Court Holds That Public Entity Can Unilaterally Replace Subcontractor Under California’s Subletting and Subcontracting Fair Practices Act

Garret Murai | California Construction Law Blog | June 10, 2019

The Subletting and Subcontracting Fair Practices Act (Public Contract Code section 4100 et seq.), also known as the Listing Law, is intended to prevent direct contractors on public works projects from “bid shopping” and “bid peddling.”

Bid Shopping: Bid shopping is when a direct contractor discloses a subcontractor’s bid to other subcontractors in an attempt to obtain a lower bid than the one in which it based its bid to the owner.

Bid Peddling: Bid peddling is the other side of the equation. It is when a subcontractor whose bid was not selected, lowers its bid in an attempt to induce the direct contractor to substitute it for another subcontractor after the prime contractor’s bid has been awarded.

The Listing Law advances these goals by prohibiting a direct contractor from replacing a subcontractor listed in the direct contractor’s bid unless:

  1. Consent is given by the public owner; and
  2. That consent is based on one of several specifically enumerated situations, including a subcontractor’s failure to perform its work, failure to pay prevailing wages, failure to carry the proper contractor’s license for the work, etc.

As set forth in statute, the Listing Law allows a direct contractor to request a “substitution” from a public owner. However, it says nothing about a public entity’s ability to require a direct contractor to make a “substitution.” That is, unless you read between the lines, as courts are sometimes apt to  do.

Synergy Public Management, Inc. v. City and County of San Francisco 

In Synergy Public Management, Inc. v. City and County of San Francisco, Case No. A151199 (March 14, 2019), the City and County of San Francisco awarded a bid submitted by Ghilotti Bros. for street repairs in the historic Haight-Ashbury area of San Francisco. Ghilotti had listed Synergy Public Management, Inc. in its bid to perform excavation and utilities work.

Ghilotti’s contract with the City also included a provision providing:

When a Subcontractor fails to prosecute a portion of the Work in a manner satisfactory to the City, Contractor shall remove such Subcontractor immediately upon written request of the City, and shall request approval of a replacement Subcontractor to perform the work in accordance with Administrative Code section 6.21(A)(9) and the [Act], at no added cost to the City.

Work on the project began in April 2015. During performance of the work, Synergy broke five gas lines, improperly shored trenches on multiple occasions which could have led to a street collapse, and “dangled” one of its foremen “by his ankles” into an open manhole with no safety equipment. It reminds me of those hilarious, at least to me, construction fails you read about on occasion.

Following the fifth gas line break, the City had had enough and issued a stop-work order. In a letter to Ghilotti, the City directed Ghilotti, pursuant to the contract, “to remove [Synergy] immediately” and “immediately . . . request approval of a replacement subcontractor to perform the work.”

In response, Ghilotti informed the City that it “substantively and procedurally dispute[d] the validity of the City’s replacement demand” but had “solicited proposals for the completion of Synergy’s remaining scope of work.” Synergy submitted its own response stating that it “strongly object[ed] to the [the City’s] unilateral decision of subcontractor substitution.” And we’re off to the races.

The City, in turn, scheduled a hearing under the Listing Law. At the hearing, Ghilotti and Synergy argued that the hearing officer did not have jurisdiction to hold a hearing under the Listing Law because it was the City, not Ghilotti, who was seeking to replace Synergy. The hearing officer basically called Ghilotti and Synergy’s arguments hogwash (more specifically, “absurd”) and upheld Synergy’s removal from the project.

Synergy and Ghilotti each filed a petition for writ of  mandate to have the Superior Court review the decision by the hearing officer. At the hearing on the writ, the trial court found that because Ghilotti had not requested the replacement of Synergy that the hearing officer had acted outside of his jurisdiction.

The City appealed.

The Court of Appeal Decision

On appeal, the First District Court of Appeals acknowledged that “case law reflects ‘a consistent fact pattern’ of the prime contractor, not the awarding authority, seeking substitution, and [the Listing Law’s] references to a ‘request’ by a the prime contractor contemplates this will be the normal situation.”

