Cal. Rptr. 382.]+
To the extent the delay causes a subcontractor to incur increased costs due to lost efficiency or other impacts to its schedule, recovery has been granted.+[Maurice L. Bein v. Housing Authority (1958) 157 Cal. App. 2d 670, 321 P. 2d 753.]
[4]–Delays Caused by the Subcontractor
To the extent a subcontractor has delayed a project through no fault of the general contractor or owner, subcontractors may be liable for damages caused by the subcontractor’s unexcused delay. In most contracts, these situations are typically dealt with in advance by contract provisions which attempt to delineate the owner’s damages for a contractor’s delay. These contract provisions, known as Liquidated Damage clauses under recent changes to California statutes, are presumed valid.+[Civil Code Section 1671]+ It is up to the challenging party to establish that the clause was unrecoverable under the circumstances then existing.+[Civ. Code § 1671(b).]+
Where a contract between a general contractor or owner and a subcontractor does not provide for Liquidated Damages, an owner or general contractor may still be entitled to compensation for damages due to the subcontractor’s delay through a calculation of its actual damages. Proof of actual damages to an owner for a contractor’s delay is very dependent upon the particular circumstances that the owner and contractor have found themselves under. Contractors have been held liable for damages due to its delay to an owner as a result of lost income or rental revenues.+[J’Aire Corp. v. Gregory (1979) 24 Cal. 3d 799, 598 P. 2d 60, 157 Cal. Rptr. 407.]+
One area of increasing interest and dispute among contractors and owners involves the analysis of whether the delay of either an owner or a contractor is concurrent to the subcontractor’s delay which would somehow prevent one or the other from being entitled to Delay Damages. For example, in General Ins. Co. of America v. Commerce Hyatt-House,+[General Ins. Co. v. Commerce Hyatt-House (1970) 5 Cal. App. 3d 460, 85 Cal. Rptr. 317]+ the court held that an owner who has “contributed substantially to the delayed performance of a construction contract may not recover liquidated damages . . ..”+[General Ins. Co. of America v. Commerce Hyatt-House (1970) 5 Cal. App. 3d 460, 472, 85 Cal. Rptr. 317.]+ Where, however, the delay of each is somehow allocable in causation, then it may be plausible to segregate such delays and they are no longer “concurrent.”+[Nomellini Construction Co v. Dept. of Water Resources (1971) 19 Cal.App. 3d 240, 96 Cal.Rptr. 682]+ Furthermore, there is California authority for the conclusion that the fact finder may determine relative fault for the delay through a “jury verdict” method of allocating a dollar amount to one or the other.+[State v. Guy F. Atkinson Co. (1986) 187 Cal. App. 3d 25, 231 Cal. Rptr. 382.]
One question which does not seem to have been resolved yet by the california courts is whether a contractor can recover delay damages based upon time used by another contractor or the owner that was “float”. From the subcontractors perspective,+[In reality this issue is not solely argued by subcontractors. Even general contractors will face these issues with the owner where they have developed float in the overall schedule]+ the arguement must be that a contractor is entitled to its effeciencies of its own operations and that the general contractor and the owner must avoid breaching their duty not to interfere with the subcontractor.+[See, Joanaco Projects, inc. v. Nixon & Tierney Construction Co. (1967) 248 Cal.App 2d 821, 57 Cal.Rptr. 48]+ From the general contractor and/or the owners perspective their position is that the project is given a drop dead date only and there are no guaranties that a subcontractor will be able to finish earlier than that final date. The arguement must follow that the subcontractor does not own the right to any float but that the job owns the float such that no player is entitled to be compensated for any use of the float and all parties can use it for whatever reason they need it. In other words, he or she that uses it first owns the float.
While the issue will one day have to be decided under specific circumstances of a case, one factor that may heavily upon the outcome in any particular case is to what degree do the contractual instruments and project correspondence address the issue. If the players do not have advance notice of the early planned completion date a court may be reluctant to award any damages even if it is convinced of the “float” ownership issue.
[5]–Acceleration and Disruption Claims
In addition to claims for the cost of the overhead of a contractor during an extended time or performance, delay on the construction project may also lead to other types of claims such as acceleration or disruption claims. It is basic construction contract law that a party to construction contract owes a duty to cooperate and to refrain from performing any act or omission which would prevent or otherwise hinder the other party’s performance of its contractual duties.+[Joanaco Projects, Inc. v. Nixon & Tierney Construction Company (1967) 248 Cal. App. 2d 821, 57 Cal. Rptr. 48.]+
For example, should the owner or general contractor delay the progress of the subcontractor but also insist that the subcontractor still complete within the time period that had originally been contemplated by the parties? The subcontractor, upon finishing within that time frame, does not have any extended overhead since he has finished on time. The subcontractor may, however, have additional costs as a result of having to perform the original scope of work in a shorter time period due to the delay caused by the owner or its agents.
Beyond the unresolved question of float, a subcontractor who is interferred with may be forced to supply additional manpower to the project in order to complete within the original time frame and may incur additional costs due to loss of efficiency of its manpower, overtime, stacking of trades, etc. It may be reasonable for the subcontractor to be entitled to compensation for such acceleration costs or disruption damages. These damages are awardable whether the acceleration is expressed or constructive as was previously defined.+[Maurice L. Bein v. Housing Authority (1958) 157 Cal. App. 2d 670, 321 P. 2d 753.]+
In some instances, the hinderance by the general contractor or owner may be so substantial and the changes to the schedule so great that the parties ultimately must even “abandon” their original contract and proceed on a day by day basis with the best production and progress as possible. In these instances, a subcontractor may even be entitled to recover on a total cost or quantum meruit basis.+[C. Norman Peterson v. Container Corp. of America (1985) 172 Cal. App. 3d 628, 218 Cal. Rptr. 592; State v. Guy F. Atkinson (1986) 187 Cal. App. 3d 25, 231 Cal. Rptr. 382.]+
[6]–Preserving and Perfecting Delay Claims
It is also important for subcontractors to remember that of equal significance to the ability to seek damages for delay is the significance of a contractor’s timely perfecting its claims for delay. Most contracts provide for notice provisions by the subcontractor should it wish to seek compensation for delay or impact claims against the owner, etc. These notice provisions are not barred by Public Contract Code Section 7102 and are enforced under reasonable circumstances. For example, on a Cal-Trans project, contractors must give a notice of potential claim within 10 days of the act or event giving rise to such potential claims.+[See for example the California Department of Transportation Standard Specification Section 9-1.04.]+
Similarly, there are frequently additional time frames in which to set forth with substantial accuracy the basis of the claim and amount of requested contract adjustment due to such claims. Notwithstanding the importance of meeting the above deadline and the potential significant adverse results if they are not met, there are cases which will relieve a contractor of its failure to meet deadlines under certain circumstances.+[See Peter Kiewet Sons Co. v. Pasadena City Junior College District (1963) 59 Cal. 2d 241, 379 P. 2d 18, 28 Cal. Rptr. 714, where an owner was suing a contractor for liquidated damages and the court rejected the owner’s claim even though the contractor had failed to give notice of the delays caused by the owner that accounted for the period of delay with the contractor. See also Brinderson Corp. v. Hampton Roads Sanitation Dist. (4th Cir. 1987) 825 F.2d 41 for an affirmative claim for delay under a theory of waiver or actual knowledge by the owner..]+
§35.09 Performance Issues Concerning Quality of Work
With the tremendous increase in the complexity of construction projects and trend toward building on land which requires more sophisticated earthwork engineering, there has been a tremendous explosion in disputes concerning the quality of work by contractors. This has inevitably filtered down to disputes involving the quality of work of subcontractors who perform the substantial majority of work on development projects. These disputes can range from the highly technical performance disputes involved in the more complicated and sophisticated high-tech construction to the more generic disputes involving defective work arising out of hillside construction of residences and multi-family residences. The following discussion will analyze the legal and equitable principles involved from each player’s prospective as well as the potential damages that arise out of defective work claim concerning the quality of work of a subcontractor.
