CALIFORNIA: An Introduction to Construction

AN OVERVIEW OF THE CALIFORNIA CONSTRUCTION MARKET AND LEGAL CONSIDERATIONS FOR FINDING SUCCESS IN THE ROBUST ECONOMY OF THE STATE [1]

I. California in a Nutshell 

The State of California is home to 39.6 million people, the largest state in the Union in terms of population.[2]  Its boundaries stretch nearly 900 miles along the Pacific ocean, running from the Mexican border to the south all the way up to the State of Oregon to the north. As a consequence of its size, California's landscape is hugely diverse, boasting hundreds of miles of ocean-front property, dense metropolitan and suburban areas, forestlands, tens of thousands of square miles of agricultural flat lands, mountain ranges, and a complex, interconnected system of rivers, streams, deltas, and bays. For the majority of its population, California's climate is considered temperate with warm, dry summers and mild, wet winters, which allows for year-round construction activity in most places. However, certain parts of California touch on the extremes – California is home to the driest and hottest locations in the United States.[3] The climate has also caused persistent drought conditions and seasonal wildfires have become more common, followed by atmospheric rivers, landslides, rising tides and waterfront erosion. Not to mention the ever-present threat of earthquakes. It suffices to say, for all its positives California comes with its share of challenges.

Despite these characteristics, California remains an economic powerhouse. As of the 2021 calendar year, California had the largest economy in the United States and the fifth largest economy in the world. Its "gross state product" was measured at $3.35 trillion, a figure which represents 14.6% of the entire US economy.

Keeping California's economy running on all cylinders requires recurring investments in infrastructure, commercial construction and housing. Focusing just on the infrastructure side, California has built (and is responsible for maintaining) an impressive array of roads, rail, bridges and ports, including:
- 11 major ports of entry [4]
- 25 major airports
- 25,771 individual bridges [5]
- 51,000 miles of state highways and 350,000 miles of local streets and roadways
- 4,828 miles of rail
- 805 dams

But California's infrastructure is in dire need of improvement, innovation, and maintenance.  In 2019, the American Society of Civil Engineers studied California's infrastructure, breaking it down into seventeen individual sub-categories, such as ports, aviation, bridges, dams, roads, rail, wastewater and transit, among others.  In its published findings, the ASCE gave California a "C-" grade overall, and noted that "[i]nfrastructure maintenance, renewal and replacement programs are critical for sustaining California’s economic engine, but funding constraints continue to severely delay much-needed improvements. [California's] state’s infrastructure renewal and replacement programs have been significantly underfunded for a long time."

Yes, there are well-documented challenges to building in California, however a bright future may lie ahead. The recent passage of federal legislature should provide a great opportunity to those in the heavy civil sector to help overhaul California long-neglected infrastructure.

II. An Overview of the California Construction Market

As of calendar year 2020, there were 73,587 construction firms operating in California, and the construction industry as a whole contributed $119.5 billion in revenue to California's GDP – a revenue figure that places the State near the top in terms of the size, complexity and volume of current projects underway. Looking to just the Los Angeles region, as of calendar year 2022 (as was the case for the prior year), the city leads the nation in the number of cranes that appear on the skyline (51), which accounts for 10% of all cranes used in the United States that year.[6] San Francisco, while certainly lower than Los Angeles, has seen its crane count increase in calendar year 2022 to fifteen. The majority of these west-coast cranes are being used to build residential and mixed-use developments, with hospitality, public works, healthcare, industrial and commercial projects making up the remainder.

On the infrastructure side, the major metropolitan regions in California are investing huge sums on much needed improvement projects, in particular in the area of transit. Los Angeles is leading the charge once again with an estimated $22.5 billion portfolio for projects that are scheduled to be completed before the 2028 Summer Olympic Games.[7] The San Francisco Bay Area, by comparison, is managing $10.3 billion in infrastructure projects. Alongside these regional efforts, California continues its forward press on the $105 billion, 500 mile-long High Speed Rail Project.

While the construction projects already in progress across the State are remarkable, the November 14, 2021 passage of the $1.2 trillion Infrastructure Investment and Jobs Act (IIJA) ensures a healthy future for public works infrastructure projects. California is estimated to receive $25.3 billion in funding for federal highway programs – a $6 billion increase over California's previous allotment. Current estimates also show $4.2 billion in funding for a new bridge program, $384 million for an electric vehicle charging network and $9.45 billion for public transportation (approx. $1.3 billion more than California's prior allotment under the FAST Act). These new federal investments in infrastructure are sure to kick off a wave of new megaprojects across the State.

III. Legal Tips for Building in California 

While the construction market in California has a bright future, careful consideration of the regulatory and legal environment is needed to take advantage of the opportunities on the horizon. As with many states, the business of construction in California is governed by a labyrinth of rules set by administrative agencies, statutes, municipal codes and a large, evolving body of common law.[8] The purpose of this article is to give, in broad-brush fashion, a high-level overview of some of the more unique or consequential facets of California law. We've focused this discussion into two general topics: state licensing requirements and remedies for non-payment.

