On October 14, 2017, Governor Brown signed Assembly Bill (AB) 1701 into law as California Labor Code § 218.7. This newly enacted law imposes potentially significant liability on direct contractors for their subcontractors’ failure to pay wages, fringe, or other benefits to laborers.

The new law applies to construction contracts “for the erection, construction, alteration, or repair of a building, structure, or other private work” entered on or after January 1, 2018.

At its core, the law makes direct contractors (a contractor in direct contract with an owner) liable for subcontractors’ (at any tier) failure to pay wage, fringe, or other benefit payments or contributions. The potential liability includes subcontractors’ failure to pay any interest incurred on such wages, fringe, or other benefits, but does not extend to penalties or liquidated damages. This section also extends claim rights to recover unpaid wage, fringe benefit or other benefits for labor performed on the project to third parties on the wage claimants’ behalf (e.g. the Labor Commissioner, joint labor-management cooperation committees or union trust funds). Liability attaches even if the direct contractor makes full payment to its subcontractors.

The statute gives standing to make a claim to several potential claimants: The Labor Commission can recover unpaid wages, the union trust funds can recover unpaid fringe and other benefit payments, and a joint labor-management cooperation committee can recover unpaid wages. These claimants have one year to file actions against the direct contractor from the earlier of actual completion or the recording of a notice of completion or cessation for the work covered by the direct contract.

The statute also interposes a non- reciprocal attorneys’ fees clause, including costs and expert witness fees to any prevailing third party and/or joint labor-management cooperation committee claimants. The prevailing claimants can attach property of the direct contractor to satisfy any judgment arising under this section.

There are some limitations and protections that permit direct contractors to limit their risk; for example, the bill does not create a private cause of action for the wage claimant and the bill allows direct contractors to require certain payroll records from subcontractors. In conclusion, here are some recommendations on how to minimize risk in the face of this new law.

What Can Direct Contractors Do? Direct contractors can take a number of steps to protect themselves and shift the burden of this liability:

1. Secure Broad Indemnity Rights. Direct contractors can include broad indemnity provisions that include claims arising from the subcontractor’s failure to pay wages and fringe benefits to laborers on the project.

2. Require Payment Bonds from Subcontractors. Direct contractors may require subcontractors, and their sub-subcontractors, to provide payment bonds. The inability or unwillingness to provide a bond may be a red flag of financial distress.

3. Select Financially Secure, Trustworthy Subcontractors. Now, more than ever, it is important that direct contractors be selective in choosing subcontractors and should engage subcontractors who have a proven track record or demonstrate financial solvency.

4. Monitor Subcontractors’ Payroll Records throughout the Project. Subcontractors must provide payroll records to direct contractors upon request. It is incumbent on direct contractors to request these payroll records and review them throughout the project to make sure the subcontractor is paying the wages and fringe benefits to assess compliance and mitigate potential risks. Records similar to certified payroll reports required on prevailing wage projects should be required.

While a subcontractor’s failure to provide these records will not serve to relieve the direct contractor of any potential liability under this section, the failure will serve as grounds for the direct contractor to withhold as “disputed,” all sums owed until the subcontractor provides the requested records.

Direct contractors can also include contract provisions requiring subcontractors to provide the necessary payroll records upon request and failure to provide the records could be grounds for termination.

5. Timely Pay Subcontractors for Undisputed Work. AB 1701 specifically provides that nothing in this section shall alter the direct contractor’s obligation to timely pay its subcontractors on the project or otherwise face potential prompt payment penalties. Accordingly, unless there is a sufficient reason to withhold sums as “disputed,” direct contractors should continue to timely pay their subcontractors.

What Can Owners Do? Be cautious in selecting the direct contractor and ensure the direct contractor is cautious and selective in choosing subcontractors to perform work on the projects. AB 1701 specifically provides that nothing in this section shall alter the owner’s obligation to timely pay the direct contractor. Accordingly, owners should continue to timely pay their direct contractors or otherwise face potential prompt payment penalties.

What Should Subcontractors Do? Subcontractors at every tier should keep and maintain accurate payroll records in order to: (1) provide such records upon the direct contractor’s request, and thereby avoid payment withholds over “disputed” sums; and (2) have accurate documentation to defend against any potential claims.