But, explained the Court, “this does not establish that the prime contractor must always request a substitution for there to be jurisdiction for a hearing under the [the Listing Law]. ‘Rather, the failure to literally comply with an obligatory statutory procedure, such [as those contained in the Listing Law], is valid if the procedure used complies in substance with all reasonable objectives of the statutory scheme.’”

And here, held the Court of Appeals:

There is no dispute for purposes of this appeal that Synergy performed substandard and unsafe work, yet for reasons that are unclear Ghilotti wanted to retain Synergy. Thus, no risk existed of bid shopping by Ghilotti, much less bid peddling by Synergy or another subcontractor. And once the City elected under its contract with Ghilotti to force Ghilotti to remove Synergy for unsatisfactory work, another party’s work on Synergy’s portion of the project could not lawfully proceed without the City’s consent. The City’s decision to hold a hearing on its own initiative instead of waiting for Ghilotti to “request” substitution furthered the statutory objective of protecting public safety by giving the awarding authority control over which subcontractors work on a project.

Conclusion

So, there you have it. A public entity can unilaterally replace a subcontractor on a public works project under the Listing Law without waiting for a direct contractor to make a request for a “substitution,” so long as the public entity contractually reserves its right to replace a subcontractor. What’s less clear is if a public entity can reserve its right to replace a subcontractor for any reason or whether the reason must be based on one of the enumerated situations identified under the Listing Law.

A Behind-the-Scenes Look at Substitution Hearings Under California’s Listing Law

Garret Murai | California Construction Law Blog | February 11, 2019

The next case, JMS Air Conditioning and Appliance Service, Inc. v. Santa Monica Community College District, 2nd District Court of Appeal, Case No. B284068 (December 17, 2018), provides an interesting behind-the-scenes look at substitution hearings under the Subletting and Subcontracting Fair Practices Act.

The Subletting and Subcontracting Fair Practices Act

The Subletting and Subcontracting Fair Practices Act (Public Contract Code Section 4100 et seq.), also commonly referred to as the “Listing Law,” requires that prime contractors on state and local public works projects “list” the following subcontractors in their bids:

  1. Subcontractors who are anticipated to perform work with a value in excess of 0.5% of the prime contractor’s total bid; and
  2. Subcontractors, on street, highway and bridge projects, who are anticipated to perform work with a value in excess of the greater of: (a) 0.5% of the prime contractor’s total bid; or (b) in excess of $10,000.

“Listing” a subcontractor requires that the prime contractor identify the name, business address, contractor’s license number, and public works registration number of the subcontractor.

The purpose of the Listing Law is to prevent “bid shopping” and “bid  peddling.” Bid shopping is where a prime contractor uses a low bid received from a subcontractor to pressure other subcontractors to submit even lower bids. Bid peddling is where a subcontractor uses a low bid received by a prime contractor from a subcontractor to submit an even lower bid. In enacting the Listing Law, the California State Legislature found that bid shopping and bid peddling result in “poor quality of material and workmanship to the detriment of the public, deprive the public of the full benefits of fair competition among prime contractors and subcontractors, and lead to insolvencies, loss of wages to employees, and other evils.”

To prevent these “evils,” the Listing Law prohibits prime contractors from substituting another subcontractor with a “listed” subcontractor unless consent is given by the public agency overseeing the public works project. Consent by a public agency is limited to nine circumstances:

  1. Failure to Execute Subcontract: When the listed subcontractor fails or refuses to execute a written subcontract at the price stated in the subcontractor’s bid;
  2. Insolvency or Bankruptcy: When the listed subcontractor becomes insolvent or files for bankruptcy;
  3. Failure to Perform: When the listed subcontractor fails or refuses to perform under its subcontract;
  4. Failure to Furnish Bonds When Required: When the listed subcontractor fails or refuses to furnish a payment and/or performance bond under its subcontract;
  5. Inadvertent Clerical Error: When the prime contractor demonstrates that the listed subcontractor was listed as a result of an inadvertent clerical error;
  6. Not Properly Licensed: When the listed subcontractor is not properly licensed under the Contractors’ Licensing Law;
  7. Unsatisfactory Performance: When the public agency determines that the work performed by the listed subcontractor is substantially unsatisfactory and not in substantial accordance with the plans or specifications or that the listed subcontractor is substantially delaying or disrupting the project;
  8. Labor Violations: When the listed subcontractor is ineligible to perform work as a result of labor violations under Labor Code Sections 1777.1 or 1777.7;
  9. Non Responsible: When the public agency determines that the listed subcontractor is not a responsible contractor.

