BILL ANALYSIS                                                                                                                                                                                                    






                             SENATE JUDICIARY COMMITTEE
                           Senator Ellen M. Corbett, Chair
                              2009-2010 Regular Session


          SB 972 (Wolk)
          As Amended April 5, 2010
          Hearing Date: May 4, 2010
          Fiscal: No
          Urgency: No
          KB:jd
                    

                                        SUBJECT
                                           
                          Indemnity:  Design Professionals

                                      DESCRIPTION
           
          This bill, sponsored by the American Council of Engineering,  
          would provide that all provisions, clauses, covenants, and  
          agreements contained in  all contracts with a public agency for  
          design professional services that purport to require an  
          immediate defense under an indemnity agreement are  
          unenforceable, except as provided.  This bill would only apply  
          to contracts and amendments thereto entered on or after January  
          1, 2011.

          (This analysis reflects author's amendments to be offered in  
          committee.)

                                      BACKGROUND  

          During the last five years, the Legislature has enacted several  
          measures intended to address the use of certain types of risk  
          shifting in indemnity agreements, particularly those that appear  
          in contracts for residential construction.

          In 2005, AB 758 (Calderon, Chapter 394, Statutes of 2005) was  
          enacted to address alleged abuses of "Type I" indemnification  
          clauses in contracts imposed on subcontractors by builders.   
          These clauses typically required the subcontractor to assume  
          liability for the builder's negligence and misconduct, beyond  
          what the subcontractor would be obligated to pay under tort law  
          in the absence of the Type I agreement.  Under AB 758, all  
          provisions contained in residential construction contracts  
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          entered into after January 1, 2006 that purport to indemnify the  
          builder by a subcontractor against liability for claims of  
          construction defects are unenforceable to the extent the claims  
          pertain to, or relate to the negligence of the builder or his or  
          her agents.  These provisions of existing law may not be waived  
          or modified by contractual agreement, act, or omission of the  
          parties.  AB 758 was the product of lengthy negotiations and  
          discussions between stakeholders.

          The following year, the Legislature built upon AB 758 by  
          enacting AB 573 (Wolk, Chapter 455, Statutes of 2006) in  
          response to concerns that local public agencies were requiring  
          broad indemnity agreements in contracts with design  
          professionals.  Those agreements were generally requiring the  
          design professional to hold the public agency harmless against  
          the conduct of the public agency or other third parties in a  
          public works project.  AB 573 provided that, for contracts  
          entered into on or after January 1, 2007, with a public agency  
          for design professional services, all provisions that purport to  
          indemnify the public agency against liability for claims against  
          the public agency, are unenforceable, except for claims that  
          arise out of, pertain to, or relate to the negligence,  
          recklessness, or willful misconduct of the design professional.

          Subsequently, AB 2738 (Jones, Chapter 467, Statutes of 2008) was  
          enacted as a follow up to AB 758 due to concerns that builders  
          had been circumventing the clear intent of AB 758 by requiring  
          subcontractors to pay for the builder's defense costs that had  
          no relation to the contractor's work.  AB 2738, among other  
          things, provided that a subcontractor would have no defense or  
          indemnity obligation to a builder or general contractor for a  
          construction defect claim unless, and until, the builder or  
          general contractor provides a written tender of the claim to the  
          subcontractor which includes all of the information provided to  
          the builder or general contractor by the claimant or claimants  
          relating to claims caused by that subcontractor's scope of work.  
           
            
          This bill seeks to address issues left unresolved by prior  
          legislation with respect to a design professional's exposure to  
          liability for defense costs in indemnity agreements contained in  
          contracts with public agencies. 

                                CHANGES TO EXISTING LAW
           
           Existing law  provides that specified rules are to be applied in  
                                                                      



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          the interpretation of a contract of indemnity, unless a contrary  
          intention appears.  Pursuant to these rules, the person  
          indemnifying is bound, on request of the person indemnified, to  
          defend actions or proceedings brought against the latter in  
          respect to the matters embraced by the indemnity.  However, the  
          person indemnified has the right to conduct those defenses, if  
          he or she chooses to do so.  (Civ. Code Sec. 2778.)

