Sometimes You Just Need to Call it Day: Court Finds That Contractor Not Entitled to Recover Costs After Public Works Contract is Invalidated

Garret Murai | California Construction Law Blog

January was a tough month in the courts for Hensel Phelps Construction Company. Hot off the heels of Hensel Phelps Construction Co. v. Superior Court, a case concerning the 10-year statute of limitations under Civil Code section 941, comes Hensel Phelps Construction Co. v. California Department of Corrections and Rehabilitation, Case No. B293427 (January 28, 2020), a bid dispute case . . .

The Tale of a Bid, a Bid Protest, and Two Cases

A. The Bid and Bid Protest

On March 15, 2015, the California Department of Corrections and Rehabilitation (CDCR) issues an Invitation for Bid for the HVAC project at the Ironwood State Prison. The deadline to submit bids was April 30, 2015. Hensel Phelps Construction Co. submitted a timely bid and was determined to be the “apparent low bidder” with a bid of $88,160,000.

During the bidding process, CDCR issued an amendment containing a question and answer which permitted bidders to supply certain subcontractor information 24 hours after the bid deadline.

On May 1, 2015, Hensel Phelps submitted an “amended bidder declaration” changing the percentages of work its subcontractors would perform in its subcontractor listing due to a mathematical error. However, CDCR took the position that subcontractor percentages could not be altered and rejected Hensel Phelps’ “amended bidder declaration.”

In the meantime. West Coast Air Conditioning Company, the second lowest bidder, submitted a bid protest to the CDCR protesting Hensel Phelps’ bid. However, the CDCR did not review the protest, believing that it did not have jurisdiction to hear bid protests.

On May 18, 2015, Phelps signed a contract with the CDCR for the project. According to the Hensel Phelps Vice President who signed the contract, although he was aware that the CDCR had rejected Hensel Phelps’ “amended bidder declaration” and was further that the subcontractor percentages were incorrect, he believed that the incorrect percentages were an “immaterial deviation” that could be waived by the CDCR.

B. The Bid Protest Case

On May 22, 2015, West Coast filed a petition for writ of mandate in the San Diego Superior Court seeking to invalidate the contract. While the petition was pending, CDCR issued a notice to proceed to Hensel Phelps and Hensel Phelps began work on the project. During the proceedings, and while the project was ongoing, CDCR stipulated that it had paid Hensel Phelps’ first three pay application totaling $3,510,180.64.

On December 9, 2015, the San Diego Superior Court issued a statement of decision setting aside the contract, finding that that Hensel Phelps’ bid “contained numerous mathematical errors,” that “in at least four instances, [Hensel Phelps’] subcontractor percentage listings . . .  are inconsistent with the subcontractor prices,” and that this rendered Hensel Phelps’ bid non-responsive.

C. The Cost-Recovery Case

Rather than appeal the decision, Hensel Phelps filed suit against the CDCR under Public Contracts Code section 5110 which provides for recovery by a contractor of its out-of-pocket costs if a public works contract is determined to be invalid due to a defect “caused solely by the public entity”:

When a project for the construction, alteration, repair, or improvement of any structure, building, or road, or other improvement of any kind is competitively bid and any intended or actual award of the contract is challenged, the contract may be entered into pending final decision of the challenge, subject to the requirements of this section. If the contract is later determined to be invalid due to a defect or defects in the competitive bidding process caused solely by the public entity, the contractor who entered into the contract with the public entity shall be entitled to be paid the reasonable cost, specifically excluding profit, of the labor, equipment, materials, and services furnished by the contractor prior to the date of the determination that the contract is invalid if [certain] conditions are met.

At trial, the trial court found that Hensel Phelps’ bid included both its April 30th original bid submission as well as its May 1st “amended bidder declaration,” and that when considering Hensel Phelps’ bid package in full, one of two scenarios should have occurred, either: (1) If the CDCR was required to have accepted Hensel Phelps’ May 1st “amended bidder declaration” the contract might not have been invalidated in the Bid Protest Case; or (2) If the CDCR properly rejected Hensel Phelps’ May 1st “amended bidder declaration” it should not have accepted Hensel Phelps’ April 30th original bid submission and Hensel Phelps should have never been awarded the bid.

