BILL ANALYSIS Ó AB 1354 Page 1 Date of Hearing: May 3, 2011 ASSEMBLY COMMITTEE ON BUSINESS, PROFESSIONS AND CONSUMER PROTECTION Mary Hayashi, Chair AB 1354 (Huber) - As Amended: April 26, 2011 SUBJECT : Public works: progress payments: notice: retention proceeds. 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)Decreases, from 10 to 7, the number of days within which a prime contractor or subcontractor must pay a subcontractor after receiving a progress payment, unless otherwise agreed to in writing. 2)Requires, in public works projects, a claimant to give written notice to the surety and bond principal that he or she is enforcing a claim prior to completion, or recordation of notice of completion, of the project, commencing January 1, 2012. 3)Prohibits, in public works projects, an original contractor or subcontractor from retaining more than 5% of payment or contract price from a subcontractor, and more than the retention percentage between the public entity and original contractor, and: a) Does not apply when subcontractors fail to provide proof of a performance or surety bond to satisfy a contractor's written notice prior to a bid request, as specified. b) Applies to contracts entered into between January 1, 2012 and January 1, 2016. c) Sunsets the 5% retention provisions for public works projects on January 1, 2016. 4)Requires the Department of General Services (DGS), until December 31, 2005, to retain no more than 5% of the contract price until final completion and acceptance of the project, and authorizes DGS, once the project is completed, to reduce AB 1354 Page 2 the amount retained to no less than 125% of the value of work to be completed. Sunsets these provisions on January 1, 2016. 5)Requires DGS, commencing January 1, 2016, to retain no less than 5% of the contract price until final completion and acceptance of the project, and authorizes DGS, once the project is 95 % completed, to reduce the amount retained to no less than 125% of the value of work to be completed. 6)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. EXISTING LAW : 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; and, 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 an original contractor and a subcontractor, or between two subcontractors, not exceed the percentage specified in the contract between AB 1354 Page 3 the public entity and the original contractor, and requires an original contractor to distribute retention proceeds to subcontractors within 10 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 sum equal to or greater than the contract's total payable amount. 5)Requires that, for private and public works of improvement, and in a public works contract, a prime contractor or subcontractor pay to any subcontractor, not later than 10 days after receipt of each progress payment, unless otherwise agreed to in writing, the respective amount allowed the contractor on account of the work performed by the subcontractors, to the extent of each contractor's interest therein, as prescribed. 6)Requires, with regard to a contract entered into on or after January 1, 1995, that in order to enforce a claim upon any payment bond given in connection with a public work, that a claimant give the 20-day public works bond preliminary notice, as provided. Existing law further authorizes a claimant, if the 20-day public works preliminary bond notice was not given as prescribed by statute, to enforce a claim by giving written notice to the surety and the bond principal, as provided, within 15 days after recordation of a notice of completion, or if no notice of completion has been recorded, within 75 days after completion of the work of improvement. FISCAL EFFECT : Unknown COMMENTS : Purpose of this bill . According to the author's office, "This bill seeks to provide a relief to the construction industry by limiting contractor retentions in public works construction projects to 5%. Current law requires public agencies to retain a minimum of 5% of the total cost of a public works contract AB 1354 Page 4 (except for Department of Transportation projects - 0% retention) as an assurance for the timely completion and quality of the contractor's work. Though retainage serves as a type of insurance for a public agency, it has the unfortunate effect of requiring contractors to complete work without full payment. This practice requires contractors in essence to finance the job themselves, making it difficult to timely pay their own creditors, employees and purchase materials. "The sponsor, the American Subcontractors Association, indicates profit margins in the construction industry are now typically less than 2%. Excessive retention by public agencies on the industry at this time makes it difficult for many contractors to stay in business. Under this bill, a contractor or subcontractor that has completed its work and the public agency has approved that work as satisfactory, the contractor or subcontractor would be paid at least 95% of the amount owed. Ensuring that retention is limited to 5% helps keep those in the construction industry working. "In addition to retention, public agencies already have many tools to ensure contractor compliance and protect taxpayers dollars, such as prequalifying contractors prior to the bid process, ensuring they are in good standing and known for quality work; requiring contractors to provide performance bonds to ensure faithful completion of a project; and withholding from progress payments to contractors an amount up to 150% of the value of any disputed work." Background . Retention . 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 AB 1354 Page 5 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. Liens & Bond Claims . In private works, any person who provides construction services or materials to a construction project has the right to file a lien on the property if they are not paid; however, prior to filing the lien, a 20-day preliminary lien notice must be filed with the owner and general contractor identifying the contractor and notifying the owner and general contractor of the potential lien claim. This must be done within 20 days from first furnishing labor or materials. After an owner files a notice of completion, a contractor has 60 days to record a lien and a subcontractor or materials supplier has 30 days. In public works, instead of a lien claim, there are claims that can be made against the surety bond, referred to as a bond claim. The 20-day notice applies in public works, but even if the notice is not filed, the contractor can make a claim within 15 days after recordation of a notice of completion, or if no notice of completion has been recorded, up to 75 days after the notice of completion. This bill revises this timeline to require the bond claim be filed before the final notice of completion. The author's office argues that this change avoids general contractors from being hit by "surprise" claims. Progress Payments . This bill also reduces the time period a general contractor has to pay his or her subcontractor after the AB 1354 Page 6 general has been paid a progress payment from the owner. This time period is reduced from 10 to 7 days. It is unclear what percentage of payments occur in the last 3 days of this window, and whether the reduction to 7 days will have any significant impact. 