Letter from the Editor

by James J. Sienicki

Welcome to the final 2015 edition of our Under Construction newsletter. It is hard to believe that 2016 is right around the corner!

Drones are a hot topic right now. The first article in this newsletter addresses an October 19, 2015 announcement by the FAA regarding drone registration and other requirements that may affect drone use in construction. Also be sure to check out our second article that urges caution regarding the enforceability of a pay-when-paid clause in California and the risk that it may be deemed an unenforceable pay-if-paid clause if not properly drafted. Other key topics addressed in this newsletter include recent California litigation that creates new burdensome requirements for employers paying workers on a piece-rate basis, a short article regarding a recent construction defect litigation reform ordinance that the Denver City Council recently passed, and how retainage provisions in Utah are governed by a statute that limits the amount of retention an owner can withhold and affixes penalties if retention is improperly retained upon completion of the project.

New legislation and court cases affecting the construction industry are constantly changing the way to conduct business. All of these articles can be valuable to anyone interested in keeping up with these ever-evolving issues. We hope we are able to inform and enlighten you. Please let us know if you want us to address a specific construction issue in a future newsletter. Have a fun, busy and safe holiday season!

Regards,
Jim Sienicki

How the FAA’s Announcement Regarding Drone Registration May Affect Drone Use in Construction

by Jason Ebe

Use of unmanned aerial vehicles (UAV) and unmanned aircraft systems (UAS) (aka drones) in construction is rapidly increasing and expanding. Drones have been and can be used for a variety of functions, such as imaging (i.e., monitoring job progress, job documentation, real-time data/quality control and marketing), workforce supplementation/replacement (i.e., emergency response, address construction needs in difficult/unsafe places), surveying and environmental (i.e. air and ground sampling). Benefits of using drones include cost-effectiveness, safety, ability to reach difficult project areas, efficient inspection processes, and sophisticated marketing and bid presentations. Downside risks may include safety (airplanes, wind, birds), privacy, limited airspace, technology interference, improper automation, claims from crashes, defect litigation optics and regulatory process concerns.

In the FAA Modernization and Reform Act of 2012, Congress mandated that the Department of Transportation (Department) develop a comprehensive plan to safely accelerate the integration of civil unmanned aircraft systems into the national airspace system. Since 2012, the Department has made progress in enabling operations by issuing exemptions through Section 333 of the Act permitting commercial operations, creating a test site program, issuing a notice of proposed rulemaking for small systems, and encouraging research and innovation that will enable advanced drone operations.

A foundational statutory and regulatory requirement that the Department has employed for each of these integration programs is aircraft registration and marking. In order to operate in the national air space, operators must not only be aware of the system in which they are operating, but also that the FAA intends to identify and track drones to their operators. In fact, on October 19, 2015, the Secretary of Transportation Anthony Foxx announced that all unmanned aircraft would be required to be registered with the government just as manned aircraft are today. Foxx announced the formation of a task force consisting of government leaders and diverse stakeholders who will determine the specifics of how/which drones will be covered and how the registration process will work. Information that the task force will consider include:

1. What methods are available for identifying individual products?
2. At what point should registration occur (e.g. point of sale or prior to operation)?
3. What are the advantages of point of sale approach relative to a prior to operation approach?
4. Should certain UAS be excluded from registration based on performance capabilities or other characteristics that could be associated with safety risk, such as weight, speed, altitude operating limitations, duration of flight?
5. How should a registration process be designed to minimize burdens and best protect innovation and encourage growth in the UAS industry?
6. Should the registration be electronic or web-based?
7. What type of information should be collected during the registration process to positively identify the aircraft owner and aircraft?
8. How should the registration data be stored, who should have access and how should the data be used?
9. Should a registration fee be collected, and if so, how?
10. Are there additional means beyond aircraft registration to encourage accountaibility and responsible use of UAS?