A prime contractor seeking to substitute a listed subcontractor with another subcontractor is required to provide notice of the prime contractor’s intent to substitute with the public agency. The public agency is then required to give notice by certified or registered mail to the listed subcontractor of the prime contractor’s request for substitution and the basis for the prime contractor’s request. The listed subcontractor then has five (5) working days to submit written objections to the public agency. If the listed subcontractor submits written objections, the public agency then has five (5) working days to give notice to the listed subcontractor of a hearing by the awarding agency.

JMS Air Conditioning and Appliance Service, Inc. v. Santa Monica Community College District

In JMS Air Conditioning, subcontractor JMS Air Conditioning and Appliance Service, Inc. (JMS) performed work in excess of 0.5% of the bid of prime contractor Bernards Bros, Inc. (Bernards) on a project owned by the Santa Monica Community College District (District).  JMS’ work consisted of the installation of the heating, ventilation and air conditioning at the project and JMS held a C-20 warm-air heating, ventilating and air-condition license.

In March 2016, Bernards submitted a request to the District to substitute JMS. The reasons stated by Bernards for its request was because JMS had “failed or refused to perform its subcontract obligations and may not be properly licensed for portions of its work pursuant to the Contractors’ License Law. Within five (5) working days of receiving notice from the District of Bernard’s substitution request, JMS filed an objection.

On May 6, 2016, the District held a hearing to consider Bernard’s substitution request and JMS’ objection and appointed its facility manager Greg Brown as the “hearing officer.” Prior to the hearing, Brown informed the parties that: (1) the hearing would be limited to two hours; (2) that the technical rules of evidence would not apply; (3) that neither party would have a right to cross-examine witnesses; and (4) that should the parties wish they could submit written statements and that there was no page limitation on such statements.

Both Bernards and JMS submitted written statements. In its written statement, JMS assumed that Bernards’ “lack of proper licensure” claim related to hydronic plumbing work listed in the specifications, and argued that its C-20 HVAC license covered such plumbing work as “incidental and supplemental” or “essential” to its work under Business and Professions Code Section 7059, which permits specialty subcontractors to perform work that is “incidental and supplemental to the performance of the work in the craft for which the specialty contractor is licensed,” and under the Section 831 of the of the California Code of Regulations which defines “incidental and supplemental” as “essential to accomplish the work in which the contractor is classified.”

Bernards’ written statement argued that JMS was not properly licensed because its C-20 HVAC license did not permit it to perform the “hydronic boiler” work and “hydronic plumbing” work listed in the specifications. Bernard’s written statement also included a 250-page “Exhibit Book” that identified twenty-one “[p]erformance [d]efficienc[ies]” of JMS and included a written statement by Robert B. Berrigan, a lawyer and former licensing deputy of the Contractors State License Board, in which he opined that JMS’ C-20 license did not permit it to perform hydroponic boiler work but which also stated that he “ha[d] not formed an opinion” as to whether JMS required a C-36 plumbing license to perform the hydronic plumbing work.

At the hearing, Brown allowed each side 40 minutes to present its case, a 10 minute right to reply and brief closing arguments. Bernards presented two of its employees as witnesses, Michael Toepfer, a senior project manager, and Dave Inman, a superintendent, who testified concerning the quality and timeliness of JMS’ work. JMS presented its president, Joe Messica, as its sole witness. Messica testified that his company had completed other similar projects and that the hydronic boiler and hydronic plumbing work performed by JMS on the project was “essential to the HVAC system . . . installed by JMS.” None of the witnesses testified under oath.

On May 10, 2016, Brown sent a letter to the parties informing them of the District’s approval of Bernards’ substitution request finding that JMS had “failed to perform” its subcontractor “in the most sound, workmanlike and substantial manner” required by the subcontract, and finding that JMS was not properly licensed to perform the work, holding that JMS had performed over $3 million worth of boiler and piping work” and that such a substantial amount of work could not be “incidental and supplemental.”