[1]–Defective Work Claims
As stated above, defective work claims can range tremendously between the generic work claims and the highly technical claim but can generally be stated as any claim concerning the quality of workmanship of a subcontractor where it can be said that the subcontractor’s performance failed to meet the standards for custom and practice in the industry or failed to follow the plans and specification for the project.
It is a general rule that a contractor’s performance must comply with a variety of standards, including, but not limited to, the following:
1. Standards called for under the plans and specifications.
2. The standard custom and practice within the industry.
3. The applicable codes and regulations.
Whenever someone has been damaged as a result of a contractor’s failure to perform any of the above three standards, it is usually not a complicated issue of whether the contractor has performed defective workmanship. The measure of damages for a subcontractor’s performance of defective work is commonly known as the cost-to-correct rule.+[Jones v. Kvistad (1971) 19 Cal. App. 3d 836, 46 Cal. Rptr. 49.]+
In addition to claims arising from a contractor’s failure to perform according to any of the above standards, there are many defective work claims which cannot be coherently articulated as a violation of one of the above three standards. In these situations, the property owner may be complaining of defects in construction when, in fact, the problems that the owner is concerned with are symptoms of problems that arose out of defective design rather than defective quality of work by a subcontractor. By far, these latter types of cases are the more complicated since it is sometimes a gray area between a true defective work claim and a claim arising out of symptoms due to deficiencies in design. The construction law practitioner and counsel for the insurance company of contractors have been steadily bombarded with claims which fall under one of these two types of cases involving defective work claims. Counsel must be careful to differentiate between the two. When a claim of defective work clearly involves a contractor’s failure to meet one of the above standards, then an appropriate analysis of the resulting damages arising out of those breaches of duties must be undertaken. Where, on the other hand, the substantial portion of the claim really arises out of symptoms of problems associated with deficiencies in design, then the construction law practitioner must address not only the potential damages of the complaining party but also potential cross-complaints that the contractor may have against the design professional, owner, or other players.
Although the cost-to-repair method is a proper measure of damages, there may be instances where that method would create economic waste such that the diminution in value of the property as defectively constructed is far outweighed by the cost to repair. In those cases, the courts will apply the diminution in value rather than the normal measure of damages.+[Bayuk v. Edson (1965) 236 Cal. App. 2d 309, 46 Cal. Rptr. 708.]+
In addition to the potential civil liability for failure to comply with the above standard, a contractor may also be subjected to administrative or disciplinary proceedings. California Business and Professions Code Section 7109 states:
(a) A willful departure in any material respect from accepted trade standards for good and workman-like construction constitutes a cause for disciplinary action, unless the departure was in accordance with plans and specifications prepared by or under the direct supervision of an architect.
(b) A willful departure from or disregard of plans or specifications in any material respect which is prejudicial to another, without the consent of the owner or his or her duly authorized representative and without the consent of the person entitled to have the particular construction project or operation completed in accordance with such plans or specifications, constitutes a cause for disciplinary action.
In Bailey-Sperber, Inc. v. Yosemite Insurance Company,+[Bailey-Sperber, Inc. v. Yosemite Insurance Company (1976) 64 Cal. 3d 725, 134 Cal. Rptr. 740]+ the court held that Sections 7109, 7110, and 7116 expressly required that the conduct subject to discipline be such that it is willful in order for there to be a violation. Other sections of Chapter 7 of the Business and Professions Code beginning with Section 7090 do not contain such a requirement. The court stated that “we must assume that the difference in statutory phraseology among sections indicates a legislative determination to differentiate between conduct not subject to discipline where inadvertent and that subject to discipline even inadvertent.”+[Bailey-Sperber, Inc. v. Yosemite Insurance Company (1976) 64 Cal. 3d 725, 134 Cal. Rptr. 740, 742]+. Thus, mere negligent defective workmanship, although giving rise to civil liability for damages, will not be grounds for administrative proceedings.
Where disciplinary proceedings are appropriate, administrative sanctions might be avoided under appropriate post performance conduct of the subcontractor in good faith. In Terminix Company v. Contractors’ State License Board,+[Terminix Company v. Contractors’ State License Board (1948) 190 P.2d 24, 84 Cal. App. 2d 167]+ the court stated as follows:
The remaining alleged violations and all of those which we have discussed up to this point . . . must fall because an essential element of each of them, material prejudice, or substantial injury, is lacking. As can be seen from our previously presented summary of the four statutory provisions, Sections 7109, 7113, 7116, and 7119, such prejudice or injury is expressly required, save for Section 7113. However, we believe this requirement to be implicit in this section. It deals with fixed- price contracts only, and a material failure of the contractor to complete such a contract. Necessarily, in such a case, the owner will suffer to the extent of the cost of completion which must be done at his own expense . . .. [A]ppellant’s claimed misconduct consisted of the making of certain direct and indirect overcharges . . .. Long before the complaint herein was filed with respondent, both Byram and Hamilton made settlements with appellant which respondent’s hearing officer characterized as ’eminently fair’ and which granted to them in credit adjustment substantially more than the trial court found was due to them . . .. Thus, Byram, Hamilton, and Holm have suffered no injury or prejudice by reason of appellant’s apparent overcharges. Accordingly, no cause for disciplinary action by respondent against appellant existed because of them.
. . .
While appellant has made no settlement with Holm, it offered, prior to the initiation of this proceeding before respondent, to settle with him on terms more favorable to him than he was entitled to under the findings of respondent’s hearing officer . . . . A comparison of the terms of this offer with what respondent found was due as between Holm and appellant establishes that completion of the job by appellant on the terms offered would have amounted to substantially more than complete performance or restitution, as defined by respondent. As long as the matter stands in the present status, appellant has been guilty of no violation of the act. Its offer in good faith, coupled with its admitted ability to complete the work for a fair price, must, under the circumstances, and for present purposes, be deemed the equivalent of performance.
The statute does not penalize a licensee for making overcharges which the owner does not pay, nor for poor work which is done over to the satisfaction of the owner. A contractor cannot be held guilty of a violation of the act so long as he stands ready, able, and willing to fulfill his contract.
Other statutory provisions which may be applicable to claims of defective workmanship by a subcontractor include:
Business and Professions Code Section 7110 states: “Willful or deliberate disregard and violation of the building laws of the state, or of any political subdivision thereof . . . constitutes a cause for disciplinary action.”
Business and Professions Code Section 7113 states: “Failure in a material respect on the part of a licensee to complete any construction project or operation for the price stated in the contract or for such construction project or operation or in any modification of such contract constitutes a cause for disciplinary action.”
[2]–Damages and the Substantial Completion Doctrine
The measure of damages for a contractor’s defective performance depends upon the circumstances. As stated above, the general rule applies the cost to complete or correct rule.+[Shell v. Schmidt (1958) 164 Cal. App. 2d 350, 330 P. 2d 817.]+ Other courts have allowed recovery against a contractor on a measure of damages such that the court determined the difference in value of the building as performed compared to as it would have been valued had the contractor complied fully with the plans and specifications.+[Avery v. Frederickson & Westbrook (1944) 67 Cal. App. 2d 334, 154 P. 2d 41.]+ In the Shell case,+[Shell v. Schmidt (1958) 164 Cal. App. 2d 350, 330 P. 2d 817]+ the court in refusing to apply the difference in value rule looked at whether the contractor’s deviations from the contract were intentional or substantial. If so, the contractor would not be allowed the benefit of the lesser measure of damages and must be required to pay the actual cost of repair.
There are instances, however, where the cost of repair of the defects involved such significant costs that it greatly exceeds the true loss of market value and in those circumstances it would be an economic waste to require the larger measure of damages.+[Bayuk v. Edson (1965) 236 Cal. App. 2d 309, 46 Cal. Rptr. 49.]+ However, where the contractor’s performance is so substantially defective or intentional, California cases have held the proper measure of damages to be the true cost of repair since the doctrine of substantial performance does not apply.+[Famous Builders, Inc. v. Bolin (1968) 264 Cal. App. 2d 37, 70 Cal. Rptr. 17; see also Tolstoy Construction Company v. Minter (1978) 78 Cal. App. 3d 665, 143 Cal. Rptr. 570.]+
§35.10 Performance Issues Regarding Design Criteria
[1]–Duty of Subcontractor
Undoubtedly, since there is no such thing as a perfect set of design criteria, virtually every subcontractor has on occasion noticed, problems in the plans and specifications which are guiding its performance. These problems can range from meaningless clarifications to tremendous changes in the scope, timing, or manner of the contractor’s performance.