A. California's Licensing Law 

The licensing regime that governs the work of construction in California is extensive. It is managed and overseen by a state agency called the Contractors State License Board (CSLB), which falls under the Department of Consumer Affairs. The CSLB is headquartered in the capital city of Sacramento, and is comprised of a 15 member board made up of both public and private industry members. Each member is appointed by the governor and approved by the state legislature. The board then appoints a “Register of Contractors” who acts as the “CEO” of the CSLB and manages the day-to-day regulatory activities performed by the 400 or so employees who work at the Board.

The body of regulatory laws that are enforced by the CSLB are found under Section VI of California’s Business & Professions Code, beginning with Chapter 9, Sections 7000. These laws, which are consumer protection-oriented, have been strengthened by decades of judicial decisions. The result is an environment where the CSLB carries substantial weight and influence across the industry, from small residential works to billion dollar infrastructure and commercial projects.

If there is one "take-away" from reading this article, it is this: you must hold a valid license to perform construction work in California. The licensing scheme, which is divided into forty-five classifications and sub-classifications, is comprehensive and has little tolerance for missteps. The license requirement applies to any work of improvement above $500 in value, and touches on all aspects and trades.[9]

The risks of performing construction activities without a valid license are dramatic, and can present an existential threat to your company if not carefully managed. Active licenses must be renewed every two years, and are submitted along with the proof that the bonding and insurance requirements are satisfied. Renewal applications are due prior to the date of expiration to avoid gaps in licensure – gaps as small as one day can spell disaster for a contractor. Changes in the corporate form, or changes in the "qualifier" on the license (often referred to as an "RMO" or "RME"), must be handled early and with great care.

As alluded to above, the consequence for gaps or lapses in a license history are dramatic.  In addition to criminal penalties and fines that can be assessed by the CSLB, unlicensed contractors are prohibited from bringing a claim for non-payment, and can be required to disgorge (i.e., repay) all construction funds received during the life of the project – even if the lapse is short in duration.[10] These rules apply even if the owner knew at the time of signing the contract that the contractor was unlicensed, or discovers the lapse prior to the contractor's completion of the work.

When it comes to licensing, even an innocent mistake is not a get-out-of-jail-free card. Under the California Supreme Court's landmark decision of MW Erectors, Inc. v. Niederhauser Ornamental & Metal Works Co., Inc. 36 Cal.4th 412, the window to prove there was "substantial compliance" with the rules is exceedingly narrow.[11] The unlicensed contractor must show (1) it was licensed prior to starting work; (2) it acted reasonably and in good faith to maintain proper licensure; (3) it did not know or reasonably should not have known that it was not duly licensed when performance commenced and (4) it acted promptly and in good faith to reinstate his or her license upon learning it was invalid.

Arguing for substantial compliance is risky business, and by far the best course is to diligently maintain your license.

B. Remedies for Non-Payment: Prompt Payment, Mechanics Liens Rights, Stop Payment Notices, and Pay-if-Paid Clauses There are several ways under California law to shore up your right to payment for work that was validly performed on a project. The first tool is found under California's prompt payment statutes.[12] For those familiar with Federal Acquisition Regulation, Rule 52.232-27, the rules for prompt payment in California are conceptually similar. The idea being that, unless modified by contract, owners (and contractors down the line) are obligated to pay for valid work performed within certain prescribed periods of time. For private works, payment to prime contractors must be made no later than 30 days following receipt of a request for progress payment. The payment deadline is slightly longer, 45 days following the "date of completion", for requests for retention. The timelines are shorter for subcontractors, who are entitled to payment no later than 7 days of the prime contractor's receipt of progress funds from the owner, and 10 days following the prime contractor's receipt of retention. Failure to pay within these timelines comes with a 2% per month penalty based on the unpaid balance, and if a lawsuit is filed to recover the unpaid sums, the prevailing party may recover attorneys' fees and costs.[13]

Public works projects have a similar set of rules for prompt payment, albeit there are some notable differences.[14] For instance, the prevailing party on a prompt payment claim is not entitled by statute to recoup its attorneys' fees and costs and the penalty on late progress payments is 10% per year (not 2% per month). The timelines are also different, and some of that depends on the contracting agency: for example, California State Universities have 39 days to make progress payments. If you find yourself facing non-payment or a withholding, it is critical to review the specific rules that govern your project.

Other tools are available to contractors facing non-payment for completed work. First, the California Constitution grants those who work on real property a right to assert a lien, or make a claim against, the title of that property for unpaid sums.  Lien rights in California are effective ways to secure rights to payment, and once recorded and served on the owner (or purported owner) and the construction lender, if any, the lien can be used in a court of law to initiate a foreclosure proceeding on the property. There are very rigid timelines and nuanced steps that must be followed to properly secure a lien right, but good practice is to serve a 20-day preliminary notice on the owner, prime contractor, and construction lender (if any) immediately upon signing the contract. This step will ensure maximum lien-leverage if a non-payment issue arises.

