BILL ANALYSIS SB 802 Page 1 Date of Hearing: June 30, 2009 ASSEMBLY COMMITTEE ON BUSINESS AND PROFESSIONS Mary Hayashi, Chair SB 802 (Leno) - As Introduced: February 27, 2009 SENATE VOTE : 35-0 SUBJECT : Public contracts: retention periods. SUMMARY : Prohibits a public entity from retaining more than 5% of a contract price until final completion and acceptance of a project. Specifically, this bill : 1)Defines "public entity" to mean the state, including every state agency, office, department, division, bureau, board, or commission, the California State University, the University of California (UC), a city, county, city and county, including chartered cities and chartered counties, district, special district, public authority, political subdivision, public corporation, or nonprofit transit corporation wholly owned by a public agency and formed to carry out the purposes of the public agency. 2)Requires that retention proceeds between an original contractor and a subcontractor, or between two subcontractors, shall not exceed 5% of payment or contract price. Does not apply if the contractor provides written notice to the subcontractor, prior to or at the time that the bid is requested, that a bond may be required and the subcontractor subsequently is unable or refuses to furnish to the contractor a performance or payment bond issued by an admitted surety insurer. 3)Provides that these provisions shall apply to all contracts entered into on or after January 1, 2010, between a public entity and an original contractor, between an original contractor and a subcontractor, and between all subcontractors, relating to public works projects. EXISTING LAW : SB 802 Page 2 1)Requires payments on contracts with progress payments to be made as the awarding department prescribes; provides that state and public agencies shall withhold at least 5% of the contract price until final completion and acceptance of the project, and that progress payments upon public contracts shall not be made in excess of 95% of actual work completed, except as follows: a) At any time after 95% of the work has been completed on a state project, the state may reduce the funds withheld to an amount not less than 125% of the estimated value of the work yet to be completed, as specified. b) Allows a public entity to withhold 150% of the value of any disputed amount of work from the final payment. c) At any time after 50% of a local government project is completed and the legislative body finds that satisfactory progress is being made, it may reduce or eliminate withholding. 2)Provides that retention proceeds between a original contractor and a subcontractor, or between two subcontractors, not exceed the percentage specified in the contract between the public entity and the original contractor, and requires an original contractor to distribute retention proceeds to subcontractors within seven days of receiving retention proceeds from the public agency. 3)Requires a contractor in a public works contract to file a performance bond with the public entity in specified amounts, depending on the value of the contract. 4)Requires every original contractor who is awarded a contract by a state entity involving expenditures greater than $5,000 for any public works project, to file a performance bond with the state entity in a sun equal to or greater than the contract's total payable amount. FISCAL EFFECT : Unknown COMMENTS : Purpose of the bill . According to the author's office, "SB 802 aims to help smaller California contractors compete for bids on SB 802 Page 3 public works projects by capping the amount of retention funds which can be withheld. Existing law requires that not less than 5% of the total payment for time and materials on a public works project be withheld (Public Contract Code (PPC) Section 10261). This policy unnecessarily disadvantages small contractors who, on many occasions, find the amount of retention withheld exceeds 10% of the total cost of the project. While this might not sound like much at first, in reality the typical profit margin for the construction industry on these projects is only about 3% or 4%. This means that contractors must finance up to 7% of the total project on their own dime. This is a classic pay-to-play scenario in which large contractors benefit and small contractors with fewer resources bear an undue burden. They must either cover the costs of labor themselves or take out lines of credit while they wait for payments on work completed to be released. In some cases, contractors pay the interest on loans for years before being fully paid for their work. "As a result of the current retention policy, any contractor who bids on a public works job must anticipate the financing of a substantial portion of the total value of the contract for an undefined period of time. For example, if a contract is worth $5 million, a small business contractor will have to anticipate taking out a loan of up to $350,000 to cover their payroll and material expenses in building the project. Many qualified small businesses simply cannot afford to tie up their own capital or operate on costly loans for an indefinite period of time. This limits the pool of available and willing contractors and keeps otherwise fully qualified and capable contractors from participating." Background . Retention proceeds represent a percentage of the amount of a contract that is withheld from a progress payment by the public entity to the original contractor, or the original contractor to one its subcontractors. By withholding a percentage of a contract, the public entity or the original contractor maintains a degree of financial control over a project. In general, the public entity or the original contractor withholds at least 5% of payment until the contract is completed to the satisfaction of the public entity or original contractor. Current law allows for the retention of a percentage of a contract price to guaranty a contractor's completion and acceptance of a project. All California contractors working