           Existing case law  interprets the above-described provisions to  
          provide that, unless otherwise provided, a duty to defend arises  
          out of an indemnity obligation as soon as the litigation  
          commences, and regardless of whether the indemnitor (the person  
          indemnifying) is ultimately found negligent.  (Crawford v.  
          Weather Shield (2008) 44 Cal.4th 541; see also UDC-Universal  
          Development, L.P. v. CH2M Hill (2010) 181 Cal.App.4th 10.) 

           Existing law  provides that, for all contracts entered into after  
          January 1, 2007, for residential construction, all provisions,  
          clauses, covenants, and agreements contained in, collateral to,  
          or affecting any such construction contract, and amendments  
          thereto, that purport to indemnify, including the cost to  
          defend, the builder, as defined, by a subcontractor against  
          liability for claims of construction defects are unenforceable  
          to the extent the claims arise out of, pertain to, or relate to  
          the negligence of the builder or the builder's other agents,  
          other servants, or other independent contractors who are  
          directly responsible to the builder, or for defects in design  
          furnished by those persons, or to the extent the claims do not  
          arise out of, pertain to, or relate to the scope of work in the  
          written agreement between the parties.  These provisions may not  
          be waived or modified by contractual agreement, act, or omission  
          of the parties.  However, contractual provisions, clauses,  
          covenant, or agreements not expressly prohibited are reserved to  
          the agreement of the parties.  (Civ. Code  Sec. 2782(c).)

           Existing law  provides that, for all contracts entered into after  
          January 1, 2009 for residential contracts, a subcontractor has  
          no defense or indemnity obligation to a builder or general  
          contractor for a construction defect claim unless and until the  
          builder or general contractor provides a written tender of the  
          claim, or portion thereof, to the subcontractor which includes  
          all of the information provided to the builder or general  
          contractor by the claimant or claimants relating to claims  
          caused by that subcontractor's scope of work.  The written  
          tender has the same force and effect as a notice of commencement  
          of a legal proceeding.  (Civ. Code Sec. 2782(d).)
                                                                      



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          Existing law  provides that if a builder or contractor tenders a  
          claim, or a portion thereof, to a subcontractor, the  
          subcontractor is entitled to either defend the claim with  
          counsel of its choice or pay, within 30 days of receipt of an  
          invoice from the builder or general contractor, no more than a  
          reasonable allocated share of the builder's or general  
          contractor's defense fees and costs.  Existing law further  
          provides that a builder, general contractor, or subcontractor  
          has the right to seek equitable indemnity for construction  
          defect claims pursuant to these provisions.  (Civ. Code Sec.  
          2782(d) & (f).)

           Existing law  provides, for all contracts, and amendments to  
          contracts, entered into on or after January 1, 2007, with a  
          public agency for design professional services, all provisions,  
          clauses, covenants, and agreements contained in, collateral to,  
          or affecting these contracts, that purport to indemnify,  
          including the cost to defend, the public agency by a design  
          professional against liability for claims against the public  
          agency, are unenforceable, except for claims that arise out of,  
          pertain to, or relate to the negligence, recklessness, or  
          willful misconduct of the design professional.  (Civ. Code Sec.  
          2782.8.)

           This bill  would provide that all provisions, clauses, covenants,  
          and agreements contained in, collateral to, or affecting  
          contracts with a public agency for design professional services  
          that purport to require an immediate defense under an indemnity  
          agreement are unenforceable, except as provided below.  This  
          bill would apply to contracts, and amendments to contracts,  
          entered into on or after January 1, 2011.

           This bill  would provide that a design professional is not  
          required to defend or indemnify the indemnified party unless and  
          until the indemnified party provides a written tender of the  
          claim to the design professional, at which point the design  
          professional may choose to either defend the claim with counsel  
          of its choosing or pay a reasonable allocated share of the  
          indemnified party's defense fees and costs.  

           This bill  would provide for the allocation of damages and  
          attorney's fees if the design professional fails to fulfill his  
          or her duties under the bill's provisions.

           This bill  would provide that nothing in its provisions would  
                                                                      



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          prohibit the parties from mutually agreeing to reasonable  
          contractual provisions for damages if any party fails to elect  
          for or perform its obligations under this bill.