Very generally speaking, it is the responsibility of every contractor who is bidding upon a work of improvement to notify either the architect (and/or the engineer) or the owner of any material deficiencies the contractor notices in the plans and specifications prior to submitting his bid.+[John F. Miller Co. v. George Fichera Construction Corp (Mass. 1979) 388 N.E. 2d 1201.]+
Although there is an absence of a lot of authority on this concept in California this responsibility has been described as a “duty” by some+[Vol.1, S. Stein, Construction Law, Section 2.01 (2)(b), (Matthew Bender 1991)]+ and may have some basis in California as either an implied covenant or representation or even under the doctrine of mitigation of damages.+[See also Wiechmann Engineers v. State Department of Public Works (1973) 31 Cal. App. 3d 741, 107 Cal. Rptr. 529; and Umpqha River Nav. Co. v. Crescent City (9th Cir. 1980) 618 F.2d 588.]+ In fact, many contracts and requests for proposals expressly provide that the contractor is to inspect the property prior to bidding and to review the plans and specifications, noting any substantial problem.+[See American Institute of Architects Form Document A201, Article 4.3.6.]+ This duty applies to both contractors and subcontractors.
In most instances, a subcontractor who has discovered problems in plans and specifications will notify the general contractor, architect, and owner, preferably in writing, who upon determining the significance of the requested clarification, may publish an addendum to the plans and specifications upon which all contractors should include in their bid.
Although a subcontractor probably maintains a responsibility to notify the owner/architect of errors of which it is “aware,” this responsibility should not require the contractor to guarantee that it has reviewed the plans and specifications with the same care that a design professional has or that it has guaranteed that no other errors exist. This issue of to what degree does the contractors responsibility extend, is probably a large contributing reason for many construction disputes surrounding projects that have resulted in litigation of design issues.
As will be seen below, owners and design professionals have attempted to place the burden as much as possible on contractors and their subcontractors, and the courts have struggled to find a reasonable approach to this heavily disputed area. Suffice it to say that as of this point in time, there appears to be no California cases which place a burden or responsibility on the contractor to discover errors in the plans and specifications beyond those which are either known to him or those which a reasonably prudent contractor/bidder should have known.
[2]–Warranties of Plans and Specifications
As a general rule, despite a contractor’s bid being for a specific sum, owners of construction projects have been held liable for “extra work” necessitated by errors or ambiguities in plans and specifications. If owners are liable to general contractors for such errors, so to are subcontractors entitled to recovery. The general rule is based upon the notion that an owner warrants and represents that the project can be constructed in accordance with the plans and specifications as given to the contractor to bid upon. In California, claims for extra work due to errors or ambiguities in plans and specifications have been based upon theories of various theories of recovery.
In the case of Gogo v. Los Angeles County Flood Control District,+[Gogo v. Los Angeles County Flood Control District (1941) 45 Cal. App. 2d 334, 114 P. 2d 65]+ the court determined that a contractor who has reasonably relied upon plans and specifications to indicate conditions upon which his bid is based is entitled to recover the value of extra work necessitated by the conditions being other than as represented. The same conclusion was followed in Souza and McCue Construction Company v. Superior Court+[Souza and McCue Construction Company v. Superior Court (1962) 57 Cal. 2d 508, 370 P. 2d 338]+ where the California Supreme Court utilized a theory of breach of an implied warranty of the correctness of plans and specifications which misled the contractor in furnishing its bid to perform the work.
As a result of the misrepresentation and implied warranty theories being applied against owners of construction projects, owners and their design professionals attempted to circumvent such conclusions by invoking assumption of the risk clauses in their requests for bids and contracts with general contractors. These defensive clauses generally required the contractor to familiarize itself with the site, materials, bidder information, and the like, and to require the contractor to conduct affirmative investigation of the conditions of the project as it related to the plans and specifications designed by the design professional.
There appear to be differing rulings from California courts in interpreting the contractor’s and owner’s rights and obligations under these clauses. However under careful scrutiny, these cases can be made consistent and the contractor and construction law practitioner should be aware of the differences in how the courts will treat the parties based upon deficiencies in the plans and specifications.
For example, in Wunderlich v. State,+[Wunderlich v. State (1967) 65 Cal. 2d 777, 423 P. 2d 545, 56 Cal. Rptr. 473]+ the Supreme Court held that where there is no actual misrepresentation of factual matters within the public entity’s knowledge and when both parties have equal access to the information which gave rise to the claim, the contractor may not claim in the face of an assumption of the risk clause that a misrepresentation or breach of warranty has been made.+[See also Jasper Construction, Inc. v. Foothill Junior College District of Santa Clara (1979) 91 Cal. App. 3d 1, 153 Cal. Rptr. 767.]+
In that same year, the same Supreme Court concluded in E.H. Morrill Company v. State+[E.H. Morrill Company v. State (1967) 65 Cal. 2d 787, 423 P. 2d 551, 56 Cal. Rptr. 479]+ that although a contract contained an assumption of the risk clause, the conclusion would be different and the contractor was entitled to extra work compensation since there was sufficient facts to constitute some actual misrepresentation on behalf of the public entity that the contractor would not encounter the types of problems he encountered.+[See also City of Salinas v. Souza and McCue Construction Company (1967) 66 Cal. 2d 217, 424 P. 2d 921, 57 Cal. Rptr. 337; Warner Construction Corp. v. City of Los Angeles (1970) 2 Cal. 3d 285, 466 P. 2d 996, 85 Cal.Rptr. 444.]+
In the most recent case concerning this area, a California Court of Appeals has concluded that in addition to the express representations an owner makes as to the plans and specifications, an owner also impliedly warrants and represents that certain events will occur with respect to the contractor’s assumptions based upon the plans and specifications and that in the event those events do not occur, the owner may be subjected to extra work claims.+[Tonkin Construction Company v. County of Humboldt (1987) 188 Cal. App. 3d 828, 233 Cal. Rptr. 587.]+
In addition to theories of recovery for extra work due to misrepresentation or breach of express or implied warranty, owners may also be responsible for claims caused by deficient plans and specifications on other theories. One such theory, known as the cardinal change or excess change order or abandonment, has been expanded on very recently in California. The theory first was enunciated in California under the case of Daugherty Company v. Kimberly-Clarke Corp.+[Daugherty Company v. Kimberly-Clarke Corp. (1971) 14 Cal. App. 3d 151, 92 Cal. Rptr. 120]+ as well as other federal cases which have been relied upon by the California authorities.
More recently, in the case of C. Norman Peterson Company v. Container Corp. of America,+[C. Norman Peterson Company v. Container Corp. of America (1985) 172 Cal. App. 3d 628, 218 Cal. Rptr. 592]+ the California Court of Appeals determined where there are changes of such a magnitude that the parties have basically abandoned the original contractual basis for the project contemplated by the parties, the contractor is entitled to recover the reasonable value of all the services, even though the amount of such damages has exceeded the original contract scope.+[See also State v. Guy F. Atkinson Company (1986) 187 Cal. App. 3d 25, 231 Cal. Rptr. 382.]+ Again, a subcontractor may recover against the general contractor for these same damages which who may in turn recover against the owner.
[3]–Design Professional Liability
In addition to a contractor’s claim against an owner for the deficient plans and specifications, a subcontractor may also have claims arising against the design professionals who are ultimately responsible for the design provided to the owner. These claims for economic damages many times take the character of negligence claims against either an architect or an engineer. It has also been held in California that an architect or engineer may be liable to a contractor on a third party beneficiary theory.+[COAC, Inc. v. Kennedy Engineers (1977) 67 Cal. App. 3d 916, 136 Cal. Rptr. 890.