on SB 802 Page 4 a public works project are required to possess performance bonds that cover up to 150% of the cost of any disputed work. Contractors have an incentive to complete projects without conflict, because it becomes more difficult to find a bonding agency willing to bond a contractor who has failed a project. Performance bonds can be one option a public entity uses to guarantee that a project will continue to proceed, should a contractor fail. If a contractor does not meet the contract obligations and the public entity seeks to use the performance bonds, the bonding company will seek selects the replacement contractor to complete the remainder of the contract obligations at the lowest cost. According to the author's office, the following states have capped retention rates at 5%: Arizona, Delaware, Hawaii, Idaho, Iowa, Maine, Massachusetts, Minnesota, Mississippi, Missouri, Montana, New York (for bonded contractors), Oregon, Rhode Island, Utah, Virginia, and Washington. Supporters argue that retention ties up capital in the current economy and that there are already many protections in place to guarantee project completion. The sponsor contends that failure to complete a project ruins a contractor's reputation and results in occupational suicide. According to supporters, in order for contractors to compensate for the additional loan interest for labor and materials resulting from retention, contractors may factor in these costs in their contract bids and therefore increase taxpayer costs for a project. The sponsor also notes that the federal government does not use retention on Caltrans projects and that some cities and counties already cap retention at 5%. Opponents argue that schools need a guarantee that projects will be completed on time because schools need to be built according to strict specifications because they are also used as emergency shelters. Opponents contend that schools will usually leave a "punch list" of outstanding concerns to work with the contractor towards the end of a project as to not hold the project up; the opponents claim that discretionary retention is appropriate because retention of 5% or less, depending on the situation, may not be financially enough to commit the contractor to complete the remainder of the project according to specifications. Arguments in support . According to the sponsors, "Current state SB 802 Page 5 law requires the withholding from contractors of not less than 5% of the contract price. Often times this retention amount can be as much as 10% or more. The typical profit margin in the construction industry for public works projects is 3%. In some cases, contractors must wait for years before being fully paid for their work. Thus, any contractor who bids on a public works job must anticipate the financing of as much as 7% of the total value of the contract for an undefined period of time just to make payroll and pay suppliers. This includes a non-reliance on the realization of a 3% profit? "The current payment retention policy constitutes an unfair and unreasonable requirement for licensed, responsible and bonded California contractors. The total cost to taxpayers for public works improvement projects increase as a result of 1) the loss of bids from qualified local small businesses, and 2) the bid inflation that occurs due to the fact that the cost of these capital loans are built into the cost of the project. "Public agencies are protected from problems associated with contractor 'non-compliance' through a variety of mechanisms rendering the existing retention codes obsolete. In fact under PCC Section 20129, contractors on public works of improvement must post 'performance bonds' to ensure completion of the project. Further, PCC Section 7107 allows a public agency to withhold an amount up to 150% of the value of the disputed work from the final payment. These protections, pre-qualification procedures and others allow public agencies more than adequate assurances of contractor compliance." According to the California Landscape Contractors Association (CLCA), "For many smaller contractors, delays in final payment can be fatal if credit is unavailable or the delay becomes so lengthy that interest expenses erase anticipated profits. CLCA believes that retention amounts of more than 5% are unnecessary to ensure satisfactory performance of a contract because of the overlapping protections provided by the performance bond. We also note that CalTrans, which has eliminated retentions on federally-funded highway projects, has not encountered any difficulties with contractor performance. In addition, because of the risk of a long retention of proceeds after completion of a public works project, contractors tend to factor these additional costs into their bids resulting in taxpayer costs that are higher than necessary. SB 802 Page 6 "Reforms in public works retention policy are particularly needed now because of tight credit markets and the need to expeditiously bid and award infrastructure projects targeted for federal stimulus funding. The need for this bill is particularly acute for small contractors who lack the capital and credit needed to survive excessive retentions and long payment delays." According to the State Building and Construction Trades Council, "Cities and counties using design-build authorization are required to hold no more than 5% retention on contractors and recently the UC changed their construction practices to withhold only 5% retention on its public works projects." According to CSI Electrical Contractors, Inc., "The practice of holding retention, along with performance bonding, forces contractors to cover the costs of financing projects long after the work has been approved and accepted. Under current law, a contractor is by common practice on public works, paid 90 cents on the dollar for work completed and accepted, but has a financial obligation close to 100 cents on the dollar. These obligations include meeting payroll, paying employee benefits, paying material