Presently, commercial use of drones – i.e., professional service for business purposes – is banned without an exemption under Section 333 of the Act. This applies even if you are only flying to supplement or aide your business and not charging fees for doing so. Hobby use, for now, is ok. The main requirements to operate an unmanned aircraft or drone for your business are:

1. A Section 333 grant of exemption;
2. A Certificate of Waiver or Authorization (COA);
3. An aircraft registered with the FAA; and
4. A pilot with an FAA airman certificate.

See generally www.faa.gov/uas/legislative_programs/section_333/333_faqs.

All Section 333 grants of exemption are issued with conditions and limitations applicable to the operator. The FAA publishes all Section 333 grants of exemption, on its UAS website: http://www.faa.gov/uas/legislative_programs/section_333/333_authorizations/.

The operating conditions and limitations associated with each authorization are listed within the grant of exemption document.

The Section 333 exemption process is different from the COA process. All Section 333 grants of exemption are automatically issued with a “blanket” 200-foot nationwide COA with certain restrictions around airports, restricted airspace and other densely populated areas. Details are available at: http://www.faa.gov/news/updates/?newsId=82245.

An operator who wants to operate outside the parameters of the blanket COA are eligible to apply for a separate COA specific to the airspace required for their operation. Applications for these COAs must be submitted through the UAS Civil COA Portal.

COA applications MUST include:

1. An exemption number – issued with your Section 333 grant of exemption.
2. An aircraft registration number – all aircraft must be registered with the FAA to be issued a COA.

The FAA will evaluate your petition and send you its decision based on a full review of your request. An FAA grant or denial of exemption is based on the specifics of each situation. If your petition for exemption is similar enough to previous grants of exemption, it may qualify for a summary grant of exemption. The FAA requires a reasonable amount of time to conduct the study. Whenever possible, all efforts are made to handle proposals expeditiously. Under current regulations, a petitioner requesting a Section 333 exemption is advised to make the request 120 days prior to the date they anticipate needing it for operations.

By law, the FAA cannot authorize an aircraft operation in the National Airspace without a certificated pilot in command of the aircraft (Title 49 of United States Code § 44711). Exemptions granted in accordance with Section 333 carry the following requirement regarding the pilot in command (PIC) of the aircraft: Under this grant of exemption, a PIC must hold either an airline transport, commercial, private, recreational, or sport pilot certificate. The PIC must also hold a current FAA airman medical certificate or a valid U.S. driver's license issued by a state, the District of Columbia, Puerto Rico, a territory, a possession, or the Federal government. The PIC must also meet the flight review requirements specified in 14 CFR § 61.56 in an aircraft in which the PIC is rated on his or her pilot certificate.

If you intend to operate a drone for use in your design or construction business, whether or not you charge for that use, be sure to comply with the applicable laws and regulations regarding use. In addition, though not required by the foregoing, you should also talk to your insurance broker regarding coverage under your CGL policy, including a special aircraft/UAS endorsement, if appropriate. If you are contracting with subconsultants or subcontractors who you know intend to utilize drones for their services or work, consider appropriate risk allocation (i.e., indemnity insurance) relating to such use. Finally, because the laws regarding commercial drone use are changing rapidly, stay on the lookout for new developments in this area.

Caution: Pay-When-Paid Clauses Are a Danger Zone in California

by Jeffrey M. Singletary and Kelly C. Smith

Subcontracts often contain payment provisions to deal with the issue that a general contractor wants to be paid by the project owner before the general contractor has to pay its subcontractors. Two common subcontract provisions that are used to address this issue are: (1) pay-if-paid clauses, and (2) pay-when-paid clauses. In California, pay-if-paid clauses have been unenforceable since 1997. Pay-when-paid clauses are still enforceable in California, but must be carefully drafted or they will be invalidated for the same reasons pay-if-paid clauses are no longer legal.