[4]–Limitations Concerning Disputes Involving Design
In California, it is also important to realize that there are limitations on the right to recover extra costs caused by deficient design documents. First, to the extent the contractor seeks recovery from a design professional based upon a tort of professional negligence the subcontractor must offer expert testimony that the professional failed to meet its standard of care.+[Miller v. Los Angeles County Flood Control Dist. (1973) 8 Cal. 3d 689, 505 P. 2d 193, 106 Cal. Rptr. 1.]+ This notion of required expert testimony is not absolute:
“Ordinarily where a professional person is accused of negligence… the accepted standards must be established only by qualified expert testimony unless the standard is a matter of common knowledge.+[Huber, Hunt, etc, supra at 313; See also Chaplis v. County of Monterey (1979) 97 Cal App 3d 249, 158 Cal. Rptr. 395.]+
Second, there are also statutory limits for claims or action due to defects in design or construction. Pursuant to California Code of Civil Procedure Section 337.1, an action for damages from persons performing design or construction or other related services which is patently deficient is four years after the substantial completion of the work of improvement. A patent deficiency is one which is apparent by reasonable inspection. This limitation period must be contrasted with California Code of Civil Procedure Section 337.15 which provides that the statute of limitations for any latent deficiency must be brought within ten years from substantial completion of the project. Obviously, any deficiency which does meet the definition of “patent” must be by its nature “latent.” One case interpreting these statutes has found liability outside the limitation period where there has been some sort of “tolling.”+[Cascade Gardens Homeowners Association v. McKellar & Associates (1987) 194 Cal. App. 3d 1252, 240 Cal. Rptr. 113]+ Because of the severe consequences of these statutes of limitations, the practitioner in this area must be very careful.
§ 35.11 Performance Issues Concerning Shop Drawings and other Submittals by Subcontractors
There is great debate among contractors, owners, design professionals, and construction law practitioners over the purpose and function of contractor submittals of shop drawings and, consequently, their legal effect. Subcontractors will expect the Architect to notify the contractors of any problems in the proposed method of construction. Architects on the other hand contend that their rview of shop drawing submittals does not require them to be responsible that their review of these drawings do not warrant that the means, methods and techniques are proper or safe.+[See Architect-Engineer Liability Under California Law, page 22-7 (1989 The Cambridge Institute)]+ Further depending upon the contract language, the architects review of the shop drawings may not mean that the contractor can deviate from the plans or specifications.+[See 1, Stein Construction Law 5.04 [3],[k] (1991 Mathew Bender); See also Architect-Engineer Liability Under California Law, page 22-7 (1989 The Cambridge Institute)]+ At a minimum, the shop drawing submittal process allows the owner through the design professional the ability to review and analyze what it is the contractor is proposing to install for the purposes of insuring that the owner is getting what it has contracted to get.+[1, STEIN Construction Law 5.04 [3],[k] (1991 Mathew Bender)]+ From that basic level, the claims of the various players to the construction development process ranges from the design professional’s duty to discover errors to the trade contractor’s duty to avoid them. To the extent an architect has reviewed a subcontractors shop drawings and is exercising its professional expertise, it is very likely that an architect will be liable for any errors or ommisions in its services.+[See Gagne v. Bertran (1954) 43 Cal. 2d 481, 264 P. 2d 641]+
§35.12 Performance of Payment Provisions
[1]–Duty of General Contractor to Make Payment Generally
Under California law, contractors must pay subcontractors within 10 days of receiving payment from the owner unless the subcontract provides otherwise or there is a bona fide dispute to allow the general contractor to withold up to 150% of the amount in dispute.+[See Public Contract Code Section 10262.5 and Business & Professions Code Section 7108.5]+ Of course the significant questions that arise are (1) what is a “good Faith” dispute, and (2) may the general contractor withold payment to the subcontractor indefinately where the owner has not paid the general contractor. California courts have dealt with the problem in a very limited fashion. In fact the good faith dispute exception is very new and no cases have interpreted it yet.
With respect to the second issue, in the seminal case a court held that courts will avoid determining provisions calling for payment only after the contractor has been paid as covenants rather than as a condition.+[Yamanishi v. Bleily & Collishaw, Inc. (1972) 29 Cal App 3d 457, 105 Cal. Rptr. 580]+ This follows the normal rule in California set by statute.+[Cal. Civ. Code 1442]+
Since the outcome of the Yamanishi+[Yamanishi v. Bleily & Collishaw, Inc. (1972) 29 Cal App 3d 457, 105 Cal. Rptr. 580]+ case became widely known by the industry, some general contractors have modified their subcontract language to avoid the outcome of that case by adding a provision in their contract that indicates that receipt of payment from the owner is an express condition precedent. The next question which will have to be addressed by the courts is even with expressed condition precedent language will the “pay when paid” provision be upheld in the face of evidence that the only reason the general contractor was not paid by the owner has nothing to do with the work of the subcontractor. Certainly under the AIA Form A-401 this will not occur since that contract clearly provides so.+[See A-401 Art. 4.7.1]+ Some general contractors will argue that the new language should over come the claims of the subcontractor while the subcontractors will claim that a court should apply other rules of contract interpretation to protect the rights of the subcontractor. One arguement for the general contractor is that the court need only look to the plain meaning of the contract to rule that the subcontractor must await the outcome of the dispute between the owner and the contractor before being paid.+[See Cal. Civ. Code 1638, 1644]+ The arguement for the subcontractor must be that any ambiguity in the contract must be construed against the drafter+[Cal.Civ.Code Section 1654]+ and that to the extent the reason for nonpayment is due to no fault of the subcontractor the pay when paid provision can be attacked through application of unconscionability grounds+[See Cal. Civil Code Section 1670.5]+
If payment has not been made within the time called for under the contract and statute then the general contractor may be held liable for an interest penalty of two percent (2%) per month and attorney fees.+[See Public Contract Code Section 10262.5 and Business & Professions Code Section 7108.5]+ There is a similar statute with respect to final payment of retention on private works.+[Cal.Civ.Code Section 3260]+
It should also be pointed out that in addition to the civil legal issues involved when a contractor fails to pay a subcontractor their may also be other administrative or criminal sanctions as set by statute. For example, certain Business and Professions Code Sections provide for disciplinary violations which can result in a wilful violation in suspension or revocation of a contractors license.+[Bus.& Prof. Code Section 7108.5, 7120]+ Such violations can also give rise to civil remedies under the contractors license bond.+[Bus. & Prof. Code § 7120.]+
Finally, if a contractor has in fact diverted and misappropriated the contract funds due another, the contractor can be prosecuted criminally under statutory theft laws in California.+[Penal Code Section 484(b).]+
[2]–Duty of Subcontractor in the Event of Nonpayment
Generally speaking, the subcontractor is required to perform the work generally in advance of being paid since most contracts are written such that the contractor is entitled to payment as work progresses in an amount which is equal to the value of the work that has been installed. Some contracts are also regulated by statute and require that contractors never bill for services in excess of the actual value of the work performed to date.+[See Bus. & Prof. Code § ____ involving home improvement contracts.]+
Where, however, there is a substantial dispute between a subcontractor and a general contractor which has led to the general contractor’s withholding of payment to the subcontractor, the subcontractor is often faced with the decision of whether to cease performance of work at the job or to continue performance without any promise for future payment. Generally speaking, a contractor may not abandon performance of any project where there has not been a material breach by the other contracting party.+[See Bus. & Prof. Code § ____.]+ Courts and administrative disciplinary officers will probably construe the general rule very conservatively such that subcontractors must act very cautiously in deciding to abandon work since if it is ultimately found that they have abandoned work without a true material breach by the opposing party, the contractor could be subjected to both disciplinary proceedings and civil penalties. The leading case in California to address the issue of when a contractor may treat the failure of payment as a material breach giving rise to rescission is Integrated, Inc. v. Alec Fergusson Elec. Contr. where the court explained:
The proposition that in building contracts failure to make progress payments is not such a breach as will authorize a contractor to abandon the work and sue for damages, but that it does constitute such a breach as will justify rescission and recovery of the reasonable value of labor and materials furnished, was first announced in this state in Cox v. McLaughlin, 52 Cal. 590; 54 Cal. 605; 63 Cal. 196; 76 Cal. 60 [18 P. 100, 9 Am.St.Rep. 164] and has thereafter been repeatedly stated to be the settled law of this state. [Citations].