           This bill  would provide that a public agency or design  
          professional shall have the right to seek equitable indemnity  
          for any claim governed by this bill.  This bill would further  
          provide that nothing in this section limits, restricts, or  
          prohibits the right of the indemnified party or the design  
          professional to seek equitable indemnification against any  
          entity other than the indemnified party or design professional.   


           This bill  would define design professional as including all of  
          the following:  (1) an individual licensed as an architect, and  
          a business entity offering licensed architectural services; (2)  
          a licensed landscape architect, and a business entity offering  
          licensed landscape architectural services; (3) an individual  
          registered as a professional engineer and, a business entity  
          offering professional engineering services; and (4) an  
          individual licensed as a professional land surveyor, and a  
          business entity offering professional land surveying services.  

           This bill  would define "design professional services" as  
          including all contractual services offered or performed by a  
          design professional.  

          This bill  would define "public agency" as including any county,  
          city, city and county, district, school district, public  
          authority, municipal corporation, or other political  
          subdivision, joint powers authority, or public corporation in  
          the state.  This definition would not include the State of  
          California.

                                        COMMENT
           
           1.Stated need for the bill
          
          The author states: 

              This bill is in response to the 2008 California Supreme  
              Court decision in Crawford v. Weather Shield.  In that  
              decision the Court held that Civil Code Section 2778 allows  
              indemnity contracts that require defense of [lawsuits]  
              against others even if the person providing the indemnity  
              and defense has no liability.
                                                                      



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              Under current law an indemnitor has a duty to defend a  
              lawsuit covered by an indemnification contract prior to any  
              fault determination.  This exposes the indemnitor to expense  
              before they have been found at fault, possibly exposing them  
              to excessive defense costs.  An individual should only be  
              responsible for their own negligent conduct and not of other  
              third parties.  Furthermore, if an individual is found to be  
              at fault, they should only be held liable for the extent of  
              the harm caused by the negligent conduct and should only  
              have to defend allegations involving their own misconduct.    
               

          Supporters of the bill also generally assert that Crawford has  
          particularly grave implications for design professionals because  
          professional liability insurance, in contrast to general  
          liability insurance typically used by owners, contractors and  
          subcontractors, does not cover contractually assumed liability.   
          Instead, professional liability insurance will cover a design  
          professional's common law liability, i.e., negligent acts,  
          errors, or omissions.

           2.Crawford v. Weather Shield 
           
          In Crawford v. Weather Shield (2008) 44 Cal.4th 541, the  
          California Supreme Court considered whether, by their particular  
          terms, the provisions of a pre-2006 residential construction  
          subcontract obliged the subcontractor to defend its indemnitee,  
          the developer-builder of the project, in lawsuits brought  
          against both parties, even though (1) a jury ultimately found  
          that the subcontractor was not negligent, and (2) the parties  
          had accepted an interpretation of the subcontract that gave the  
          builder no right of indemnity unless the subcontractor was  
          negligent.  In the contract at issue, Weather Shield (the  
          subcontractor) promised to (1) "indemnify and save [contractor]  
          harmless against all claims for damages ? losses, ? and/or theft  
          growing out of the execution of [Weather Shield's] work," and  
          (2) "at [its] own expense to defend any suit or action brought  
          against [the contractor] founded upon the claim of such  
          damage[,] loss, ? or theft."  (Id. at 547-548.) 

          The Court held that the terms of the agreement, even if strictly  
          construed in Weather Shield's favor, obligated Weather Shield to  
          defend, from the outset, any suit against the general contractor  
          insofar that the suit was founded upon claims alleging damage or  
          loss arising from the Weather Shield's negligence.  The Court  
                                                                      



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          interpreted Civil Code Section 2778(d), as placing in every  
          indemnity contract, unless otherwise provided, a separate duty  
          to assume the indemnitee's defense if tendered against all  
          claims embraced by the indemnity.  The Court further held that  
          this duty does not depend on the outcome of the litigation, and  
          the subcontractor thus had a contractual duty to defend the suit  
          even thought it was later found not to be negligent.  