In either event, found the trial court, “due to a defect or defects in the competitive bidding process caused solely by the public entity” under Public Contracts Code section 5110, the contract was found invalid, and Hensel Phelps was entitled to recover its out-of-pocket costs.

The CDCR appealed.

The Appeal

On appeal, 2nd District Court of Appeal, focusing on the following language in the Public Contracts Code section 5110: “If the contract is later determined to be invalid due to a defect or defects in the competitive bidding process caused solely by the public entity . . .,” explained that the CDCR and Hansel Phelps each argued that it should be read differently.

According to the Court of Appeal, the CDCR’s position was that Public Contracts Code section 5110 only applies if a contract is invalidated due to a defect or defects in the competitive bidding process. However, Hensel Phelps’ position was that Section 5110 also applies if, after a contract a contract is invalidated, it is determined that the invalidation finding itself was due to a defect or defects in the competitive bidding process.

Let’s break that down a bit. According to the CDCR, Public Contracts Code section 5110 only applies if, due to a defect or defects in the competitive bidding process, a contract is invalidated. In other words, Section 5110 only applies if a contract was approved, but it is determined that it should not have been.

Hensel Phelp’s position is a bit nuanced. According to Hensel Phelps, Public Contracts Code section 5110 also applies if a contract is invalidated, and it is later determined that the finding that a contract was invalid, was in itself incorrect. In other words, Section 5110 also applies if a contract is approved, is later invalidated,  and it is later determined that it should not have been invalidated.

Between the two interpretations, the Court of Appeal found that the CDCR’s interpretation was more reasonable:

[W]e conclude CDCR has the better argument. We must consider the key language in the context of the rest of the statute. The first sentence of section 5110, subdivision (a) provides, “When a project for [a public work] is competitively bid and any intended or actual award of the contract is challenged, the contract may be entered into pending final decision of the challenge, subject to the requirements of this section.” It is the next sentence which provides, “If the contract is later determined to be invalid due to a defect or defects in the competitive bidding process caused solely by the public entity, [the contractor may recover].” The “later” in this sentence must refer back to the “pending final decision of the challenge” in the sentence immediately preceding. In other words, the subdivision provides that the parties to a challenged public contract may enter into that contract pending final resolution of the challenge, but if the challenge is resolved by invalidation because the public entity was at fault, the contractor may recover.

Phelps’s alternative construction is not reasonable. Phelps would interpret the statute to involve two distinct legal proceedings: (1) a challenge to the contract, which may result in the court invaliding the contract for any number of reasons; and (2) a second proceeding which looks beyond the reasons given for invalidation, to determine whether the court’s invalidation of the contract was caused by any defects in the bidding process caused by the public entity. Nothing in the statutory language suggests there is to be a second proceeding, to consider the reasons for the first court’s ruling.

In short, held the Court of Appeal, Hensel Phelps was not entitled to recovery under Public Contract Code section 5110, because the trial court in the Bid Protest Case held that the contract was invalidated due to a material error in Hensel Phelp’s bid not due to a defect in competitive bidding process.

Conclusion

So, there you have it. Public Contract Code section 5110 allows a contractor to recover its out-of-pocket costs if a public entity approved a contractor’s bid but it is later determined that the public entity shouldn’t have due to a defect or defects in the competitive bidding process. Section 5110 does not apply, and does not permit a contractor to recover its out-of-pocket costs, if a contract is invalidated, and the contractor later argues that the contract should not have been invalidated due to a defect or defects in the competitive bidding process.

AB5 Construction Exemption – A Checklist To Avoid Application Of AB5’s Three-Part Test

Blake A. Dillion | Payne & Fears

Construction companies have a unique opportunity to avoid the application of the restrictive new independent contractors’ law that took effect this year. This article provides a checklist that will help construction companies determine whether their relationships with subcontractors qualify for this exemption. 