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. Support . According to the sponsor, American Subcontractors Association California, Inc., "Reducing retention increases cash flow which enables contractors to purchase materials instead of taking out loans; this leads to lower bids. Lower retentions also keep people working instead of being laid off due to lack of cash flow to the contractors. Because contractors' profit margins are typically much less than 5%, any retention above this amount is an unfair withholding of the contractors' own money. " According to the California Landscape Contractors Association (CLCA), "Most public agencies today withhold at least 5% of the contract, and prime contractors in turn withhold the same percentage from the various subcontractors on the project. In some instances, the retention amount has been as high as 10% of AB 1354 Page 7 the contract price. Agencies often withhold retention proceeds long after the project is completed and drag out final approvals for months, and sometimes years, before the prime contractor and subcontractors are fully paid. Because profit margins on public works contracts are usually less than 5%, contractors are often required to borrow money to pay for employee wages and materials while awaiting final payment from the contracting agency. For smaller contractors, delays in final payment can be fatal if credit is unavailable or the delay becomes so lengthy that interest expenses erase profit margins. "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. ÝCLCA] also notes 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." Opposition . According to a coalition of opponents, "AB 1354 puts scarce resources for schools, hospitals, parks, fire houses, and other public infrastructure at risk. Contract retention ensures that: public projects are delivered on time and on budget; contractors complete all contract requirements, including small unprofitable punch-list items; there are sufficient funds to correct defective work if a contractor fails to do so; and, there are sufficient funds to pay workers in the event contractors fail to pay prevailing wage properly. A 5% retention cap diminishes out ability to ensure that the provisions of our construction contracts are fully executed, and therefore our ability to protect state and local taxpayer dollars. "Supporters assert that this bill is in response to the downturn in the economy; however, this is the eighth attempt to enact this legislative proposal, the first of which dates back to 1996. We do not believe that this legislation is in response to the hard economic times, rather a solution in search of a problem? Current law provides contractors the ability to establish escrow accounts that allow retention proceeds to gain interest payments for the contractor while providing adequate assurance to the public agency that the project will be AB 1354 Page 8 completed. Additionally, 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. According to the Los Angeles County Board of Supervisors, "The Los Angeles County Department of Public Works (DPW) states that retention funds may be used to satisfy the claims of unpaid subcontractors and suppliers, fund the cost of completing the work if the contractor fails to do so, and to fund the cost of emergency work or work performed by an agency when the contractor fails to respond. Also, the amount of liquidated damages may be withheld from the amount of retention paid. DPW states that AB 1354 would remove a major incentive for completion, would eliminate the value of stop notices and a subcontractor's or supplier's right to place a lien against retained funds, would make collection of liquidated damages more difficult, and would eliminate a tool for general contractors to ensure the completion of work by their subcontractors." Previous Legislation . AB 2216 (Fuentes) of 2010 would have reduced the time available to a claimant to give written notice that he or she is enforcing a claim against a bond for a public works project, and decreases the time period during which a contractor must pay his or her subcontractors. This bill was held on the Senate Floor. SB 802 (Leno) of 2009 was a similar bill that would have prohibited a public entity from retaining more than 5% of a contract price until final completion and acceptance of a project. The Governor vetoed this bill with the following message: When a contractor fails to complete a public works project, the public entity needs recourse to ensure that the project gets completed. Public works contracts have a higher level of risk as public entities usually have to accept the low bidder. Though there are options available to the State to go after a contractor who fails to complete the terms of a public works contract, retaining portions of payment to the contractor provides incentive for the contractor to complete the project. While I am sympathetic with the concerns of subcontractors, the State's responsibility is to protect the taxpayer to make certain that public works projects are completed correctly and within budget; AB 1354 Page 9 limiting the retention amount hampers the State's ability to do that. AB 396 (Fuentes) of 2009, would have reduced the time available for a claimant to make a claim against a bond by providing that if a claimant has not provided a 20-day public work preliminary bond notice as specified, the claimant may enforce a claim by giving written notice to the surety and bond principal prior to the completion of the project or recordation of a notice of completion. This bill was held in the Assembly Appropriations Committee. REGISTERED SUPPORT / OPPOSITION : Support American Subcontractors Association California, Inc. (sponsor) AAA Fence Company, Inc. Brady Company/Los Angeles, Inc. Burnett & Sons California Landscape Contractors Association Chula Vista Electric Construction Industry Legislative Council Construction Preliens & Paperwork Delta Electrical Construction, Inc. Dowdle & Sons Mechanical, Inc. Dynamic Forecast Co., Inc. Masonry Concepts, Inc. Partition Specialties, Inc. PTS Masonry, Inc. Surety Associates of Southern California Swiridoff Construction Co. Opposition Anaheim City School District Association of California Construction Managers Association of California Healthcare Districts Association of California Water Agencies Associated General Contractors Banta Elementary School District Beaumont Unified School District California Association of Joint Powers Authorities California Association of Sanitation Agencies California Special Districts Association AB 1354 Page 10 California State Association of Counties City of Lakewood Coalition for Adequate School Housing Community College Facility Coalition Construction Employers' Association Corona-Norco Unified School District County Sanitation Districts of Los Angeles County County School Facilities Consortia Desert Water Agency East Valley Water District El Dorado Irrigation District Fresno Unified School District Irvine Ranch Water District League of California Cities Los Angeles County Board of Supervisors Los Angeles Unified School District Regional Council of Rural Counties Riverside County Superintendent of Schools San Marcos Unified School District Three Valleys Municipal Water District Tracy Unified School District Analysis Prepared by : Joanna Gin / B.,P. & C.P. / (916) 319-3301