Pay-If-Paid Clauses Are Unenforceable in California

Pay-if-paid clauses dictate that a general contractor is only required to pay a subcontractor for completed work if the general contractor is paid by the project owner. If the general contractor is never paid for the project, the general contractor does not have to pay the subcontractor. In 1997, the California Supreme Court held that pay-if-paid clauses are unenforceable in Wm. R. Clarke Corp. v. Safeco Ins. Co. (1997) 15 Cal. 4th 882. The Court explained that California subcontractors have a state constitutional right to utilize mechanics liens to ensure payment for completed work. Pay-if-paid clauses, the Court reasoned, circumvent that right by conditioning the subcontractor’s right to be paid for completed work on whether the general contractor is paid, which is contrary to California public policy. Therefore, the Court invalidated pay-if-paid clauses in California contracts.

As a practical note, general contractors should not include language in a California subcontract conditioning a subcontractor’s right to payment on whether the general contractor is first paid by the project owner and subcontractors should note any such provisions in their subcontracts are invalid. Subcontracting parties should also be aware that California courts have been extending Wm. R. Clarke Corp. v. Safeco Ins. Co.’s reasoning to invalidate pay-when-paid clauses that condition the subcontractor’s right to payment.

Pay-When-Paid Clauses Must Be Carefully Drafted To Be Enforceable

Pay-when-paid clauses establish the timing by which a general contractor will pay a subcontractor after receiving payment from the project owner. Pay-when-paid clauses that merely fix the time for the subcontractor’s compensation MAY be enforceable. See, e.g., Capitol Steel Fabricators, Inc. v. Mega Construction Co. (1997) 58 Cal. App. 4th 1049; Yaminishi v. Bailey & Collishaw, Inc. (1972) 29 Cal. App. 3d 457. But to be valid, a pay-when-paid clause must provide that the subcontractor will be paid within a reasonable amount of time after the subcontractor completes the subcontract work regardless of whether the project owner pays the general contractor. Without that guarantee, the subcontractor would never receive payment if the general contractor is not paid, and that pay-when-paid clause would amount to an unlawful condition precedent equivalent to a pay-if-paid clause. Indeed, California courts have found that pay-when-paid clauses that defer payment to a subcontractor until the general contractor is paid by the project owner are invalid. The provision that conditions the subcontractor’s right to be paid on payment from the owner violates the same public policies as pay-if-paid clauses. See, e.g., Capitol Steel Fabricators, Inc. v. Mega Construction Co. (1997) 58 Cal. App. 4th 1049.

Conclusion

Pay-if-paid clauses are void in California. General contractors should not include these clauses in California subcontracts. Otherwise, they risk other potentially valid provisions being tossed out in later litigation with a subcontractor. One way that may reduce this risk is for the general contractor to have a severability clause in its subcontract. Subcontractors should be aware in contract negotiations that any pay-if-paid clause is unenforceable. Pay-when-paid clauses are trickier. They are enforceable when carefully drafted to provide that, at the latest, the subcontractor will be paid in a “reasonable amount of time” (which term could be defined in the subcontract), after completing the subcontract work regardless of when the general contractor is paid by the owner.

Kelly C. Smith has passed the State Bar of California and is awaiting receipt of her bar number.

New California Law Creates New Requirements for Employers Paying Workers on a Piece-Rate Basis

by Brian J. Mills and Colin R. Higgins

On October 10th, Governor Jerry Brown signed into law Assembly Bill No. 1513, which creates new burdensome rules for employers that utilize piece-rate employees in California. Effective January 1, 2016, the new law (which will be added to California Labor Code § 226.2) will require employers to compensate piece-rate employees—who are generally paid based on the number of units, or pieces, they complete, rather than on the number of hours they work—for rest and recovery periods and “other nonproductive time.” The following are some of the new requirements the law imposes on employers:

• Pay piece-rate employees for rest and recovery periods at an hourly rate that is the higher of the employee’s average hourly rate or minimum wage. The employee’s average hourly rate is determined by dividing the employee’s total compensation for the workweek (excluding compensation for rest and recovery periods and overtime premiums), by the total hours worked during the workweek, exclusive of rest and recovery periods.
• Pay piece-rate employees for “other nonproductive time,” defined as time under the employer’s control that is not directly related to the activity being compensated on a piece-rate basis, at a rate of at least minimum wage.
• Include on the piece-rate employee’s itemized wage statement the total hours of compensable rest and recovery periods, the rate of compensation and the gross wages paid for those periods during the pay period, and the total hours of other nonproductive time.