          In reaching this decision, the Court noted that, in noninsurance  
          contexts, the indemnitee often has superior bargaining power,  
          which it may utilize to unfairly shift a disproportionate share  
          of the financial consequences of its own legal fault onto  
          someone else.  (Id. at 552.)  The Court further noted that these  
          policy reasons have been the basis for statutory limits on the  
          enforceability of noninsurance indemnity agreements in the  
          construction industry.  (Id.)  However, focusing on the specific  
          language of the contract, the Court found that Weather Shield  
          had a contractual obligation to defend claims alleging damage or  
          loss arising from Weather Shield's negligent role in the  
          residential project.    

          The California Court of Appeal, Sixth Appellate District,  
          recently applied the Crawford holding in UDC-Universal  
          Development, L.P. v. CH2M Hill (2010) 181 Cal.App.4th 10.  
          The court held that, pursuant to the specific terms of the  
          contract at issue, a design professional had a duty to defend a  
          developer of a condominium project independent from the duty to  
          indemnify, even though a jury ultimately found that the design  
          professional had not been negligent.  The court further held  
          that the duty to defend arose when the homeowners association  
          alleged harm resulting from deficient work that was within the  
          scope of the services for which the developer had retained the  
          consultant.  The court found that the clause under scrutiny was  
          comparable to the one in Crawford in that it was broadly worded  
          to apply to claims connected in any way to any negligent act or  
          omission by the design professional.  (Id. at 21.)  The court  
          thus rejected the design professional's assertion that the  
          underlying plaintiff must have alleged negligence by the design  
          professional in order for the defense obligation.  The court  
          noted that such a requirement would contravene Civil Code  
          Section 2778 and the Supreme Court's admonition that a duty to  
          defend arises out of an indemnity obligation as soon as  
          litigation commences and regardless of whether the indemnitor is  
          ultimately found negligent.  (Id. at 21-22.) 

           3.Author's amendments narrow scope of bill to contracts with  
                                                                      



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            public agencies
           
          As previously stated, this bill is in response to the Crawford  
          ruling in that a duty to defend is a separate obligation that  
          arises out of an indemnity agreement which commences at the  
          outset of litigation, irrespective of whether the indemnitor is  
          found negligent.  The current version of the bill would have  
          applied prospectively to all contracts entered into for design  
          professional services except for residential construction  
          contracts.  However, the author is offering amendments to narrow  
          the scope of the bill so that it only applies to contracts with  
          public agencies for design professional services.  

          As noted by the Court in Crawford, "[p]arties to an indemnity  
          contract can easily disclaim any responsibility of the  
          indemnitor for the indemnitee's defense, or the costs thereof.   
          Short of that, they can specify that the indemnitor's sole  
          defense obligations will be to reimburse the indemnitee for  
          costs incurred by the latter in defending a particular claim."   
          (Crawford, supra, at 559.)  The contracts in both Crawford and  
          UDC-Universal Development did neither of these.  

          The public works bidding process is distinct, however, than what  
          occurs, for example, in negotiating a contract for commercial  
          construction.  According to the sponsor, indemnity agreements,  
          particularly in the public entity sector, are often not  
          negotiable and are presented on a "take it or leave it basis."   
          Thus, a design professional contracting with a public agency may  
          not have the same type of bargaining power, as in contracts with  
          private entities, to require that language which disclaims  
          responsibility for the agency's defense costs be inserted into  
          the contract.  As proposed to be amended, this bill would be  
          arguably consistent with the policy approved by the Legislature  
          in AB 573 in that it recognizes the distinct nature of the  
          bidding process for public works projects, and would accordingly  
          limit the extent that a public agency could require a design  
          professional to assume a duty to defend in litigation arising  
          out of the contract.   

           4.Bill would proscribe limitations to the duty to defend and  
            indemnity obligations

           This bill would proscribe parameters with respect to the duty to  
          defend and indemnity obligations similar to those contained in  
          AB 2738 for residential construction contracts.  Specifically,  
          this bill would provide that a subcontractor would have no  
                                                                      



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          defense or indemnity obligation to a public agency for a claim  
          of liability unless and until the indemnified party provides a  
          written tender of the claim or portion of the claim to the  
          design professional.  The written tender would be required to  
          include all of the information provided to the public agency by  
          the claimant or claimants relating to claims caused by the  
          design professional's services, and would have the same force  
          and effect as a notice of commencement of a legal proceeding.   