The mechanical application of the rule as phrased in the cases heretofore cited would lead one to the conclusion that any failure to make progress payments would entitle the contractor to rescind. A careful examination of the facts in those cases in which the rule has been applied reveals, however, that the failures to make progress payments which were held to justify rescission involved either an extended and unreasonable delay, imposition of new and onerous conditions to payment, outright refusal, or a total repudiation of the contract. They did not involve a minor deviation from the covenant. Significantly in Porter v. Arrowhead Reservoir Co., supra, 100 Cal. 500, the court discussed the holdings in the Cox case and concluded at p. 504: “From the foregoing views it follows that, to entitle the plaintiffs [contractors] to recover in the present action, it is only necessary that they prove a substantial failure upon the part of the defendant to comply with its agreement as to the payment of an installment upon the contract price, and in addition thereto that they rescinded the contract by reason of such failure…” In stating the rule, subsequent cases have omitted the word substantial and merely state generally that failure to make progress payments entitles a contractor to rescind. In our opinion, Porter v. Arrowhead Reservoir Co., supra, expresses a more precise statement of the rule. (Guerini Stone Co. v. P.J. Carlin Constr. Co., 248 U.S. 344, 344-345, [63 L. Ed. 275, 285, 39 S.Ct. 102, 106]; United States v. Southern Constr. Co., 293 F.2d 493, 498, reversed in part on other grounds, 371 U.S. 57 [9 L. Ed. 2d 31, 83 S.Ct. 108].) A slight deviation either in time or amount of progress payments should not justify rescission or abandonment. See United States v. Southern Constr. Co., supra.
In the instant case, therefore, if the court should find that Integrated failed to make progress payments within the time required by the contract, the court must determine whether such failure constituted a substantial failure to comply. That is a question of fact to be determined by the trial court. (Associated Lathing, etc. Co. v. Louis C. Dunn, Inc., 135 Cal.App.2d 40, 49 [286 P.2d 825]; Smith v. Empire Sanitary Dist., 127 Cal.App.2d 63, 73 [273 P.2d 37].)
If Integrated’s breach be found to be substantial, the court must also determine whether Fergusson was itself in default in any material respect. One who is himself in default in the performance of a dependent or concurrent obligation or where his default is so related to the obligation in which the other has failed that it affects the performance thereof or the duty of the other to perform may not unilaterally rescind because of the other’s breach. (Fairchild, etc. Co. v. Southern Etc. Co., supra, 158 Cal. 264, 273; Nelson v. Spence, 182 Cal.App.2d 493, 499 [6 Cal.Rptr. 312]; American-Hawaiian Eng, etc. Co. v. Butler, supra, 165 Cal. 497, 516; Eade v. Reich, 120 Cal.App. 32, 38 [7 P.2d 1043].) Where, however, the delinquency of the rescinding party has no relation to the other’s obligation in respect of which the right of rescission is asserted, it will not preclude rescission. (American-Hawaiian Eng. etc. Co. v. Butler, supra; Eade v. Reich, supra.+[See Integrated, Inc. v. Alec Fergusson Electrical Contractor (1967) 250 Cal.App 2d 287, 58 Cal.Rptr. 503; See also 1 Witkin, Summary California Law, Contracts 793 (9th ed 1987)]+
Furthermore, if it is found that the abandonment of the project was not legally excused the administrative penalties can include suspension or revocation of a license. The civil penalties can also be substantial since having abandoned further performance at the project, the subcontractor loses control over the costs of the work necessary to complete the project by the completing contractors.
There is authority however that where the parties have contractually agreed to a party’s right to stop work the contractor may in fact stop work and need not prove the materiality of the payment withheld.+[Big Boy Drilling Corp. v. Etheridge (1941) 44 Cal.App. 2d 114, 111 P.2d 953]+ Therefore the A-401 provision in Article 4.7.1 will be of tremendous assistance to any Subcontractor faced with an unscrupulous general contractor. It should be cautioned however that Article 4.7.1 will probably be construed to qualify the subcontractor to suspend further work and not to terminate or rescind since as will be discussed a separate remedy for termination is found in a different provision.+[Big Boy Drilling Corp. v. Etheridge (1941) 44 Cal.App. 2d 114, 111 P.2d 953]+
To the extent a subcontractor owes payments to sub-subcontractors or suppliers, the subcontractor owes the same duties that the general contractor owes to the subcontractor as set forth above.+[See Public Contract Code Section 10262.5 and Business & Professions Code Section 7108.5]+
[3]–Payment Releases and Joint Checks
Most construction subcontracts require the subcontractor to provide releases for the progress payments that it receives during the performance of the construction project. In California, releases of rights to liens, stop notices and payment bond rights commonly referred to as “job rights” are regulated on construction projects by statute.+[California Civil Code Section 3262]+ All release forms for job rights must substantially comply with the provisions of that section; otherwise, its terms are ineffective.+[California Civil Code Section 3262]+ Therefore, subcontractors are not required to provide any releases which would contravene the provisions of the Code which very carefully differentiate between unconditional releases where a contractor has already been paid and conditional releases where the contractor expects to get paid or is waiting for a check to clear the bank.+[California Civil Code Section 3262]+ Also a subcontractor or supplier who has executed a statutory waiver and release has released all of its job rights through the date the progress payment release is indicated as having been executed.+[Halbert’s Lumber, Inc. v. Lucky Stores, Inc. (1992) 6 Cal. App. 4th 1233, 8 Cal. Rptr. 298.]+ This means that if a contractor normally uses a progress billing cut-off date of say the 25th of the month the release ought to be dated the same date otherwise if it is dated a few days later the owner has a right to rely upon the later date as the date through which the release is valid+[Halbert’s Lumber, Inc. v. Lucky Stores, Inc. (1992) 6 Cal. App. 4th 1233, 8 Cal. Rptr. 298.]+ Further, if the subcontractor suspects any extra-work, delay or other claims they should be reserved in that portion of the final payment release form.+[Cal.Civ.Code Section 3262]+ In fact as a result of the recent holdings in a California case it may be wise for a contractor to add to the statutory waiver and release forms for progress payments.+[See Halbert’s Lumber, Inc. v. Lucky Stores, Inc. (1992) 6 Cal. App. 4th 1233, 8 Cal. Rptr. 298.]+
Most construction contracts and subcontract agreements also provide for the contractor and subcontractors to supply lien releases on behalf of their subcontractors and suppliers as well as to timely pay all appropriate wages to its laborers and employees. To the extent that a subcontractor fails to pay its second-tier subcontractors, suppliers, or laborers/employees, and to provide releases thereof, a general contractor may be entitled to withhold payments or provide payment by way of joint checks to insure that there are no remaining claims to the property or construction fund after the subcontractor has been paid in full.+[See AIA Form A-401 and AGCC Form AGCC-3]+
§ 35.13 Termination of Subcontracts and Subcontractors
[1]–General Background and Contract Provisions
The contractual right and power to terminate a construction contract for cause has existed in law for almost as long as contracts have been formalized since it was initially merely an embodiment of the material breach rules. That is to say it is a contract provision that the parties have agreed to ahead of time on what events give rise to stop further performance under the contract.+[See 1, Stein Construction Law 4.11,[1] (1991 Mathew Bender). The termination concept must however be distinguished from the true right to rescind the later of which requires no agreement and arise by virtue of not only material breach situations but also fraud, mistake, etc.+[Cal. Civ. Code § 1689]+ Termination must also be distinguished from rescission in that under termination all portions of the uncompleted contract are discharged and the parties can only recover their damages on what was performed.+[See 1, Witkin Summary of California Law § 868 (Contracts 9th ed.)]+ Under rescission, the parties are further able to be restored to their precontract position.+[Sanborn v. Ballanfonte (1929) 98 Cal.App 482, 277 P. 152]+
The right to termination for cause pursuant to agreement carries with it a proceedural or notice element under most contracts. For example, the AIA Form A-401 provides:
7.2 TERMINATION BY THE CONTRACTOR
7.2.1 If the Subcontractor persistently or repeatedly fails or neglects to carry out the Work in accordance with the Subcontract Documents or otherwise to perform in accordance with this Agreement and fails within seven days after receipt of written notice to commence and continue correction of such default or neglect with diligence and promptness, the contractor may after seven days following receipt by the Subcontractor of an additional written notice.+[AIA Form A-401, reprinted with permission]+
Similarly the AGCC-4 contract provides:
14.1.2 Termination for Default. If Subcontractor fails to commence and satisfactorily continue correction of a default within forty-eight (48) hours after receipt by Subcontractor of the notice issued under Section 14.1.1., then the Contractor may terminate Subcontractor’s right to perform under this Agreement+[AGCC Form AGCC-3 reprinted with permission]+
And the AGCC-4 form provides:
SECTION 10. TERMINATION
(i) Should Subcontractor fail to rectify any contractual deficiencies, including failure to pay its creditors, within three (3) working days from receipt of Contractor’s written notice . . .+[AGCC Form AGCC-4 reprinted with permission]+
