Exclusive Q&A on Construction and Real Estate Law with Marilyn Klinger

Who are the main regulators and what are the key legislations that apply to your jurisdiction?

Needless to say, California is renowned for its regulatory environment that some have said is not particularly business-friendly.  Indeed, the regulators for the construction industry in California number many, including but not limited to the Department of Labor, the Department of Industrial Relations, Cal OSHA, the Office of Statewide Health Planning and Development, the California Building Standards Commission, the California States Licensing Board, the California Building Standards Commission, the California Department of Education, the Division of the State Architect, the Department of Toxic Substances Control, the Office of Public School Construction, the city and county building departments, the California EPA, the Air Quality Management Districts, and the California Architect Board, to name a few.  Many of them govern at the design, entitlement, and development stages of construction and others govern during the course of construction.  Their titles give the reader an indication of the substantive areas where California has chosen to focus its regulations.

Have there been any recent regulatory changes or interesting developments?

Business and Professions Code section 7031(e) has been amended to slightly change the criteria for a court to determine whether a contractor has substantially complied with the California State Licensing Law to avoid the very punitive aspects of sections 7031(a) and (b).  In essence, section 7031(a) provides that a contractor cannot recover its earned but unpaid contract balance if it loses its license during the construction contract.  Section 7031(b) provides that a contractor must return back/disgorge everything it has received on the contract as well.  There is an escape hatch, section 7031(e), which protects the contractor if it has substantially complied pursuant to its provisions.  The amendment changed from a requirement that the contractor had to show that it acted promptly and in good faith to reinstate its license upon learning it was invalid to that it “acted promptly and in good faith to remedy the failure to comply with the licensure requirements upon learning of the failure.”

There are new California bills that have expanded the opportunities for Public Private Partnerships, for Caltrans, transportation, the Judicial Council, which runs all California courts, the High-Speed Rail Authority (HSRA) and local government agencies for irrigation, drainage, energy or power production, water supply, treatment, and distribution, flood control, inland waterways, ports, harbors, municipal improvements, commuter and light rail, highways, bridges, tunnels, airports and runways, purification of water, sewage treatment, disposal, water recycling refuse disposal, and  structures or buildings.  
 
Are you noticing any trends or patterns in recent litigation?

Because of the advent of arbitration, which is a private dispute process, there is now a paucity of precedent (written and published court decisions) for lawyers and their clients to look to in evaluating their current situations.  Precedent serves as a guide to courts and arbitrators in new disputes.  Precedent also serves as a method to identify growth and change in the law that governs an ever-changing industry, such as construction.  This lack of precedence is allowing for uncertainty as to how players in the construction industry conduct themselves and deal with conflict.  One of the answers is to lay out everything that possibly could happen in the governing contract documents.  That approach is a laborious one, fraught with potential omissions, inadvertent ambiguities, and missteps.  But, see the comment below regarding arbitration as the primary method of dispute resolution for the construction industry.

Claims and disputes have always been a problem in the construction industry. In recent years an ever-increasing number of projects have appointed dispute boards to help with the avoidance or speedy resolution of claims or disputes. What are the basic functions of dispute boards and how effective is its implementation?

Arbitration is a 20-plus-year trend that has lost some of its luster as it does not necessarily provide a quick and inexpensive method to resolve construction disputes.  And, no matter how much the various neutral organizations, including AAA, JAMS, ADR, etc., try, there continues to be a trend or at least a perception that arbitrators “split the baby” in their decisions.  Hence, notwithstanding the immense backlog that the California court system has been experiencing, many players in the construction industry continue to proceed forward with litigation in the courts.  Because there is a view that neither of the main dispute resolutions mechanisms are particularly effective, mediation continues to be one of the primary means for obtaining dispute resolution.  Interestingly, however, mediators, who once were difficult to find, are now multiplying to the degree that the competition among mediators, except for a select few, is fierce.  That competition can be both good and bad.  On the good side, based on standard supply and demand concepts, the cost of mediation should become more reasonable.  On the bad side, although mediators are neutrals and pride themselves on that neutral approach, there are now becoming “favorites” in the mediation world, which make opposing parties wary of agreeing to use them to mediate their disputes.

One interesting development is the concept of “settle now, argue later.”  It started in the context of the use of performance bonds in the P3.  It is a procedure by which an “adjudicator,” experienced in construction and construction law, receives the details of a dispute during construction and issues a decision, often in 30 days from receipt, that is binding on the parties until the contract is completed and, then, the parties can challenge the adjudicator’s decision via whatever dispute mechanism is provided for in the contract, arbitration, litigation, etc.  Presumably, the parties will, in the vast majority of situations, not challenge the adjudicator’s decision at the end of the project, having dealt with the results of the decision during the course of construction. 
 
Dispute Resolution Boards (DRBs), typically a three-person board of neutral, experienced construction and engineering professionals, often non-lawyers, are pre-appointed at the beginning of a construction project pursuant to the contract.  Their function is to help resolve disputes during the course of construction.  And, indeed, attorneys are not permitted to participate in the DRB process.  What also distinguishes the adjudication process from DRBs is the fact that the DRB’s decision is not binding at any stage of the process and is only persuasive when the parties eventually do proceed forward with their litigation or arbitration.

What should be included in a well-drafted construction contract?