The law applies retroactively, but provides a limited safe harbor defense for employers against claims for unpaid wages and other damages. To assert the safe harbor defense, the employer must compensate its previously uncompensated or undercompensated piece-rate employees for rest and recovery periods and other nonproductive time, plus interest, for the period from July 1, 2012, to December 31, 2015. The back payments must be paid on or before December 15, 2016, and the employer must give written notice of its intent to make the back pay to the Department of Industrial Relations by no later than July 1, 2016.

Now is the time for employers who utilize piece-rate employees to implement the changes needed to comply with the law, including updating their payroll systems and wage statements. In addition, employers should analyze the safe harbor provision and whether to utilize that option.

Denver City Council Passes Construction Defect Litigation Reform Ordinance

by Scott C. Sandberg

After successive failures to pass similar legislation at the state level, the Denver City Council is following Lakewood and other municipalities to pass reforms to curb construction defect litigation. Designed to address concerns about the chilling effect construction defect lawsuits have had on condominium development, the ordinance provides that failures to substantially comply with the building code cannot support any type of defect claim unless the violation causes actual damage to property, loss of use of property, bodily injury, death, a risk of bodily injury or death or a threat to life, health or safety. The ordinance prohibits any strict liability or negligence per se claims based on a violation of the building code. The ordinance also provides that to the extent the building code specifically regulates any particular element, feature, component or other detail of construction, if the work complies with the building code, then it shall not be considered defective. The ordinance requires that before asserting a construction defect claim the HOA must provide certain information about the claim to all HOA members and obtain the consent of a majority of HOA members. The ordinance also provides that if a condominium declaration requires arbitration of defect claims the HOA cannot modify or eliminate that provision without the developer’s consent. The ordinance has been strongly supported by construction trade organizations and business leaders.

Final Acceptance Under Utah’s Retainage Law: It’s Not Over Until It’s Over

by Sean M. Mosman and Mark O. Morris

Property owners seeking to insulate themselves from some of the inherent risks associated with construction projects often turn to retainage provisions to reallocate very specific risks—the risks of delay, defective performance and default—to the parties actually doing the construction. A retainage provision is a contractual clause whereby the owner withholds some percentage of the prime- and sub-contractors’ earned compensation until their work is complete. The percentage withheld for retainage is sometimes reduced at 50 percent completion or at another milestone. Retainage gives contractors a strong economic incentive not to abandon the job. Particularly near the end of a project, a contractor may find that the cost of completing its work outstrips the remaining value of the contract. Withholding retention incentivizes a contractor to stay on the job, see it through to completion and correct all remaining deficiencies with the project.

In some states, retainage provisions became so onerous and withholding percentages so steep that legislatures had to intervene on behalf of contractors and subcontractors. Utah has adopted a retainage statute that governs, among other things, the amount of retention an owner can withhold and affixes penalties if retention is improperly retained upon completion of the project. While the statute has reined in many aspects of retainage, it explicitly conditions the release of retention proceeds upon the owner’s final acceptance of the project without defining “final acceptance,” thereby giving parties an opportunity to agree among themselves on the conditions upon which final acceptance will be granted and retention proceeds released.

Pursuant to Utah Code § 13-8-5, Utah’s retainage statute, the total retention proceeds withheld from a project may not exceed 5 percent of the total contract price. Utah Code § 13-8-5(3)(b). Further, the maximum percentage that can be withheld from progress payments by an owner[1] to its contractor, or by any tier of contractor to its sub-contractors, cannot exceed 5 percent. Utah Code § 13-8-5(3)(a). Notwithstanding the normal 5 percent maximum, however, if a contractor or sub-contractor breaches or defaults on the construction agreement, the owner may withhold retention in an amount greater than 5 percent for as long as reasonably necessary to cure the breach or default. Utah Code § 13-8-5(8)(a). The owner must explain the reasons for this additional withholding in writing within 45 days of the withholding. Utah Code § 13-8-5(8)(b).