suppliers and all taxes on the value of the work completed." According to the Engineering & Utility Contractors Association (EUCA) and Golden State Builders Exchanges (GSBE), "SB 802 increases competition by allowing highly qualified California contractors to bid on infrastructure jobs without being forced to finance up to 7% of the total cost of the project. This measure also directs more of our taxpayer supported bond revenue to purchase actual bricks-and-mortar infrastructure versus being spent on costly interest rates to banks." Arguments in opposition . According to California's Coalition for Adequate School Housing, "School districts, in good faith, negotiate contract provisions and typical retention amounts are negotiated at approximately 10% of the contract value. If a contractor and a public agency wish to limit retention proceeds to 5% - as the bill seeks to achieve - current law allows for it. Retention is necessary for public agencies to ensure 1) prompt completion of a project; 2) that contractors return to a project to complete all contract requirements, including small unprofitable punch list items; 3) there are sufficient funds for SB 802 Page 7 public agencies to correct defective work if a contractor fails to do so; and 4) to have sufficient funds withheld in order to pay workers in the event contractors have failed to properly pay prevailing wage as required by state law. By prohibiting contract withholdings from exceeding 5%, and removing the flexibility to negotiate a good faith provision between a public agency and a contractor, SB 802 significantly thwarts an agency's ability to ensure that the provisions of their public works contracts are fully executed. "Finally, contractors are currently provided the protection intended by SB 802. Existing statute requires public agencies to make timely payments of both progress payments and final payments unless there is a legitimate dispute over work. Additionally, contractors may opt to place all retention in a contractor-established escrow account and to receive the interest from that account." According to the California State Association of Counties (CSAC) and the League of California Cities (League), the "bill removes the authority of public entities to decide the appropriate amount of retention?local agencies must accept the lowest responsible bidder and the flexible retention rate helps to ensure timely and budget-conscious project completion. Local agencies commonly reduce retention to 5% at the half-way point of project completion, if adequate progress is being made and the contractor is acting in good faith. However, SB 802 would require local agencies to limit retention to 5% regardless of the progress or good faith of the contractor, thus protecting bad actions unknown or even known to the public agency, placing public interests and public funds at risk. "CSAC and the League have had many discussions in recent years regarding similar proposals (AB 1949: Conroy, 1996, vetoed; AB 940: Miller, 1997, vetoed; AB 806: Keeley, 1999, vetoed; and, SB 619: Migden, 2008, held); however, we continue to express concern over these measures because we have yet to see specific examples where 10% retention is problematic. On the other hand, we have specific examples from cities and counties opposed to these proposals because in certain instances current retention of 10% is inadequate." According to a project manager for the Fresno Unified School District (FUSD), she has "worked in the Public Works arena for FUSD for over 14 years... (and has) personally been involved in SB 802 Page 8 numerous projects (where) a 5% withholding would not be enough to compensate the District, subcontractors or employees in the event of a failure on the part of the general contractor to fulfill his contract responsibilities. Many times, the State of California is dependent on those retention monies to pay back wages or penalties imposed by the Department of Industrial Relations." According to the South Bay Cities Council of Governments, "Cities use retention in public contracts because it helps assure that work is done in compliance with the contract document and serves as a financial incentive for contractors to complete a project. In addition, should a contractor fail to perform or not complete the project, the retention funds can be used to cover the cost of project completion. For many local agencies, it is also common practice to reduce the retention rate midway through a project to reward efficient project completion. Either way, local control over retention rates should be retained as a tool to ensure project completion is on-time and within budget." According to the California Association of School Business Officials, "Lowering the retention amount to 5% will make it too easy for unscrupulous contractors to simply cut their losses and move on if they choose not to complete a project. What's more is that under current provisions, the 10% retention proceeds are often put into escrow and collect interest for the contractor during the project. The incentive to live up to a contract is greater under current law than under SB 802 if it becomes law." Related Legislation . AB 396 (Fuentes) modifies, recasts and, consolidates various provisions governing the timely payment of progress payments, retention proceeds, and final payments under a contract for a public or private work of improvement. This bill was held in the Assembly Appropriations Committee. SB 629 (Liu) is a similar bill, prohibits retention proceeds withheld form any payment made by an owner to the original contract from exceeding five percent of the amount otherwise due under the contract, applicable to all contracts entered into on or after January 1, 2010. This bill is currently pending in the Assembly Rules Committee. SB 802 Page 9 Previous Legislation . SB 619 (Migden) of 2007 was an identical bill, was held by the sponsor on the Senate Floor to continue working with the Administration. SB 593 (Margett), Chapter 341, Statutes of 2008, prohibits