By statute, lien rights do not apply to public works projects; so other tools must be used to ensure payment for those who work in the public arena. One way is to make a claim against a bond. All significant public works projects require the General Contractor to provide Payment and Performance Bonds for the full amount of the contract.

Subcontractors are also granted a unique right to send a "stop payment notice" to the public agency, which places a freeze on the amount in dispute.[15] The ramifications of this procedure can be significant, as the public owner will undoubtedly raise the non-payment issue with the prime contractor, and will withhold sums from future progress payments unless a stop payment release bond is issued (typically at the prime contractor's expense). But to make use of this tool, a subcontractor must serve a 20-day preliminary notice at the beginning of the job.

One final comment on the topic of non-payment: unlike other states, California does not tolerate "pay-if-paid" clauses that are typically found in construction contracts, an issue that was soundly decided by California Supreme Court's decision in William R. Clarke Corp. v. Safeco Ins. Co. of America (1997) 15 Cal.4th 882. The reason these clauses are unenforceable is because, in effect, they amount to an impermissible waiver of the constitutional lien rights discussed above.[16] Through an ongoing practice of trial-and-error, construction contracts in California have adapted to this bar by creatively drafting “pay-when-paid” clauses. But any delay on payment that is tied to the owner's payment must be limited in duration to pass scrutiny.[17]

IV. Closing Remarks 

The above discussion is a light touch on a few important rules that govern contractors' work in California, but they are not the only ones to which contractors must adhere. Safety requirements, labor prerequisites, competitive bidding rules and listing laws, both state and local regulations, insurance and many other conditions may be involved in any given construction project. Consultation with experienced personnel is encouraged so that all applicable parameters can be identified and followed.

[1] Authors: David M. Buoncristiani and Brian M. Schnarr are both partners that practice in the Chambers USA ranked Construction Practice Group at the law firm of Hanson Bridgett LLP. Their area of focus is in heavy civil and commercial construction disputes in California and elsewhere.

[2] The three largest population centers are the Los Angeles Metropolitan area and the City of San Diego to the south, and greater San Francisco Bay Area to the north.

[3] Death Valley, California in the northern Mojave Desert holds the top 12 records for the hottest temperature in the United States; the highest being 134 degrees – which is the highest ambient air temperature ever recorded on the surface of the Earth.

[4] The Port of Los Angeles and the Port of Long Beach, if taken together, would be the largest port of entry in the world.

[5] Included in this number are the iconic 8,891 foot-long Golden Gate Bridge, the neighboring 23,556 foot-long Bay Bridge, the 36,960 foot-long San Mateo/Hayward Bridge, and the 29,040 foot-long Richmond/San Rafael bridge.

[6] RLB Crane Index, North America – Q1 2022.

[7] LA Metro Program Management Dashboard; see also "LA Metro pushes timeline to complete key rail projects by 2028 Summer Olympics", Progressive Railroading (Sept. 2019) (noting "[b]y the time thousands of Olympians and international visitors descend on the city in mid-2028, they’ll find about $88 billion worth of new light-rail and subway lines, bus rapid transit options and express lanes open for service, according to the city’s Olympics website.").

[8] According to the 2021 Court Statistics Report of Statewide Caseload Trends, there were 2,794 different appellate opinions that were written in civil matters during the 2020 calendar year.

[9] There are several court decisions that address whether certain industry actors, such as an "owner's representative" or "construction manager", require a license from the CSLB to consult on a project. See, e.g., The Fifth Day, LLC v. Bolotin (2009) 272 Cal.App.4th 939. The line drawn is that so long as the consultant does not have responsibility or authority to perform any construction work on the project, or to enter into any contract or subcontract for the owner, then no license is needed.

[10] Business & Professions Code, Section 7031.

[11] The "substantial compliance" rule is codified under Bus. & Prof. Code, § 7031(e).

[12]  Civ. Code, §§ 8800 et seq. and Bus. & Prof. Code, §§ 7108.5 and 7108.6.

[13] There is a "good faith dispute" exception that allows a withholding of up to 150% of the disputed amount. Civ. Code, §§ 8800(b), 8812(c). However, California's Supreme Court has tightened down the rule, noting that the withholding must be directly relevant to the work in dispute. United Riggers & Erectors, Inv. v. Coast Iron & Steel Co., 4 Cal.5th 1082. In other words, you cannot withhold more than 150% of the specific amount attributed to the dispute from a payment.

[14] Pub. Contract Code, §§ 10260 and 20104, et al. governs public works.

[15] A stop payment notice can be used by prime contractors on private works only, and can cause a construction lender to withhold funds from the owner.  Civ. Code, §§ 8520, 8530.  Be mindful, however, that a stop payment notice issued to a construction lender must be bonded to be effective. Civ. Code, § 8536(b).

[16] Civ. Code, § 8126.

[17] A good discussion of the validity of "pay-when-paid" clauses can be found in Crosno Construction, Inc. v. Travelers Casualty and Surety Company of America, 47 Cal.App.5th 940.