Any money withheld by the owner as retainage must be maintained in an interest-bearing account. Utah Code § 13-8-5(4)(a). The interest is for the benefit of the prime contractor and subcontractors and must be distributed to the prime contractor and subcontractors pro rata after the project is accepted by the owner. Utah Code § 13-8-5(4)(b)-(c). The owner must release retainage to the prime contractor within 45 days from the latest of the following: (a) the date the owner receives the prime contractor’s billing statement; (b) the date that a certificate of occupancy or notice of final acceptance is issued to the prime contractor, the owner or the architect; (c) the date that the building inspector permits partial or complete occupancy of a building; or (d) the date the prime contractor accepts the final pay quantities. Utah Code § 13-8-5(5).

Meanwhile, once the owner releases retention proceeds to the prime contractor, the contractor must release any retainage it has withheld to its own subcontractors within 10 days thereafter. This applies as between subcontractors and their subcontractors as well. Utah Code § 13-8-5(9).

Any violations of this statute subject the violating party to potential liability for attorney’s fees and other costs. Utah Code § 13-8-5(10)(a). Additionally, any knowing and wrongful retention of funds is subject to an added 2 percent interest fee per month on the wrongfully withheld amounts. Utah Code § 13-8-5(10)(b).

Utah’s retainage statute goes a long way towards evening the playing field between subcontractors, contractors and owners with regard to the withholding and payment of retention funds. By limiting the amount owners can withhold from prime contractors—and, in turn, that prime contractors can withhold from subcontractors—to 5 percent of each progress payment, not to exceed 5 percent of the total contract price, the legislature keeps owners from forcing prime and subcontractors to disproportionately bear more of the up-front costs and financing of the work. The statute also requires retainage to be held in a separate interest-bearing account, with interest accruing for the benefit of the prime contractor and subcontractors, which prevents owners from using retention funds to effectively “finance” all or parts of the project, or from earning interest off of the contractors. Finally, it cracks down on the improper withholding and/or use of retention funds by levying strict penalties, including attorneys’ fees and an additional 2 percent interest, against violators.

Still, the retainage statute leaves an important “out” for owners. The statute explicitly conditions the release of retention funds upon the occurrence of the “late[est]” of a list of triggering events, one of which is the issuance of a “final acceptance notice” by the owner to the contractor. Yet the statute fails to specify what must be accomplished before the owner is obligated to issue such a notice to the contractor, instead of leaving it up to the parties to define “final acceptance” without the benefit of statutory guidance. This provision gives the owner the opportunity to negotiate a favorable definition of “final acceptance” in the construction contract, effectively de-clawing perhaps the most important provision in an otherwise fairly contractor-friendly statute. Case law in Utah is similarly silent on what conditions trigger final acceptance by the owner under the retainage statute. Consequently, if there is a breach of the terms governing final acceptance in the construction contract, the owner likely may continue to withhold retention—and, indeed, ramp up its retention to proportions greater than 5 percent —for “as long as reasonably necessary to cure the breach.”

To ensure that owners release retention fees in a timely manner upon completion of a construction project, prime contractors should negotiate an explicit, objective definition of “final acceptance” in their construction contracts. It is especially important that the contract contain clearly defined terms regarding the award of the final acceptance notice from the property owner. Conversely, owners who wish to increase the economic incentive for prime contractors and subcontractors to complete their work should condition “final acceptance” upon the owner’s subjective satisfaction with the project. A broad definition of “final acceptance,” conditioned upon the owner’s subjective approval of the work, would probably permit owners to withhold retention funds for as long as is reasonably necessary to encourage contractors to complete the project according to contractual specifications and timelines.