the Department of Transportation from withholding retention proceeds to its contractors when making progress payments for work performed on a public works project. AB 806 (Keeley) of 1999 would have limited retention proceeds on public works contracts to 5%, and prohibits the state, including all state agencies and political subdivisions of the state, contractors, and subcontractors from withholding more than 5% of a scheduled payment on a public works contract. AB 806 was vetoed by the Governor. AB 2084 (Miller), Chapter 857, Statutes of 1998, provides that the percentage of retention proceeds withheld by a contractor from a subcontractor may not exceed the overall retention percentage specified in the public works contract between the contractor and the public agency builder. AB 940 (Miller) of 1997 would have, among other things, limited retention payments by public entities on public works to 5 percent. AB 940 was vetoed by Governor Wilson, who made the following statements in his veto message: "Regrettably, once again, I find a bill before me that establishes a double-standard for the treatment of the retention levels charged by public agencies. The private sector is free to establish its own level for retention in an open marketplace, where building owners, contractors and subcontractors freely enter into construction contracts, which often include a 10% retention level. Here before me is a bill which would arbitrarily restrict public agencies to retention rates of half the private sector standard. "As I expressed in my veto message of AB 1949 (Conroy) last year, 'Government agencies must be able to protect public construction projects from unnecessary risk in a fashion similar to the private sector.' I have not deviated from that stance. As a public manager, I believe it is reasonable to ask public agencies to manage public works projects according to the same SB 802 Page 10 standards, criteria and level of professionalism as is practiced in the private sector. It would be irresponsible of me, however, to tie the hands of public agencies with statutory restrictions and expect a similar performance standard. AB 1949 (Conroy) of 1996, would have, among other things, limited retention payments by public entities on public works to 5%. AB 1949 was vetoed by Governor Wilson. REGISTERED SUPPORT / OPPOSITION : Support California Association of Sheet Metal and Air Conditioning Contractors' National Association (CAL SMACNA) (sponsor) California Legislative Conference of the Plumbing, Heating, and Piping Industry (sponsor) Abdulaziz, Grossbart & Rudman ACH Mechanical Contractors, Inc. AGC, Inc. Air Conditioning Sheet Metal Association Air-conditioning & Refrigeration Contractors Association (ARCA) Air-Ex Air Conditioning, Inc. American Subcontractors Association California, Inc. Associated Plumbing & Mechanical Contractors of Sacramento Best Electrical Company Building Industry Credit Association Cadri Company Inc. California Chapters of the National Electrical Contractors Association (NECA) California Fence Contractors' Association, California Chapter California Landscape Contractors Association (CLCA) Champion Industrial Contractors, Inc. Chula Vista Electric Company Collins Electrical Company, Inc. Construction Industry Legislative Council (CILC) Critchfield Mechanical, Inc. CSI Electrical Contractors, Inc. Desert Air Conditioning, Inc. Dynalectric Company Electric Cal Partners, Inc. Engineering & Utility Contractors Association (EUCA) Engineering Contractors' Association Flasher/Barricade Association Foothill Air Conditioning and Heating, Inc. SB 802 Page 11 Glendale Unified School District Golden State Builders Exchanges (GSBE) Heating & Air Conditioning, Inc. Industrial High Voltage L&H Airco Lupen and Hawley, Inc. Marin Builders' Association Mendenhall Mfg., Inc. Mike Brown Electric Co. Power Communication Systems, Inc. Precision Air Balance Co., Inc. Ray L Hellwig Mechanical Ray Scheidts Electric Inc. R.I.S. Electrical Contractors, Inc. Schetter Electric, Inc. Smith Heating & Air State Building and Construction Trades Council, AFL-CIO Southern Contracting Company Tardif Sheet Metal and Air Conditioning, Inc. Thermal Mechanical, Inc. Western Air Limbach LP Western Allied Mechanical, Inc. Opposition California's Coalition for Adequate School Housing (CASH) Anaheim City School District Association of California School Administrators (ACSA) Bonita Unified School District California Association of School Business Officials (CASBO) California Special Districts Association (CSDA) California State Association of Counties (CSAC) Colbi Technologies, Inc. Dry Creek Joint Elementary School District Dublin Unified School District El Dorado Irrigation District Evergreen School District Fremont Unified School District Fresno Unified School District Glendale Unified School District Global Business Solutions, Inc. Hemet Unified School District Hibser Yamauchi Architects, Inc. Humboldt County Office of Education League of California Cities (League) SB 802 Page 12 Liberty Union High School District Los Angeles Unified School District (LAUSD) Milpitas Unified School District Morgan Hill Unified School District New Haven Unified School District Norwalk - La Mirada Unified School District Oceanside Unified School District Palo Verde Unified School District Pleasanton Unified School District RGM and Associates Rowland Unified School District Saddleback Valley Unified School District San Bernardino City Unified School District San Ramon Valley Unified School District Sanger Unified School District SCArchitect, Inc. SGI Construction Management (SGI) Sierra Sands Unified School District Solano County Board of Supervisors South Bay Cities Council of Governments (SBCCOG) Tahoe Truckee Unified School District Three Valleys Municipal Water District Travis Unified School District Victor Elementary School District Visalia City Council Western Placer Unified School District Yosemite Community College District Analysis Prepared by : Joanna Gin / B. & P. / (916) 319-3301