California’s Assembly Bill 5 (“AB5”), which went into effect Jan. 1, 2020, enacts into a statute last year’s California Supreme Court decision in Dynamex Operations West, Inc. v. Superior Court, 4 Cal. 5th 903 (2018), and the Court’s three-part standard (the “ABC test”) for determining whether a worker may be classified as an employee or an independent contractor. 

Certain professions and industries are potentially exempt from this standard, including the construction industry. The ABC test does not apply to the relationship between a contractor and an individual performing work pursuant to a subcontractor in the construction industry if certain criteria are met. In order for the “construction exemption” to apply, the contractor must demonstrate that all of the following criteria are satisfied. 

1. The subcontract is in writing;

2. The subcontractor is licensed by the Contractors State License Board and the work is within the scope of that license;

3. If the subcontractor is domiciled in a jurisdiction that requires the subcontractor to have a business license or business tax registration, the subcontractor has the required business license or business tax registration;

4. The subcontractor maintains a business location that is separate from the business or work location of the contractor;

5. The subcontractor has the authority to hire and to fire other persons to provide or assist in providing the services;

6. The subcontractor assumes financial responsibility for errors or omissions in labor or services as evidenced by insurance, legally authorized indemnity obligations, performance bonds, or warranties relating to the labor or services being provided; and

7. The subcontractor is customarily engaged in an independently established business of the same nature as that involved in the work performed.

The contractor must be able to establish each of the above criteria for the construction exemption to apply. If the contractor is successful, the long standing multi-factor test for determining independent contractor vs. employee status as described in S.G. Borello & Sons, Inc. v. Dep’t of Industrial Relations, 48 Cal. 3d 341 (1989) will apply. 

You should review your processes and procedures for engaging subcontractors to ensure that you can satisfy the above criteria. If you have questions about the application of AB5, the construction exemption, or the Borello factors, you should speak with an attorney.

California Appellate Court Confirms: Additional Insureds Are First-Class Citizens

Scott Thomas | Payne & Fears

Many businesses shift risk by requiring others with whom they do business – e.g., vendors, subcontractors, suppliers, and others – to procure insurance on their behalf by making the business an “additional insured” under the other person’s liability insurance policy.  Unfortunately, insurance companies sometimes treat these additional insureds as second-class citizens, refusing to acknowledge that the additional insured has the same rights as the policyholder, who paid the premium.  In Philadelphia Indemnity Insurance Company v. SMG Holdings, a California appellate court removes any doubt whether these additional insureds are third-party beneficiaries entitled to the same rights – and bound by the same duties – as the entity that bought the policy.  

While the dispute at issue in SMG Holdings was a narrow one – i.e., whether the additional insured was bound by the policy’s arbitration clause – the implications of its holding are far ranging in ways that, in some instances, may benefit the additional insured.  For example, because the additional insured is an intended beneficiary under the policy, neither the insurer nor the policyholder may do anything to impair the additional insured’s rights under the policy; if they do, they may be liable for tortiously interfering with the additional insured’s contract rights.  This means that (again, by way of example) if the insurer attempts to rescind, or cancel, or amend the policy in a way that impairs the additional insured’s rights, the additional insured may have recourse.  It also means that if the policyholder does something untoward that jeopardizes the additional insured’s rights under the policy, the policyholder may be liable to the additional insured for any resulting harm.

SMG Holdings also reminds us that – subject to the terms and conditions of the policy – additional insureds are entitled to the same benefits as is the named insured.  For example, an insurer may not, as insurers have been known to do, refuse to fully defend (or defend at all) its additional insured against a third-party claim when it is, at the same time, fully defending its named insured.  

Of course, all of this is a two-way street: These same principles may, in certain instances, benefit the insurer in a dispute with its additional insured.  But we won’t elaborate here, because that would be giving aid and comfort to the enemy.  

What is important to businesses facing risks arising out of relationships with their business partners is that additional-insured coverage under policies issued to those partners is a valuable risk-shifting tool that should not be neglected.  

The Shifting Sands of Alternative Dispute Resolution

Tim Scully | Porter Law Group

In California there are few tools which work to protect the employer, and California employers may have just lost another one. On October 10, 2019, Governor Gavin Newson signed into law AB 51, which bans the use of mandatory arbitration agreements in employment contracts.

