CALIFORNIA: An Introduction to Construction
Current Status of Construction in California, 2023: Funding Sources, New Opportunities and Caveats
Our prior Chambers Overview submission contained a detailed summary of the construction industry in California, highlighting some of the major projects and opportunities, and the necessity to comply with Contractors State License Board regulations. Despite the continuing repercussions of the COVID-19 Pandemic, rising inflation and mounting concerns of a recession, the California construction market is still very active
The Rise of Public Private Partnerships for Funding
California relies heavily on its infrastructure, but it has not been maintained at an appropriate level. The highway system is a key example. The California Department of Transportation ("CalTrans") continuously monitors thousands of projects which will require billions of dollars in construction. Some of the projects are in the planning stage and others are in progress, in order to keep the overall system operational and safe. However, budget constraints are a constant concern.
To assist in funding, CalTrans has turned to Public Private Partnerships ("P3") financing, starting with the Presidio Parkway Project. That USD1.1 billion project replaced the seismically deficient southern access to the Golden Gate Bridge, under a contract whereby a private entity took on financing, design, construction, and long-term operation and maintenance.
The Los Angeles Metropolitan Transportation Authority ("LA Metro") has perhaps the most aggressive P3 program in the country, attracting private capital to assist in funding various projects. While LA Metro will receive substantial funding from Measure M, the sales tax projected to provide USD120 billion dollars over the next 40 years, it is still actively seeking opportunities to work with the private sector because it still needs additional sources of revenue for its planned expansions and improvements. Infrastructure and transit projects remain on the forefront, and funding now includes the private sector.
The Apocalypse of Office Space
One unanticipated opportunity arising from the COVID-19 Pandemic is the current so-called "Apocalypse" of office and business space. In March 2020, California issued a mandatory, statewide shelter-in-place order, mandating that all but essential workers stay at home. As a result, many workplaces went virtual. It took some time for the workforce to adjust, but within several months, employees discovered that they could effectively and efficiently work from home and did not need to go to the office except on rare occasions. In addition, they avoided commuting, which in some cases could take hours and might involve personal contacts which increased the risk of infection. Given the duration of the pandemic, most grew comfortable with the new arrangement, and many determined it was no longer necessary to live close to their office or business location. They could avoid the high cost of living in metropolitan areas and move to an area with lower housing prices or a better standard of living. They had no intention of commuting again.
Now, more than three years after the onset of the pandemic, there has been a massive reduction in the number of people going into the office to work, and an equivalent reduction in the demand for office or business space. Statistics show that in San Francisco, there is an overall reduction in office occupancy of some 30%, and many large buildings in San Francisco have vacancy levels ranging from 80 to 100%. The vacancy rate for Los Angeles is approximately 27%.
This is a disaster for commercial owners and lenders, but what is emerging is a potential growth area for construction. California has the largest population in the country, but has long had a housing shortage, resulting in sky-high home prices and homelessness. Many well-intentioned programs designed to increase housing inventory have not been as successful as envisioned. But savvy investors and contractors have seen an opportunity to convert office spaces and under-utilized commercial property like malls, to residential use.
One prior impediment to these conversions has been the reluctance of local government to change the zoning from commercial to residential, fearing a decrease in the tax base. But Governor Newsom recently signed two bills to make the transition easier. One law will allow residential construction on commercial land without local approvals, provided the project includes a certain percentage of affordable housing. The other law would allow market rate housing on commercial land provided the project goes through an environmental review. California also established a USD400 million dollar fund to provide grants to developers who want to convert commercial space to housing.
Conversion to residential is not an easy proposition in many cases. But the economic reality is that the demand for office space and retail malls has diminished. Conversion to residential offers a desirable, profitable alternative. San Francisco has successfully converted a 28-story office tower into 418 apartments. And Los Angeles adopted a program called Adaptive Reuse which encourages such conversions.
Large office structures pose problems with plumbing, mechanical and access to exterior light and air. But many structures are much more easily converted. In any event, the construction industry has always been innovative, so any difficulty will be surmounted. Office and commercial property conversion to residential may be the next frontier in California.
The Plenary Power of the Contractors State Licensing Board
A major cautionary note in our prior Overview was that contractors must be constantly vigilant about obtaining and maintaining a contractor's license for all construction projects. A lapse of even a day can result in the inability to recover compensation for work performed and the requirement to pay back any compensation previously collected. And there is virtually no escape from licensing requirements.
Perhaps the best example was in Hydrotech Systems, Ltd. v. Oasis Waterpark, 52 Cal.3d 988 (1991). A New York manufacturer of artificial wave systems for water parks was solicited to install one of its systems in California. Hydrotech did not have a contractor's license, so it proposed to furnish only the equipment. Oasis insisted that the system was unique and required hands on work by Hydrotech.
Oasis assured Hydrotech of payment and Hydrotech installed the wave equipment. When Hydrotech was not paid, it sued for the balance due. Hydrotech conceded it did not have a contractor's license but argued that it was induced to enter the contract by fraud, and that it was entitled to quantum meruit recovery. The Court of Appeal held that Section 7031 of the Business and Professions Code, which mandates a license, barred Hydrotech 's contractual or quasi-contractual claims, but not its fraud claim.
The Supreme Court granted review and concluded that the Section 7031 bar against suits by unlicensed contractors applies even when the owner fraudulently and knowingly entices an unlicensed contractor to enter a contract. The Court stated, “[R]regardless of the equities, Section 7031 bars all actions, however they are characterized, which effectively seek ‘compensation��� for illegal unlicensed contract work". Thus, an unlicensed contractor cannot recover either for the agreed-upon contract price or for the reasonable value of labor and materials. The moral is that the California licensing statutes are strictly enforced and cannot be side stepped or avoided even by theories like fraud.
Contractors in California must also be wary of the burden of proof regarding their license. In Vascos Excavation Group LLC v. Robert Gold, 87 Cal App 5th 842 (2022), Gold defended against a claim in arbitration arguing that Vascos failed to prove it had a competent Responsible Managing Employee ("RME"). Vascos provided its verified, current license and identified its RME. Vascos also filed a declaration from the Project Manager attaching snippets of video showing the RME on the jobsite. The Arbitrator was satisfied with that evidence but Gold challenged the Arbitrator's Award, contending that Vasco did not put on evidence that the RME was a permanent employee or that the RME worked 32 hours per week or 80% of the total time that the company’s business was in operation, which are license requirements under California Business & Professions Code section 7068.
The trial court and the court of appeal agreed. The court observed that Vascos should have submitted a declaration from its RME addressing these requirements. Because Vascos had not met the RME burden of proof it was therefore unlicensed. The contract was void and the Award was vacated.
In reaching its decision, the court cited the Hydrotech case holding that the purpose behind the licensing statutes is protection of the public and that section 7031 applies despite injustice to the unlicensed contractor. Cases like Vascos demonstrate that California courts continue to strictly construe contractor licensing requirements.
Conclusion
Over the past few years, the Country has experienced several exceptional phenomena, from a once-in-a-century pandemic to meteoric inflation triggering genuine concerns of a recession. Still, the construction industry in California remains vibrant. In addition to the need for new and updated infrastructure, the paradigm shift in where and how people work has created new opportunities for the construction industry to address California's housing shortage by converting commercial properties to residential developments. This is truly a new frontier for construction, not just in California, but in all metropolitan areas where housing is in short supply.