California Construction Law Update for 2021 | Snell & Wilmer

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In the 2020 COVID-19 year, there were not that many construction-related cases decided by the California Courts of Appeal, and none by the California Supreme Court. However, there were a number of interesting cases that raise new issues, and others that resolved certain issues. We discuss the key cases below. As an overview, an owner may now be liable to a non-performing subcontractor for contract interference for insisting the general contractor fire the non-performing subcontractor, and an owner suing for excessively filing mechanic’s liens may not only be unsuccessful but may expose an owner to damages and attorney’s fees if unsuccessful. Some other issues were clarified, such as: 1) who is responsible for costs of defense and indemnity involving multiple insureds when one or more of the indemnitors were not liable for damages; 2) the application of the substantial compliance doctrine on an expired contractor’s license; and 3) the measure of damages in a misrepresentation action involving the cost of construction. Finally, we take an important look at the False Claims landscape since there exists a split in authority among federal courts as to “objective” falsity. This split impacts those companies doing business with the federal government in multiple circuits.

Moore v. Teed

This case involves contractual fraud, construction defects and a novel twist of the application of Business and Professions Code §7160. The dispute mainly revolved around whether the remodel would cost $900,000 as promised or approximately $4.5 million that it ended up costing. The court had to choose between the “out-of-pocket” measure of damages or the “benefit of the bargain” measure. The “benefit of the bargain” measure satisfies the expectancy interest of the defrauded party by putting him in the position he would have enjoyed if the false representation relied upon had been true; it awards the difference in value between what the parties actually received and what he was fraudulently led to believe he would receive. The “out-of-pocket” measure of damages restores the defrauded party to the financial position enjoyed by him prior to the fraudulent transaction, and thus awards the difference in actual value between what the plaintiff gave and what he received. The majority of courts in California have concluded that benefit of the bargain damages are recoverable in fraud actions where a fiduciary induces an individual to purchase, sale, or exchange real property to his detriment. Here the fiduciary was the sales agent/unlicensed contractor. This court applied the benefit of the bargain measuring.

In an interesting twist, the parties argued attorney’s fees under Business and Professions Code §7160 which allows the recovery of attorney’s fees in a home improvement contract to a victim of false or fraudulent representations. Even though no formal home improvement contract was entered, nor was there a licensed contractor, the court upheld the award of fees under this provision. This result should benefit homeowners, many of which are taken advantage of by misrepresentations made by home improvement contractors who, unfortunately, do not follow the law.

Carter v. Pulte Homes

This case decided which insurer was primarily liable and responsible for the cost of defense and liability and apportionment among insurers for the loss and attorney’s fees. The court determined that the insurer cannot shift the costs of defending the contractor against claims unrelated to the contractor’s scope of work. The court also distinguished between indemnity claims and insured claims. If a party’s failure to comply with its contractual obligation to indemnify and defend the contractor for claims arising from the contractor’s work, it does not make the contractor liable for losses due to the work of other independent contractors. The court noted that equitable subrogation allows a loss to be shifted from one who is legally liable to another who is more responsible for the same loss.

C.W. Johnson and Sons, Inc. v. Carpenter

This case is about the lapse of a contractor’s license due to death of the Responsible Managing Officer (RMO), who was the principal of the contracting company. Work was initially performed in March 2016, with all proper licensing in order. Other work in question was performed in September 2016 but not prior to the RMO passing away on September 21, 2016. The replacement of the license holder was not approved until 2018. The contractor was subsequently sued for breach of contract and failure to be licensed. The flooring contractor whose license lapsed sued the owner. The defendant owner moved to have the case dismissed on the grounds that the license lapsed.

The court recognized an exception to the license requirement if the contractor can show it substantially complied with the licensing requirements of the Contractor Licensing Law. In short, the contractor has to prove it was a duly licensed contractor prior to and during the part of the performance of the contract; that the contractor did not know or have reason to know that he was not the RMO for the company at the time of the RMO’s death; that the contractor as soon as it realized it was not properly licensed applied to be the designated licensee; and, the CSLB grants the application shortly thereafter. Here, the contractor got by the motion to dismiss by pleading that it substantially complied, but this contractor may not make it in the long run. The takeaway here is that the successor compliance doctrine is still alive and well, but its application is quite limited. Generally speaking, an RMO has to be replaced within 90 days of death, and missing this deadline could result in disgorgement of any monies received if unlicensed.

RGC Gaslamp, LLC v. Ehmcke Sheet Metal Co.

In this case, a subcontractor recorded a mechanics lien of $250,000 for allegedly unpaid work. This was the beginning of a nightmare scenario for the owner who, unfortunately, did not properly attack the improper lien and ended up not only losing the case, but paying the subcontractor’s attorney’s fees.

After the initial lien was recorded, the owner subsequently secured and recorded a bond to release the lien. Normally, if the case is not settled, the contractor brings an action for breach of contract and enforcement of the lien release bond. However, two months after the release bond was obtained, the subcontractor recorded another lien. Then several months after recording the second lien, that second lien was withdrawn, and a third lien was recorded. As if that wasn’t enough, the subcontractor then withdrew the third lien and recorded a fourth lien. By the time of the recordation of the fourth lien, the owner filed a complaint against the subcontractor for slander of title.