In response, JMS filed a petition for writ of administrative mandamus which was rejected by the superior court. JMS appealed.

The Court of Appeal Decision

On appeal, JMS raised several arguments, all of which, were rejected by the Court of Appeal. The rationale of the court is less important than its holding, so I’ll be brief:

  • JMS’ Argument That Only the District, Not a “Hearing Officer” (i.e., Brown), Could Conduct the Substitution Hearing Under the Listing Law

JMS’ first argument was that, under the Listing Law, Brown lacked jurisdiction to conduct the substitution hearing, because under the Listing Law only the “awarding agency” may conduct a substitution hearing not a “hearing officer” designated by the awarding agency.

The Court of Appeal disagreed, explaining that the Listing Law was intended to prevent bid shopping and bid peddling, and nothing in the “[legislative] record, nor the [Listing Law’s] history, nor its overall structure suggests that preventing an awarding authority’s agent from conducting a substitution hearing might help combat bid shopping or bid peddling.”

  • JMS’ Argument That it Was Denied Due Process Because the Hearing Was Too Short, it Did Not Have the Right to Cross-Examine Witnesses, and Did Not Receive Sufficient Notice of Bernards’ Basis for its Substitution Request

JMS’ second argument was that it was denied due process under the Listing Law because: (1) the hearing was too short given the complexity of the issues involved; (2) it was not afforded the right to cross-examine witnesses; and (3) it did not receive sufficient notice prior to the hearing of the basis for the substitution request.

Again, the Court of Appeal disagreed, explaining that nothing in the Listing Law “requires a hearing of a particular length or the opportunity to cross-examine witnesses.” Furthermore, explained the court, so long as parties have “a reasonable opportunity to be heard, taking into account the ‘specific factual context,’” the conduct of proceedings will be upheld. And, here, explained the court, although Bernard’s substitution request stated that JMS might not be properly licensed to perform “some portions” of the work, JMS correctly concluded that Bernards’ request was premised in part on its contention that JMS needed a C-36 plumbing license to install the hydronic plumbing, and while JMS was not aware that Bernards’ request was also promised on its claim that JMS could install the hydronic boiler, “JMS failed to request a continuance to prepare additional evidence and argument to defend against Bernards’ boiler licensure argument.”

  • JMS’ Argument That There was Insufficient Evidence for the District to Grant Bernards’ Substitution Request

Finally, JMS argued that, while Brown testified that JMS’ C-20 HVAC license was not sufficient for it to install the hydronic boiler, because its president Messica testified that the boiler work was “incidental and supplemental” or “essential” to JMS’ HVAC work, that there was insufficient evidence for the District to grant Bernards’ substitution request.

The Court of Appeal disagreed, holding that the substantial evidence standard of review applies, rather than the broader independent judgment standard of review, and that under the substantial evidence standard of review, court’s “resolv[e] all conflicts in the evidence and draw[ ] all inferences in support of [the administrative findings].” And, here, explained the court, the credibility of witnesses and weight given to conflicting testimony is left to the discretion of the public agency unless “a reasonable person could not reach the conclusion reached by the agency.”

As to the hydronic boiler installation, the Court of Appeal held that it would not “second-guess[ ] Brown’s decision to believe Berrigan’s testimony over Messica’s. However, as to the hydronic plumbing installation, the Court of Appeal held that, because Berrigan expressly disclaimed offering an opinion on whether  JMS was properly licensed to perform the hydronic plumbing installation, substantial evidence did not support the District’s finding that JMS was not properly licensed to perform the hydronic plumbing installation.

Conclusion

JMS Air Conditioning provides an interesting behind-the-scenes look at substitution hearings under the Listing Laws, the primary take-aways being that: (1) the governing body of a public agency does not need to conduct substitution hearings itself, and can designate a hearing officer instead; (2) public agencies have broad discretion in how such hearings are conducted so long as the parties have a reasonable opportunity to be heard given the “specific factual context;” and (3) that substitution hearings are reviewed on appeal under a substantial evidence standard of review, whereby, appellate courts will resolve conflicts in the evidence and draw all inferences in support of the administrative findings.