          If a public agency tenders a claim to a design professional as  
          provided for in this bill, the design professional would have  
          the choice between the following two options, the performance of  
          which would be deemed to satisfy the design professional's  
          defense obligations to the public agency.  

              (a)  Assume defense of the claim

             The first option for the design professional is to defend the  
            claim with counsel of his or her choosing.  If the design  
            professional elects to defend the claim, he or she would be  
            required to maintain control of the defense for any claim or  
            portion of the claim to which the defense obligation applies.   
            The design professional would be required to provide written  
            notice of its election to the indemnified party within 90 days  
            after receipt of the written tender.  The defense by the  
            design professional would be a complete defense of the public  
            agency of all claims or portions thereof alleged to have been  
            caused by the design professional.  
           
             (b)  Pay allocated share of defense fees and costs
           
            The second option for the design professional would be to pay,  
            within 30 days of receipt of an invoice from the public  
            agency, no more than a reasonable allocated share of the  
            public agency's defense fees and costs, on an ongoing basis  
            during the pendency of the claim, subject to reallocation, and  
            including any amounts reallocated upon final resolution of the  
            claim either by settlement or judgment.  The public agency  
            would be required to allocate a share to itself to the extent  
            a claim or claims are alleged to be caused by its work,  
            actions, or omissions.  The public agency would also be  
            required to allocate a  share to each design professional to  
            the extent that a claim or claims are alleged to have been  
            caused by the design professional.  In addition, the public  
            agency would be required to allocate a share to all other  
            parties or entities that it believes are potentially liable  
                                                                      



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            for the claim or claims, regardless of whether the public  
            agency actually tenders the claim to any particular design  
            professional, and regardless of whether that design  
            professional is participating in the defense.  Any amounts not  
            collected from any particular design professional could not be  
            collected from any other design professional.
                                              
           1.Remedies for design professional's failure to perform  
            proscribed duties

           Should a design professional fail to timely and adequately  
          perform the duties described above, this bill would provide that  
          the public agency would have the right to pursue a claim against  
          the design professional for any resulting damages, as well as  
          for interest on the defense and indemnity costs, from the date  
          incurred, and for reasonable attorney's fees incurred to recover  
          these amounts.  The public agency would bear the burden of proof  
          to establish both the design professional's failure to meet his  
          or her duties and any resulting damages. 

          Further, this bill would specifically provide that nothing  
          prohibits the parties from mutually agreeing to reasonable  
          contractual provisions for damages if any party fails to elect  
          for or perform its obligations as contained in the bill.  Public  
          agencies, design professionals, and other parties would also  
          have the right to seek equitable indemnity for any claim  
          governed by the bill's provisions, including against entities  
          other than the public agency or design professional. These  
          remedies are consistent with those contained in AB 2738.  

           2.Opposition

           In opposition, the California Special Districts Association  
          writes:

            This bill would impose a "one size fits all" solution to  
            contractual negotiations by specifying that the only defense  
            obligation a public agency can agree to with a design  
            professional is one in which the public agency does not get an  
            upfront defense from the design professional, but has to rely  
            on reimbursement of its own defense costs incurred, and then  
            only if the design professional is found negligent ?
            Parties to a contract should be afforded the freedom to  
            allocate responsibilities as they see fit.  This is critical  
            to special districts.  In order to best protect taxpayers, a  
            district may wish to negotiate a contract which provides that  
                                                                      



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            the design professional defend the district in any claim by a  
            third party alleging a design defect, whether the design  
            professional is liable for a defective design or not, on the  
            theory that the district is not involved in the design  
            process, has delegated those duties to a professional, and  
            should not have to expend taxpayer funds defending the  
            district in a lawsuit ? Many special districts operate on  
            small budgets with limited staff.  These districts  
            purposefully contract for certain projects that they do not  
            have the expertise to construct.  In such situations, it seems  
            most appropriate that the district may wish to seek protection  
            for legal defense associated with the project.