The subcontractor in turn filed what is known as an anti-SLAPP suit against the owner for retaliation against the subcontractor for participating in a protected/privileged activity. The court found that statements made in preparation for litigation or in anticipation of bringing an action are protected statements. The court held that because the recording of a mechanics lien is a prerequisite to filing a lien foreclosure lawsuit, recording a lien is a “protected prelitigation statement.” Significantly, the court held this was true regardless of whether the subcontractor had any right to file the liens or actually intended to foreclose them. The lien recording fell within the litigation privilege regardless of any evidence that the party recording the lien had any intention of actually foreclosing. This resulted not only in a dismissal of the owner’s lawsuit against the subcontractor but also an award of attorney’s fees to the subcontractor.

Alternative procedures that owners may want to consider are to seek declaratory and injunctive relief challenging the validity of the lien; proceeding under applicable statutory scheme to challenge the lien; or, requesting that the court release the duplicate of liens in lieu of posting a single bond for the lien amount. The owner did not avail itself of any of those options. This case demonstrates the need for an owner to proceed carefully when fighting a lien, and it opens another avenue for contractors to counter any owner’s move seeking to sue for slander of title by filing the anti-SLAPP action.

Caliber Paving Company, Inc. v. Rexford Industrial Realty and Management, Inc.

In this case, the court examined whether a higher tiered party on a construction project can be liable for intentional interference with a contract when it interferes with the contract between lower-tiered parties even though the higher tiered party has an economic interest in the contract between the lower-tiered parties. Here, the owner, Rexford, got involved in a contractor – subcontractor dispute. The contractor kicked the subcontractor off the job after being told that the owner wanted the subcontractor off the job. The subcontractor later sued both the contractor, for breach of contract, and the owner, for intentional interference with contract. The owner filed a motion for summary judgment arguing that it was a stranger to the contract and could not be sued for interfering with the contract. The trial court ruled in favor of the owner noting that “it is hard to envision where the alleged party does not have a more direct economic interest [in] the contract than one between its general contractor and the subcontractor over how the property is improved.” The Court of Appeals reversed, noting that “a defendant who is not a party to the contract or an agent of a party to the contract is not immune from liability for intentional interference with contract by virtue of having an economic or social interest in the contract,” because without potential liability, a non-contracting party, including one claiming a social or economic interest contractor relationship, has no incentive to refrain from interfering with the contractual relationship. Everyone needs to pay attention to this case. When problems arise on a job with a subcontractor and the owner gets involved, parties need to be prudent in who to resolve the problems.

Government Contractors Beware: False Claims Act’s “Objective Falsity” Requirement Dispute Between Circuits Persists

In February 2021, the U.S. Supreme Court denied certiorari to adhere to petitions, which would have resolved a Circuit Court split regarding whether the False Claims Act (“FCA”) requires “objective falsity” of information or claim to establish liability. The California FCA is modeled on the federal law.

The FCA is a federal statute whose enactment dates back to the Civil War and has been amended by Congress three times. In general terms, the FCA set forth liability for any person who knowingly submits a false claim to the government or causes another to submit a false claim to the government or knowingly makes a false record or statement to get a false claim paid by the government. False Claim violations can be extraordinarily expensive, resulting in steep fines, and in some circumstances may lead to debarment of participating in the government contract process.

Liability under the FCA requires proof that the individual had (1) actual knowledge that the claim or information was false; (2) deliberate ignorance of the truth or falsity of the information; or (3) a reckless disregard of the truth or falsity of the claim of information. The FCA’s construction and application has been the subject of thousands of court decisions. At issue now is whether proof is required to establish that the information is actually false. The Federal Circuit courts are split on this issue. On one side, the 11th Circuit Court held that a reasonable difference of opinion is not sufficient on its own to suggest that those judgments, or any claim based upon them, are false under the FCA. In reaching this decision, proof of “objective falsity” is required. That is, statements or information of claims must be more than “objectively untrue” they must suggest intentional deceit. In contrast with the 11th Circuit, the Third Circuit ruled that evidence of “objective falsity” for FCA claims is not required, and that the difference in opinions, particularly where another expert calls another’s opinion into question after the fact, can constitute legal falsity.

Here, in California, the Ninth Circuit, similarly held that proof of “objective falsity” is not a requirement under the FCA where a pleading sufficiently alleged “more than just a reasonable difference of opinion” among expert physicians regarding the necessity of inpatient hospital admissions. This was in the healthcare context, but an analogy can be drawn to construction and design government contracting.

Following the Supreme Court’s denial of the petitions, all circuit courts will likely have to pick a side, which will inevitably create a larger schism among courts. The varied applications of the “objective falsity” standard for FCA claims will also subject government contractors across the country to different levels of litigation risks. For example, the courts in the Ninth Circuit, Arizona and California, take a more evenhanded approach, such as holding that the FCA claims cannot be based on a reasonable disagreement among experts without additional evidence, thereby recognizing instances where a more stringent standard of “objective falsity” may be appropriate and others where it may not be necessary. Government contractors and their counsel may want to consider reviewing internal decision-making policies, as well as reviewing due diligence measures in place, for decisions tied to an expert’s opinion. Furthermore, companies may want to consider outside programs and audits.

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