These procedural or notice provisions are not mere recitals and are essential to a contractors ability to invoke a termination provision.+[L. K. Comstock & Co. v. United Engineers and Constructors, Inc. (9th Cir., 1990) 880 F. 2d 219.]+ This is because a subcontractor may be able to have cured the reason for the termination within the contract time called for.+[See 1, STEIN Construction Law 4.13 [1] [c] (1991 Matthew Bender)]+ Further, without a termination clause, the contractor’s breach must be material in order to justify ejection from the job.+[Crofoot Lumber, Inc. v. Thompsons (1958) 163 Cal. App. 2d 324, 329 P. 2d 302.]+
The termination for cause concept must however be distinguished from the termination for convenience notion the later of which is a relatively new addition to construction subcontracting. The termination for convenience notion was an outcropping of government contracts first utilized in the federal procurement field.+[See 1 STEIN Construction Law 4.13, [3] (1991 Matthew Bender)]+ The federal government during time of war does not Know how long the war will last and there will be a need for war materials and as a result, the concept of termination for convenience was born and have been incorporated into other governmental and private contracting agreements. Examples of termination for convenience clauses a subcontractor may find on a project are:
. . . (ii) Contractor may at any time and for any reason terminate subcontractors services hereunder at Contractors convenience . . . .+[AGCC Form AGCC-4]+
A similar provision can be found in the AGCC-4 form. So far a termination for convenience has not been included in the AIA Form A-401 however it is found in many other customized forms used in the industry. As will be discussed in the following subsection, the significance of such termination for convenience clauses is the calculation of damages in the event of a termination.
[2]–Damages Arising Out of Termination
[a]–Termination for Cause
Regardless of whether a contractual agreement contains a termination for cause provision, subcontractors may always be terminated for cause under the normal material breach rules applying to contract law. Under a material breach setting, the owner or general contractor who has terminated the subcontractor for cause is entitled to the damages which normally flow from a contractual breach such as the cost of repair or diminution in value measure of damages.+[See § 35.09 discussing defective work remedies of contractors and owners.]+
However construction contracts that contain specific termination for cause provisions which may alter the measure of damages to which the non-breaching party is entitled. For example the Associated General Contractors’ Long Form Subcontract provides
14.1.2 Termination for Default. If Subcontractor fails to commence and satisfactorily continue correction of a default within forty-eight (48) hours …, then the Contractor may terminate Subcontractor’s right to perform under this Agreement and use any materials, implements, equipment, appliances, or tools furnished by or belonging to Subcontractor to complete Subcontractor’s work without any further compensation to Subcontractor for such use. Contractor also may furnish those materials and equipment, and/or employ such workers or subcontractors as Contractor deems necessary to maintain the orderly progress of the work.
In such case, Subcontractor shall be entitled to no further payment until the balance of Subcontractor’s work has been completed. At that time, all of the costs incurred by Contractor in performing Subcontractor’s work, including a markup of fifteen percent (15%) for overhead and profit on such expenses, plus actual attorneys’ fees as provided above, shall be deducted from any monies due or to become due Subcontractor. Subcontractor shall be liable for the payment of any amount by which such expenses may exceed the unpaid balance of the Contract Price.
Similarly, the Associated General Contractors’ Short Form Subcontract provides:
SECTION 10. TERMINATION
(i) Should Subcontractor fail to rectify any contractual deficiencies, including failure to pay its creditors, within three (3) working days from receipt of Contractor’s written notice, Contractor shall have the right to take whatever steps he deems necessary to correct said deficiencies and charge the cost thereof to Subcontractor, who shall be liable for the full cost of Contractor’s corrective action, including reasonable overhead, profit, and attorneys’ fees.
Those contractual damage calculation provisions can alter the normal measure of damages.+[1 Witkin, Summary of California Law, Contracts § 799 (9th ed.).]+ Therefore, it is important to focus specific attention on the measure of damages to the terminated party to quantify the damages under a termination proceeding.
If the termination is later found to be wrongful, the terminated party may treat the contract as a rescission and recover for the reasonable value of services rendered or may affirm the contract and sue thereunder.+[1 Stein, Construction Law 4:15[5] (1991, Matthew Bender).]+
[b]–Termination for Convenience
As indicated above, the use of termination for convenience clauses in construction contracts has greatly increased in recent years and especially in the last two decades. Since its inception in federal procurement contracts, most sophisticated owners and industry forms have attempted to provide for some sort of termination for convenience provisions. For example, the Associated General Contractors’ Standard Subcontract Agreement provides:
14.1.3 Termination for Convenience. Contractor may at any time and for any reason terminate Subcontractor’s services and work at Contractor’s convenience…
Upon such termination, Subcontractor shall be entitled to payment in accordance with Section 4 only as follows: (1) the actual cost of the work completed in conformity with this Agreement; plus, (2) such other costs actually incurred by Subcontractor as are permitted by the prime contract and approved by the Owner; plus (3) fifteen percent (15%) of the cost of the work referred to in Subparagraph (1) above for overhead and profit. There shall be deducted from such sums as provided in this subparagraph the amount of any payments made to Subcontractor prior to the date of the termination of this Agreement. Subcontractor shall not be entitled to any claim or claim of lien against Contractor or Owner for any additional compensation or damages in the event of such termination and payment.+[AGCC-3 Long Form Standard Subcontract, reprinted with permission]+
Although the AIA Standard Subcontract Agreement does not contain a detailed termination for convenience clause, it does contain other termination provisions that may alter the normal rules of the measure of damages. For example:
7.1 TERMINATION BY THE SUBCONTRACTOR
7.1.1 The Subcontractor may terminate the Subcontract for the same reasons and under the same circumstances and procedures with respect to the Contractor as the Contractor may terminate with respect to the Owner under the Prime Contract, or for nonpayment of amounts due under this Subcontract for 60 days or longer. In the event of such termination by the Subcontractor for any reason which is not the fault of the Subcontractor, Sub-subcontractors or their agents or employees or other persons performing the portions of the Work under contract with the Subcontractor, the Subcontractor shall be entitled to recover from the Contractor payment for Work executed and for proven loss with respect to materials, equipment, tools, and construction equipment and machinery, including reasonable overhead, profit, and damages.+[AIA Form A-401 reprinted with permission]+
In reviewing the language from any of the industry forms containing termination for convenience clauses, it should be noted that such clauses usually contain very specific language for the measure of damages that the terminated party may recover. They will limit the contractee’s damages to those that are expressly provided for under the contract. This conclusion may not follow where the termination for convenience was in bad faith+[Paul Holdeman, Inc. v. Arkansas Power and Light Co. (1974 E.D. Ark) 380 F. Supp. 298]+, or follows a prior material breach or repudiation of the contract and is invoked merely as an after the fact defense.+[Rotterson Aircraft Corp. v. Fairchild Industry, Inc. (1986) 632 F. Supp. 1494 (C.D. Cal.).]+
Of course, the use of termination for convenience clauses by unscrupulous owners or general contractors must have limitations and the courts have will find some way, even when there is a lack of express language to impose such limitations. Undoubtedly, these limitations stem in part from the rationale that one party should not have an unfettered power to terminate a contract at will without some protection for the terminated party. Such clauses will at least be limited to uses in “good faith”.+[Call v. Alcan Pacific Co. (1967) 251 Cal App 2d 442; For a detailed discussion of the good faith limitation on termination clauses see 1, Stein, Construction Law, Matthew Bender at page 4-112.]+
In one federal case, the court determined that since the owner had initially defaulted the contractor for cause and it was later proven that the owner did not have sufficient cause, the owner may not subsequently invoke the benefits of a termination for convenience clause.+[See Rotterson Aircraft Corp. v. Fairchild Industry, Inc. (1986) 632 F.Supp 1494 (C.D.Cal .]+
[c]–Other Termination Principles
Many times there are reasons why an owner or general contractor will not or should not invoke a termination clause. One reason includes the owners duty in some contracts to inherit the liability the terminated party had to sub-subcontractors and material suppliers.+[See AIA 201; and Pike Industries, Inc. v. Middlebury Assoc. (1980 Vt.) 436 A. 2d 725.]+ Unless the terminating party has carefully calculated the potential exposure that may come from a termination such a remedy should be sparingly used.