More specifically, AB 51 adds Section 432.6 to the California Labor Code, making it unlawful to require a prospective employee, or current employee, to waive any right, forum, or procedure for a violation of any provision of the California Fair Employment and Housing Act  (“FEHA”)(Part 2.8 (commencing with Section 12900) of Division 3 of Title 2 of the Government Code) or the California Labor Code, starting January 1, 2020. Additionally, an employer is also prohibited from threatening, retaliating or discriminating against, or terminating any applicant or employee who may choose not to sign a voluntary arbitration agreement.

Previously, an employer was able to require employees and prospective employees to agree to arbitration to resolve almost any and all disputes between the employee and the employer as a term of their employment. These terms were often the bulk of employers’ written contracts. Employers could have employees waive the right to a jury trial, the right to court costs, and other expenses, provided that the employer paid for the expenses of the alternative dispute resolution. The injured employees right to recover attorney’s fees was always a non-waivable right under the Labor Code. There were only a few actions which could not be arbitrated, the most prominent exception being the right to seek recovery under the Private Attorney’s General Action (PAGA).

It is hard to understate the loss California employers will have under AB 51. The vast majority of employee/employer disputes are centered around alleged Labor Code and FEHA violations. Under AB 51, the few remaining subjects still allowed to be covered by an arbitration agreement will be torts and contract disputes, subjects which are very rarely litigated between these two parties.

This change is important for several reasons; employers will now be liable for more expenses related to dispute resolution, may be subject to additional criminal liability and be subject to more aggressive litigation from employees.

With arbitration agreements in place, employers were allowed to control many of the cost aspects of the dispute resolution. Litigation is very expensive, and the requirement to pay filing fees, jury fees, expert fees, and other court costs, often adds a significant expense to this course of resolution. Cases that are handled in arbitration often get a resolution at a fraction of cost of litigation, as arbitrators are usually more attentive to the immediate case at hand, and the case is not bound by the clutter of an overworked judicial system. As a by-product, cases which are resolved faster, tend to resolve for smaller sums as there is less opportunity for attorneys’ fees to swell as in a stagnating case. While not inexpensive, arbitration generally did not disadvantage employees, but did allow employers to mitigate costs and expenses if they were found to be liable for the employees claims.

It is a little-known fact, but many wage and contracting violations under the Labor Code are misdemeanors. AB 51 inserting Labor Code 432.6 under Article 3, “Contracts and Applications for Employment,” expands criminal liability to employers who violate the terms of Article 3, as described by Labor Code 433. Employers who continue the practice of including arbitration agreements in new, or renewed employment contracts after January 1, 2020 may now find themselves criminally prosecutable. While it is usually the place of the Department of Industrial Relations (DIR) Division of Labor Standards Enforcement (DLSE) or private counsel to prosecute violations of the Labor Code and FEHA, it has been a growing trend in the state for local District Attorneys (DA) to prosecute Labor Code compliance against less desirable employers as the office can collect state mandated fees from non-compliant employers. The additions of AB 51 will provide more liability and leverage against employers in the future.

Finally, it is predicted that employers will face new allegations of discrimination and retaliation. Disgruntled ex-employees will now have new grounds to allege disparate treatment. If the employer treats or is perceived to treat employees who volunteered for an arbitration agreement any differently from employees who did not volunteer for an arbitration agreement, that employer may now be liable under Labor Code 432.6(b). It will be the responsibility of every employer to educate their managing workers about the status of the new protected class, as even off handed comments by supervisors or shift leaders are enough to create liability for the employer in any discrimination or retaliation allegation.

AB51 has a very uncertain future. While the legislature has included language facially to avoid conflict with the Federal Arbitration Act (FAA), which expressly creates and protects an employer’s right to use arbitration clauses, it is believed that AB 51 greatly diminishes an employer’s right under the FAA. In previous years, Governor Brown vetoed nearly identical bills, like AB 3080, because the law was believed to be in direct conflict with, and preempted by, the Federal Arbitration Act, which is created by the supremacy clause of the United States Constitution. The constitutional conflict created by AB51 will likely land the law in years long litigation as it makes its ways through the appellate courts.

