By Laurence P. Lubka (November 20, 2017)
AB-1701 (the “Act”) makes a direct contractor liable for the payment of wages by any tier subcontractor. It goes into effect on January 1, 2018. The direct contractors’ liability is for unpaid wages, fringes, other benefit payment to subcontractor workers of any tier and for interest. It does not include penalties or liquidated damages.
Curiously, the statute applies only to the general contractor. The Act does make a subcontractor liable for unpaid wages by a lower-tier subcontractor. The Act is all about the direct contractor, often known as the general contractor.
Labor Code §218.7 is used to implement the Act. Enforcement of Labor Code § 218.7 can be done in one of three ways: 1) brought by the Labor Commissioner (in a Labor Commissioner hearing or in court), in which case recovery can be made for wages and interest. The language in that section leaves out the reference to fringes and benefit payments; 2) by a third party owed fringe or other benefit payments on a wage claimant’s behalf (e.g. labor union), to which recovery will be for those fringes, attorney’s fees and expert witness fees; or 3) by a joint labor-management cooperation committee, which can also recover attorney’s fees and expert witness fees. Attorney’s fees are only available to a third party owed fringe or benefit payments or to a joint labor-management cooperation committee. There is little incentive for the Labor Commissioner to engage in large numbers of law suits with regard to the thousands of underpayments that might be identified in any year, particularly since it can’t recover attorney’s fees, expert witness fees, penalties or liquidated damages pursuant to the Act.
Section 218.7 does not provide a direct cause of action to the unpaid worker. In fact, it specifically states that no one other than the three claimants listed above can seek recovery.
The action must be filed within one year of the earliest of a recorded notice of completion, a recorded notice of cessation or actual completion.
Section 218.7 also provides that a direct contractor may obtain the payroll records of subcontractor of any tier. If the information is not timely provided, the direct contractor may withhold “all sums owed” to a subcontractor (presumably its first-tier subcontractor).
WHAT CAN YOU DO?
The ability of the direct contractor to obtain payroll information as set forth in Section 218.7 is a powerful tool and should be implemented on a regular basis by the direct contractor. A direct contractor (general contractor) might want to include a provision that automatically requires the information be provided every month with subcontractor’s pay application. If the information is not provided, the pay application is not paid. The direct contractor has a far better chance of promptly identifying worker payment issues by getting and reviewing the payroll information every month.
Further, the contract clause might provide an electronic format for the payroll information (perhaps an Excel spreadsheet in a specified format), so that the direct contractor can easily review the information. On a public works project, the direct contractor would get such information in the form of a certified payroll.
Having the payroll information is useful, but what if a subcontractor is not paying its workers in full. That gap could be addressed in a flow-down provision allowing spot audits and spot interviews with workers. Of course, that would require a subcontract audit clause used by the direct contactor, that would require that subcontractors of every tier include that audit clause in the subcontracts used by every tier subcontractor below them. However, such audits require expertise in the performance of the audit, are time consuming and may not be sufficient to identify payment issues where the subcontractor is intentionally underpaying workers costs and hiding the underpayment.
Some direct contractors may simply have their first-tier subcontractors certify or declare that they have checked payrolls of every tier and confirm they have been paid. Such certifications or declarations may help the direct contractor explain why they thought that all workers had been paid, but does not insure that they have been paid in fact.
The second-best step is to mitigate the risk. That could be done through a surety bond provided to the direct contractor by the first-tier subcontractor. Although payment bonds exist, they only ensure payment to lower tier subcontractors, suppliers and workers. So, to that extent, the bond would help. They would not cover the impact, such as legal fees, on the direct contractor. However, in the commercial and residential market, many subcontractors lack the financial wherewithal to obtain any kind of surety bond.
INDEMNITY AND PERSONAL GUARANTEE
Although a direct contractor could have indemnity rights against a first-tier subcontractor for non-payment of wages by a lower tier subcontractor (please check your indemnity clause), indemnity rights are not the same as a subcontractor having the funds to make a payment. If you regularly deal with financially weak subcontractors who tend to submit overly low bids, you should obtain a personal guarantee from the principals of the subcontractors of every tier. However, if the subcontractor has no money, its principals may be equally broke.
FLOW DOWN OF TERMS AND CONDITIONS
The contact between the direct contractor and the first-tier subcontractor should state that every subcontractor (including the first-tier subcontractor) is responsible for full and timely payment of that subcontractor’s workers and all sub-tier subcontractor’s workers. That provision should be a required flow-down term and condition which appears in the subcontracts of every subcontractor of every tier. Please keep in mind that small subcontractors often use out of date and poorly drafted subcontracts. It is well and good to flow down terms and conditions to lower-tier subcontractors, but it is another thing for those lower tier subcontractors to insert a flow-down provision in their subcontracts. There needs to be a mechanism to ensure the flow-down provision is inserted in every subcontract. Without a properly drafted provision in the lower tier subcontract, some or all the risk will rise back to bite the general contractor.
OBLIGATION TO DEFEND
Given the cost of litigation related to AB 1701, there should also be a provision in the subcontract requiring the subcontractor to defend the general contractor and senior subcontractors with attorneys of the general contractor’s choice. This obligation should be independent of the indemnity obligation (e.g. even if there is no indemnity obligation, there is still an obligation to defend). That too should be covered by a well drafted defense clause imposed on every tier subcontractor.
There are multiple ways to address the liabilities created by the Act. They start with irregular use of the power to obtain payrolls, as provided for in the Act and ends with using carefully drafted contract provisions which flow down to subcontractors of every tier.