The following provisions that should be included in a well-drafted construction contract are based on the types of disputes that most commonly arise on a construction project.  Scope of Work.   It is always surprising how often a dispute on a construction project arises because there is confusion as to the scope of work.  For example, a prime contractor may point to certain portions of the plans and specifications applicable to the project.  However, those plans and specifications may, in turn, reference other aspects of the construction in other areas of the plans and specifications.  That scenario could obviously cause confusion and conflict regarding the responsibilities of the various parties.  Change Order Request/Change Order Procedures. 

The change order request and change order procedures should be as simple and straightforward as possible.  Often, a contractor or subcontractor will be accustomed to handling change orders one way whereas the contract or the owner or prime contractor may be accustomed to handling them a different way.  Accordingly, if (1) the provisions are extremely simple and straightforward, and (2) are highlighted to all of the parties and their representatives at the commencement of construction, the construction process can be streamlined.  Payment Procedures.  The comments above related to what the parties are accustomed to also apply to payment procedures.  One particularly thorny issue is the immense amount of paperwork that contractors and subcontractors are required to provide in order the receive payment, including lien releases, updated schedules, union sign-offs, manufacturers’ warranties, etc.  Rather than have those requirements scattered throughout the contract, the payment procedures should list each requirement right there for the contractor/subcontractor to track down, item by item.  Insurance Requirements.  People often simply cut and paste from prior construction contracts. 

We recommend that the insurance professionals representing each side of the construction process provide detailed input applicable to the insurance requirements so that there are no gaps in coverage.  Indemnification Provisions.  Some states have very specific statutory provisions as to what a party to a construction contract can indemnify for and what it cannot not, e.g., California.  And, there is some fear that putting in the kitchen sink could negate the entirety of the indemnity provision.  Therefore, it is important to have an attorney versed in the indemnity requirements to review all of the indemnity provisions in a construction contract.  Differing Site Conditions.  Differing site conditions provisions have become fairly standard in construction contracts over the years, but one aspect that should be addressed are the exculpatory clauses that some owners try to add to their contracts in order to shift the risk of differing site conditions down the chain.  Other than the notice provisions, which courts often enforce, most exculpatory clauses are not enforceable.  Cure Procedures.  Unless it is the precursor to termination, cure procedures can be effective in putting a contractor or subcontractor on notice of issues with its performance and should be worded in the contract to require clarity and responses that make the provisions effective.  Termination Procedures.  Except in connection with performance bond claims, termination procedures are rarely challenged.  Dispute Clauses.  Without an appropriate dispute clause, the parties are left to litigation for their disputes.  In today’s day and age, there are many alternate dispute resolution methods that may be more desirable than litigation.  However, in order to take advantage of any of the alternative procedures, they must be included in the construction contract.

Procurement in the construction industry is unlike any other due to the complexity of projects. Can you outline the various methods of procurement and the potential benefits or risks attached to each?

There is often a blurring of the lines between procurement methods and delivery methods.  As the question focuses on procurement, there are only three true procurements methods: Competitive Bid, Best Value/Merit-Based, and Negotiated.  For delivery methods, the sky seems to be the limit with design-bid-build, design-build, integrated project delivery, construction management at risk, construction management not at risk, construction management/general contract, time and material/cost-based plus a fee, and time and material/cost-based plus a fee with a guaranteed maximum price, to name a few.  As to the three basic methods listed above, pre-qualification is often an integral and preliminary part of the process by which the owner can narrow the potential candidates for the job via a pre-qualification process. 

Competitive Bid.  The biggest benefits to competitive bid procurement include the lack of any subjectivity to the selection process — it is all a numbers game — and the ability to prevent corruption, cronyism, or bribery in the process.  It cannot prevent bid-rigging, of course, if the various bidders determine to collude together.  The concern is that the owner is not obtaining the best contractor for the job.  And, if the contractor low bid/underestimated the project, it will be looking at ways to cut costs and submit change orders to make up for its losses in other ways.

Best Value/Merit-Based.  Best value/merit-based is touted for its ability to identify the best contractor for the project, taking price into account but not using price as the only determiner.  Historically, project owners have found that a best value/merit-based approach has better outcomes generally, avoids disputes, and prevents the aggressive change order process that they encounter with pure competitive bidding.  The public entities that have instituted best value/merit-based approaches have attempted to incorporate numerous safeguards to prevent corruption in the process. 

Negotiated.  Only when there is sole source situation in the public sector or in the private sector, are negotiated contracts a reality.  The private sector sometimes uses a form of competitive bidding but, of course, private owners are not bound by the process and can further negotiate any of the contract terms including price.  Many private owners are comfortable with time and materials or cost-based contracts with a fee attached as they allow the owner to audit the contractor’s costs such that there is a great deal of transparency and the owner, therefore, believes that it has obtained the best value for the price.  There are a few ways, but not many, for a contractor to hide profit.  By the same token, in a time and material/cost-based contract, the contractor is not incentivized to be efficient or obtain materials at the best price possible.  Therefore, such contracts require vigilance and supervision on the part of the project owner.

Marilyn Klinger is chair of Sedgwick’s Commercial Division and chair emeritus of the Construction Practices Group. A partner in the firm’s Los Angeles office, she practices all aspects of construction law, at the state and national level, and represents the full spectrum of the construction industry, from owners, contractors, subcontractors and sureties. Her practice includes time-related claims and litigation, legal advice and counsel regarding the contracting process, payment enforcement and defense, administrative and scope claims and litigation, and counseling and transactional services to the construction industry. She has extensive experience in dispute resolution including litigation, trial, appeals, arbitration and mediation.

Marilyn can be contacted on +213.426.6900 or by email at marilyn.klinger@sedgwicklaw.com