Regardless of the future of AB51, employers acting now to safeguard their businesses against future litigation must choose between several underwhelming options. Since, AB51 was signed into law without an explicit retro-active effect like the one described in AB5 (the codification of the Dynamex Operations West, Inc. v. Superior Court of Los Angeles decision), there is a strong legal argument that contracts entered into prior to January 1, 2020 with arbitration clauses should be honored to their full terms and effects, unless the contract is entered into, modified, or extended after the January deadline. Employers who chose to continue their arbitration clause practices may be more protected if AB51 is struck down in the courts, but run the chance of being found in violation of AB51 and criminally liable in the meantime while the courts decide Ab51’s ultimate fate.

While AB51 removes the ability to require arbitration of the most common causes of action for an employee to bring against an employer, i.e. Labor Code and FEHA violations, it still allows employers to have arbitration agreements for causes of action regarding tort, contract, and property disputes. While significantly rarer, there is still a benefit to binding arbitration clauses which resolve these disputes between the parties. Arbitration agreements narrowly tailored to avoid the protected subjects can still provide some protections to an employer. Narrowed agreements will provide the most protection for employers who retain performance-based employees, such as graphic designers, artists, musicians, and sales persons, as these relationships are more likely to regard contract and property disputes.

Employers may also choose to simply stop implementing arbitration clauses in their employment contracts after January 1, 2020. While this option relinquishes the rights previously described above, it may be the safest way to proceed. If AB 51 is struck down in the future, it is still an employer’s right to update and alter an at-will contract as the business requires. This right will allow employers to reinstate arbitration clauses when there is more certainty as to their enforceability and less liability for employers.

Employers who already have written employee contracts are encouraged to audit their contracts in the next two months and determine what is the best course of action for their business. No two employers face the same circumstances, and an assessment of the risks and benefits should be made on an individual level. If you are feeling confused or overwhelmed by the constantly changing burdens of California employers, you should have a conversation with competent employment counsel for guidance and advice on how to best protect your business.

Things Are About To Change, What This Means For A California Contractor’s License

Amy Pierce, Mark A. Oertel and John Lubitz | Lewis Brisbois Bisgaard & Smith

If you are contemplating purchasing or selling a business entity that is a licensed California contractor or even simply changing the type of business entity under which you operate as a licensed California contractor, you must carefully consider and understand the implications and consequences. A basic tenant of the Contractors License Law, Cal. Bus. & Prof. Code §§ 7000 et seq., is that a contractor’s license is not transferrable or reassignable to another individual or business entity, except under very limited circumstances. In turn, under certain circumstances, changes to a business entity will require a new contractor’s license.

Maintaining proper licensure is imperative to avoiding the rather draconian consequences of Section 7130.

Sole Owner License

A sole owner license is issued to a specific individual and it cannot be sold or transferred to another individual. However, Section 7075.1(c) provides for the reassignment of a sole owner license under certain limited circumstances.

A sole owner license may be reassigned to another individual if,

  • The individual is an immediate family member of the licensee,
  • The licensee is deceased or absent,
  • The licensee is required to continue the existing (currently active and operating) family business, and
  • A written request for license reassignment is submitted along with an Original Application for Contractor License and the required fees.

In turn, a sole owner license may be reassigned to a corporation if,

  • The corporation was formed by the licensee,
  • The licensee maintains ownership of at least 51% of the corporation, and
  • A Licensed Sole Owner Applying for Corporate License is submitted along with an Original Application for Contractor License and the required fees.

Once a sole owner license number is reassigned to a corporation, it cannot be changed back to a sole owner license.

Limited Partnership License

A limited partnership license is issued to a partnership made up of one or more general partners and one or more limited partners. When a general or qualifying partner leaves the limited partnership, the limited partnership license must be canceled. Similarly, general partners cannot be added to a limited partnership license. A new license will be required for any new partnership structure that includes a change to the general partners.