Additionally there may also exist a defense to an owner or general contractors invocation of a Termination clause. Defenses to use of Termination clauses should at a minimum include such events as (1) Substantial Completion+[See 1, Stein, Construction Law, Matthew Bender, page 4-144 et.seq.]+, (2) Good Faith limitations+[see Call, supra]+, (3) Contractual Limitations such as procedural or time limits as well as damage calculations.
[3]–Liability of Others
In addition to the normal contractual analysis under termination of subcontracts and termination for convenience clauses, there may be separate theories of recovery against a third party who contributed to the termination of subcontracts or subcontractors. For example, in termination for cause situations, often times there have been third parties who have either contributed to the cause for the termination or have urged its conclusion upon the terminating party. To the extent that a sub-subcontractor or material supplier to a subcontractor has contributed to the cause for termination, the subcontractor may have contractual or non-contractual remedies against such entities.+[See Nomellini Constr. Co. v. Harris (1969) 272 Cal. App. 2d 352, 77 Cal. Rptr. 361.]+
Additionally, often times an architect or engineer is deeply involved in the decision to terminate a contractor or subcontractor and has or may be accused of interference with the subcontractor’s agreement or defamation of its business or product. California has long recognized the tort of interference with contractual relations.+[Imperial Ice Company v. Rossier (1941) 18 Cal. 2d 33, 112 P. 2d 631.]+ Interference with contractual economic relationships has been utilized against architects or engineers who have contributed to the terminating party’s decision to terminate a contractor.+[Lundgren v. Freeman (9th Cir. 1962) 307 F.2d 104.]+ In the Lundgren case,+[Lundgren v. Freeman (9th Cir. 1962) 307 F.2d 104.]+ however, and in subsequent holdings, the courts have indicated a reluctance to find liability against an architect who has contributed to termination resulting from advice given to the owner or general contractor. To the extent that the architect is truly acting within the scope of his role as the arbiter between the contractor and the owner, the architect is protected by judicial immunity unless its acts were done with malice or with a wrongful motive.+[Lundgren v. Freeman (9th Cir. 1962) 307 F.2d 104; Hubert, Hunt & Nichols v. Moore (1977) 67 Cal App 3d 278, 136 Cal. Rptr. 603.]+
For example, one court has described the analysis the court must undertake in determining whether the architect is protected by judicial immunity while acting as a quasi-arbiter as follows:
The gross error concept is not clearly defined but is generally equated with fraud, constructive fraud, bad faith, or a failure to exercise honest judgment . . .. [Citations omitted.] Fraud in this connection has a broader connotation than is ordinarily applied. In addition to its ordinary significance, in construction contracts, it includes arbitrary action and gross mistake . . .. [Citations omitted.] The underlying rationale of this concept of fraud is that in determinations of this type of contract, the high point in the architect’s practice of his profession lies in those instances when, in order to do justice to the contractor, he has to oppose the desire of his employer. He occupies a position of trust and confidence. When he acts under a contract as the official interpreter of its conditions and the judge of its performance, he should favor neither side but exercise impartial judgment.+[Macomber v. State of California (1967) 250 Cal. App. 2d 391, 397-398, 58 Cal. Rptr. 393.]+
It remains to be seen whether this standard of inquiry may be met with constructive fraud definitions such that exist in the California case law or statutory definitions.+[California Civ. Code § 3294 provides: “(1) ‘Malice’ means conduct which is intended by the defendant to cause injury to the plaintiff or despicable conduct which is carried on by the defendant with a willful or conscious disregard of the rights or safety of others; (2) ‘Oppression’ means despicable conduct that subjects a person to cruel and unjust hardship in conscious disregard for that person’s rights; (3) ‘Fraud’ means an intentional misrepresentation, deceit, or concealment of a material fact known to the defendant with the intention on the part of the defendant of thereby depriving a person of property or legal rights or otherwise causing injury.”]+
PART C. Relationship Between Subcontractor and Owner
§ 35.14 Overview and Comparisons to Relations with General Contractor
As indicated above in addition to the traditional process of trade contractors contracting with a general contractor who oversees the supervision of the various subcontractors, many owners choose to “remove the middle man” and contract directly with the trade subcontractors. As explained below the term “directly” includes both those instances where there is a contract between the owner and a subcontractor as well as the instances where there is a contract between the subcontractor and an agent for the owner such as the architect, engineer or construction manager.
There may be various reasons why an owner would choose to contract directly with the subcontractors rather than utilize a general contractor including any or a combination of any of the following. First, owners may hope by eliminating the general contractor it can eliminate anywhere a portion of the costs of the project which would normally be the general contractor’s markup for profit. Second, many owners may be persuaded by the idea that they can achieve the same coordination functions through an agent such as a construction manager or an architect/engineer for no more cost than a general contractor who allegedly is more adversarial than others. Finally, some owners may feel that they are sophisticated and equipped enough to handle the coordination functions themselves rather than pay for outside services.
Whatever the reason may be, some owners feel that contracting directly with the trade subcontractors is more efficient. For this reason, the use of such contracting vehicles is being seen with much more frequency in the last decade or so.
To the extent that an owner is fulfilling the function of coordinating the subcontractor bids and undertakes directly the performance of the general contractor’s traditional duties under direct subcontracts, many of the issues described in part B of this chapter relating to general contractors will be equally applicable to owners who are standing in their shoes.+[G & P Elec. Co. v. Dumont (1961) 194 Cal. App. 2d 868, 15 Cal. Rptr. 757.]+ What follows is a discussion of significant issues or variances from that normal application as it relates to instances where the owner has contracted directly with the subcontractor trades as well as the owners duties to subcontractors and vice versa absent any contractual undertaking between the subcontractor and the owner.
§ 35.15 Direct Contract Relationships
[1]–By Owner
In those instances where an owner has decided to contract directly with the trade subcontractors the most frequently experienced problems arise out of the coordination and scheduling of the many subcontractors which are performing work at the site all at one time. Unless the owner is sufficiently sophisticated in coordination and scheduling there is a possibility that there may be problems at the site. Legally, the owner is under a duty not to do anything that would prevent or hinder the performance of every subcontractor at the site just as other contractors.+[See Crawford v. Pioneer Box Co. (1930) 105 Cal. App. 760, 288 P. 694.]+ As a direct contracting party, the owner may be liable to subcontractors for unpaid services.+[G & P Elec. Co. v. Dumont (1961) 194 Cal. App. 2d 868, 15 Cal. Rptr. 757.]+
Because most owners in the construction/development process either do not have the level of construction sophistication or resources to adequately coordinate and manage the complex project they will seek other professional assistance even where they do not wish to employ a separate general contractor.