          Also in opposition, the League of California Cities writes:

            SB 972 would benefit [architecture and engineering (A/E)]  
            consulting firms and their insurance carriers at the expense  
            of the public in two ways.  First, the net effect would be to  
            shift to taxpayers legal defense costs that should be borne to  
            varying degrees by A/E consulting firms and their insurance  
            carriers.  Second, it would encourage protracted litigation  
            because, as a practical matter, a formal finding of negligence  
            or intentional misconduct will be a prerequsite for the public  
            agency to receive indemnity from the A/E consulting firm or  
            its insurance carrier.  

            The negotiation of terms between public agencies and A/E  
            consulting firms should be left to the free-play of market  
            forces.  SB 972 would preclude negotiation of broader  
            protection, even where the public agency is willing to pay  
            extra for such protection.

          California's Coalition for Adequate School Housing adds:

            SB 972 seeks to inappropriately erase a separate "duty to  
            defend" from the "indemnification of defense costs."  It does  
            so by making the duty to defend also contingent upon the  
            finding of a design professional's liability.  If SB 972 is  
            made law, it will shift the responsibility of defending claims  
            related to a design professional's work from design  
            professionals to the public agencies that contract with them.   


          In response, the sponsor asserts that design professionals are  
          prepared to defend claims involving allegations of design  
          professional negligence, and desire to write a statute that  
                                                                      



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          maximizes the likelihood of insurance coverage, which faithfully  
          incorporates elements of AB 2738 and SB 972.  The sponsor  
          further asserts that SB 972 does not make the duty to provide an  
          immediate defense contingent upon a finding of design  
          professional liability.  Instead, under SB 972, the public  
          agency would have the right to tender the defense to the DP, who  
          must then exercise one of two options - defend or pay a  
          reasonably allocated share of defense costs.  Finally, the  
          sponsor states that, as a matter of public policy, uninsurable  
          indemnities have little value because they will deter  
          responsible design professional firms from bidding on a project.  
           This could arguably lead to a decline in the size, quality, and  
          financial strength of a bid pool.  For opponents worried about  
          collateral lawsuits, the sponsor asserts that the worst outcomes  
          would be a meaningless indemnity agreement ignored by an  
          uninsured and impecunious indemnitor, and the resulting blizzard  
          of lawsuits.

          As indicated below, a number of builders and construction  
          companies have also written in opposition to this bill.   
          However, the author's amendments to be offered in committee will  
          likely remove their opposition. 
           3.Issues for further discussion 
           
          Under the current version of the bill, a design professional  
          would not be required to pay defense or indemnity costs in an  
          amount in excess of the finally determined percentage of  
          liability based upon the comparative fault of the design  
          professional.  This particular provision has no precedence in  
          prior legislation, and it is unclear how such a determination  
          would be made in practice.  Further, concerns have been  
          expressed that defense costs are not necessarily reflective of a  
          person or entity's finally determined liability.  For example,  
          someone could successfully defend against a lawsuit and  
          ultimately be found not negligent, but still have incurred  
          significant defense costs.  Accordingly, the author has agreed  
          to remove this subdivision from the bill pending additional  
          discussion among stakeholders.  


           Support  :  American Institute of Architects, California Council;  
          American Society of Landscape Architects; California  
          Geotechnical Engineering Association  
           
           Opposition  :  (as proposed to be amended) California's Coalition  
          for Adequate School Housing; California Special Districts  
                                                                      



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          Association; California State Association of Counties; CSAC  
          Excess Insurance Authority; League of California Cities; Los  
          Angeles Unified School District; Regional Council of Rural  
          Counties; Riverside County Schools Advocacy Association; Western  
          Municipal Water District; (to the current version of the bill)  
          Branagh Inc.,; California Building Industry Association;  
          California Business Properties Association; California Major  
          Builders Council; Construction Employers Association; C. Overaa  
          & Co.; Harris Construction Co., Inc.; Hathaway Dinwiddie  
          Construction Company; Rudolph and Sletten, Inc.; S.J. Amoroso  
          Construction Co., Inc; TBI Construction & Construction  
          Management, Inc.

                                        HISTORY
           
           Source  :  American Council of Engineering Companies

           Related Pending Legislation  :  None Known

           Prior Legislation  :  See Background.

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