In contrast, limited partners can be added to and removed from a limited partnership license by completing and submitting an Application to Change Limited Partners of a Partnership. However, at least one limited partner must be listed on the license to continue under the limited partnership license. If all limited partners leave the limited partnership, the limited partnership license must be canceled.

Corporate License

A corporate license is issued exclusively to a specific corporate registration number assigned by the California Secretary of State’s Office (SOS). If this registration number changes, a new contractor’s license number will be required. A company acquiring the “assets” of a licensee would have its own SOS registration number and, therefore, it would be required to obtain its own contractor’s license. In short, a contractor’s license is not an asset that can be acquired in an asset purchase. In turn, if a corporation dissolves, merges, or surrenders the right to do business in California through the SOS, the contractor license must be canceled.

A corporate license may, however, be reassigned to a different corporate registration number if one of the following conditions exists and the new entity is being formed to continue the business of the formerly licensed corporation:

  • The parent corporation has merged or created a subsidiary,
  • The subsidiary has merged into the parent corporation,
  • The corporation has changed its filing status with the SOS from a domestic corporation to a foreign corporation, or
  • The corporation has changed its filing status with the SOS from a foreign corporation to a domestic corporation,

The licensee must submit a written request for license reassignment, specifying which condition exists, along with an Original Application for Contractor License and the required fees.

Other Considerations When Changes Are Occurring

A Change to the Licensee’s Name

Any change to the licensee’s name or address must be reported to the Contractors State License Board (CSLB) within 90 days of the change by submitting an Application to Change Business Name or Address signed by an owner, partner, or officer of the corporation.

Any corporate name change must first be registered with the SOS; adding a “DBA” to the existing corporate name does not require any changes with the SOS, except that the DBA cannot indicate a second corporation.

A Change to the Licensee’s Personnel

Certain changes to the licensee’s personnel must be reported to the CSLB after the licensee’s records with the SOS are updated, if required. This includes adding and removing personnel and updating personnel title changes on the CSLB’s records for the licensee.

Limited Liability Corporation (LLC) licensees should be particularly careful because every person who is an officer, member, manager, or director must be listed as personnel of record with the CSLB. In contrast, other California corporations are required to identify only three corporate officers, e.g., the president, secretary, and treasurer, and foreign corporations must only identify their president.

Licensees should be very careful to make sure that they have personnel of record identified in the CSLB’s records, e.g., an owner, partner, member, manager, or officer, who can sign any required documents. They should also understand that the CSLB will review the licensee’s filings with the SOS. Any inconsistencies between the SOS’s and CSLB’s records for the licensee will delay the CSLB’s processing of any attempted changes to the licensee’s personnel of record and certain other applications.

In addition, LLC licensees are required to carry liability insurance with the aggregate limit of $1 million for licensees with five or fewer persons listed as personnel, plus an additional $100,000 required for each additional personnel, not to exceed $5 million total. Changes to the LLC licensee’s personnel of record could trigger an obligation to provide additional insurance.

A Change in the Licensee’s Qualifier

Any changes to the qualifier for the license must also be reported to the CSLB within 90 days either through an Application for Replacing the Qualifying Individual or a Disassociation Request. The licensee must replace the qualifier within 90 days of the qualifier’s disassociation date.

A licensee can request a 90-day extension if it is unable to replace the qualifier within the 90-day period. An extension request will only be considered if its is (1) received by the CSLB within 90 days from the date of the CSLB’s notice that the license will be suspended or the classification removed, and (2) if an application has been made to CSLB to replace the qualifying individual.

A new qualifier’s bond in the name of the new qualifier will also be required.

If the new qualifier will be an RME, the RME must be a bona fide employee who is permanently employed by the licensee and actively engaged in the operation of the licensee’s contracting business for at least 32 hours or 80% of the total hours per week such business is in operation, whichever is less. All qualifiers must engage in direct supervision and control of the licensee’s construction operations. “Direct supervision and control” includes “any one or any combination of the following activities: supervising construction, managing construction activities by making technical and administrative decisions, checking jobs for proper workmanship, or direct supervision on construction job sites.”

Failure to timely replace the qualifier will result in the automatic suspension of the license or removal of the classification from the licensee’s license.