[2]–By Architects and Engineers
Many times an owner who has decided not to employ a separate general contractor will look to its design professional to facilitate a greater degree of project management skills. Architects and Engineers (A/E’s) have for quite some time developed areas of expertise in scheduling and coordination and have therefore agreed to undertake such functions in lieu of a general contractor, albeit in some instances, reluctantly. Architects are considered agents of the owner for many purposes+[Huber, Hunt & Nichols, Inc. v. Moore (1977) 67 Cal. App. 3d 278, 136 Cal. Rptr. 603]+, and are liable either in tort or contract for their own acts.+[COAC, Inc. v. Kennedy Engineers (1977) 67 Cal. App. 3d 916, 136 Cal. Rptr. 890.]+
To the degree the A/E has undertaken coordination functions the owner must be careful to intercede when necessary between the A/E and the subcontractor since there may be an innate difference in viewing how to address disputes when it involves a design dispute.
[3]–By Construction Managers
There has very recently been a tremendous increase in the use by owners of construction managers in the development/ construction process. Construction Management in these circumstances usually involves an owner using an independent contractor with expertise in coordination and scheduling in lieu of the owners own employees and resources.
There are a variety of contracting variations being employed in the use of construction managers. These range from the owner contracting directly with the subcontractors and simply inserting the construction manager as an in-house resource, to directing the construction manager to contract with the various subcontractors while the owner merely oversees the services of the construction manager. This later variation looks much more like the traditional approach of using a general contractor under a different approach but in most instances the construction managers duties are in fact very different.
First, the construction manager unlike the general contractor undertakes no portion of the physical work itself. Second, the general contractor generally has the separate duty to pay subcontractors even where the owner has failed to pay whereas the construction manager merely passes on the owners funds and merely maintains a duty to coordinate and oversee the subcontractors work. With these differences some owners feel by using a construction manager in lieu of a general contractor they put an entity “in their corner” whereas the traditional method puts the general contractor typically on the side of the trade subcontractors. Be that as it may, construction managers, to the extent they are holding themselves out as experts, will be held liable for their own acts or omissions.+[Gagne v. Bertran (1954) 43 Cal. 2d 481, 264 P. 2d 641.]+
§ 35.16 Legal Implications Where No Direct Contractual Relationship
[1]–Duties Owed By Owner to Subcontractors and Vice Versa
Even where the owner does not contract directly with the trade subcontractors there may still exist other implied legal duties between them.+[Stewart v. Cox (1961) 55 Cal. 2d 857, 13 Cal. Rptr. 521 — owner recovered on negligence theory against subcontractor.]+
Where the relationship of the owner and subcontractor is such that the law will imply a duty to protect the other a breach of that duty may be enforced by the injured party even absent contractual privity.+[Gilbert Financial Corp. v. Steelform Contracting Co. (1978) 82 Cal.App. 3d 65, 145 Cal.Rptr. 448]+ Also, where an owner is entitled to recover against a general contractor as a result of a subcontractor’s actions, the court may also award the owner judgment against a supplier who was liable to the general contractor for indemnity.+[Nomellini Constr. Co. v. Harris (1969) 272 Cal. App. 2d 352, 77 Cal. Rptr. 361.]+
Many times owners or owner representatives are contacted by subcontractors to decide issues or disputes the subcontractor is asking for information. Most often, where there is a general contractor involved the contract documents will indicate that the owners representative on site should not communicate directly with subcontractors and should refer the subcontractor to the general contractor for communication with the owner. For example, the Standard Specifications, Section 8-1.01 for the California Department of Transportation (Cal Trans) provide:
“No subcontractor will be recognized as such . . . .”
The reason for such rules is obviously to maintain the lines of communication and legal relationships clearly defined to avoid claims by subcontractors that the “owner told me to do it” when the general contractor knew nothing about it and would therefore not have requested direction from the owner to facilitate payment.
Where the owners representative fails to abide by such rules it may subject the owner to liability even though there is no formal contract between the owner and subcontractor. For example, although the formal contract was between a subcontractor and a general contractor, a subcontractor could recover against an owner who involves itself in the decision to direct extra work by signing job records.+[G & P Elec. Co. v. Dumont Constr. Co. (1961) 194 Cal. App. 2d 868, 15 Cal. Rptr. 757.]+ Of course the subcontractor has the burden of proof and that burden may be difficult to establish in the face of strict contract language and denials by the owners representative and the subcontractor should also therefore follow in all instances the lines of communication and legal authority.
Other areas where the law has implied duties or liabilities against owners by subcontractors even without contract remedies is found in the “job rights” statutes of California. However, a mechanic’s lien right does not create personal liability on the part of the owner.+[Golden Gate Bldg. Materials, Inc. v. Fireman (1928) 205 Cal. 174, 270 P. 214.]+ An exhaustive discussion of the typical job rights such as mechanic’s liens, payment bonds and stop notices is contained in Chapters 62-64.
[2]–Duties Owed By Other Contractors and Suppliers
Any contractor who has performed work which is not in conformance with the plans or specifications can be liable for resulting injury even to third parties.+[Northwestern Pacific Rail Road v. Currie (1929) 100 Cal App 173, 279 P. 1057]+ If on the other hand the injury occurs where the contractor has duly performed according to the plans and specification the contractor most likely will not be liable.+[Diamond Springs Lime Co. v. American River Constructors (1971) 16 Cal App 3d 581, 94 Cal. Rptr. 200; Hamilton v. Harkins (1956) 146 Cal App 2d 566, 304 P. 2d 82]+
As far as potential liability of suppliers to an owner is concerned there is a wide area of legal precedent. In one case, the court found a supplier liable directly to an owner even though the materials were purchased through a roofing contractor.+[Del E. Webb v. Structural Materials Co. (1981) 123 Cal.App 3d 593, 176 Cal.Rptr. 824]+ In another, recovery was based upon a right of indemnity based upon warranty theories.+[Eichler Homes, Inc. v. Anderson (1920) 9 Cal. App. 3d 224, 87 Cal. Rptr. 893.]+ The courts will strain to find an implied contract or third party beneficiary theory in order to find protection to the owner even though no contractual privity existed.+[Del E. Webb v. Structural Materials Co. (1981) 123 Cal.App 3d 593, 176 Cal.Rptr. 824]+ Liability has also been found against suppliers on a therory of negligent interference with prospective economic advantage where they have delayed the completion of a project+[Chameleon Engineering Corp. v. Air Dynamics Inc. (1980) 101 Cal.App 3d 418, 161 Cal Rptr. 463. But See Stutz v. Benson lumber Co. (1936) 6 Cal.2d 688, 59 P. 2d 100 (supplier does not have to anticipate that a contractor would use its materials in a negligent manner.)]+, and for all consequential damages for defective materials.+[Stott v. Johnston (1951) 36 Cal. 2d 864, 229 P. 2d 348.]
[3]–Duties Owed By Design and Other Professionals
As set forth in Section 35.06 [4] of this chapter, a design professional has duties to third parties even though they have no contractual privity.+[See COAC v. Kennedy Engineers, supra]+ The basis for such liability is the foreseeability that a professionals conduct can affect others who are not in direct privity with the professional.+[Oakes v. McCarthy Co. (1968) 267 Cal App 2d 231, 73 Cal. Rptr. 127 – architect liable to a remote home buyer; Peak v. Richmond Elementary School District (1958) 161 Cal App 2d 366, 326 P. 2d 860 – Architect liable to adjacent landowner; Montijo v. Swift (1963) 219 Cal App 2d 351, 33 Cal. Rptr. 133 – Architect liable to third party injured by unsafe construction by contractor architect was supervising; 68 Ops Cal Atty Gen 250- Engineer liable for injury caused where it fails to disclose dangerous conditions]+
In addition to the potential liability of a design professional to outsiders, other professionals such as construction managers and professional estimators are likely to find themselves enmeshed in controversy from others. California courts have recognized the precepts of liability of professionals who have held themselves out as possessing capabilities beyond the normal layman.+[Gagne v. Bertran (1954) 43 Cal. 2d 481, 264 P. 2d 641]+
Disclaimer:
The information contained in this article is for informational purposes only, does not constitute legal advice or create an attorney-client relationship. Any comments and responses to this post are not considered confidential under the attorney-client privilege. No representations are made as to the currency or completeness of the information contained in this post or its applicability to any given set of facts and there are no guarantees of any results.