California civil code (Sec)3110.5: Is the cure worse than the disease?

Real Estate Issues, Summer 2002 by Cathcart, Robert J, Jackson, Bryan C

APPLICABILITY OF CIVIL CODE sec 3110.5

The statute became effective January 1, 2002. By its terms, it applies to construction, alterations, or repairs on real property. It does not apply to public works, to single family residences including subdivisions, or to housing developments eligible for Government Code sec 65915 density bonuses. The term "single family residences" means "a real property improvement used or intended to be used as a dwelling unit for one family." Although somewhat vague and susceptible to dispute, the language probably does not exempt apartment or condominium projects unless the density bonuses apply.

RETROACTIVE APPLICATION

Another potential for dispute arises from the lack of language discussing retroactive application. While some will cite constitutional protections against retroactive application, the more troubling arguments will probably center on the ongoing payment obligations of various owners that occur after the law became effective on January 1, 2002. In other words, while the statute should squarely apply to construction contracts executed after January 1, 2002, will it also apply to payment obligations that commenced before January 1, 2002 but continue after that date? Further, does the statute apply to contracts signed in 2001 where work does not commence until 2002? Does the statute apply to projects where the work commenced in 2001, but the contract is not executed until 2002? What if the parties sign a contract in 2002 but date it "as of 2001? In short, the statute's silence on these and similar issues may lead to disputes and uncertainty.

SECURITY

The amount of the security, whether through a bond, letter of credit, or escrow account, is 25 percent of the construction cost if the project is to be completed within six months, and 15 percent of the construction cost for projects scheduled for six months or longer. The amount is based on the fixed price contract amount, the guaranteed maximum price ceiling, or the parties' "good faith estimate" as to the total cost anticipated to be incurred if the contract is neither a fixed price nor a guaranteed maximum contract.

The security "shall be used only when the contracting owner defaults on his or her contractual obligations to the original contractor." Those obligations do not appear to be limited to the financial obligations of the owner except by implication from the other terms of the statute. This ambiguity could be used by a contractor to argue for securing non-payment obligations, such as delay, extra work, and injury claims which would increase the required security if they are converted to mutually agreed change orders that increase the contract amount.

The statute provides that the security may be in one of the three described forms. It does not give the contractor the right to demand one or another of the specified forms of security. Presumably, the owner may opt for whichever form it wants to provide.

Payment Bond: The bond option is a payment bond issued by a specifically defined, California-admitted surety in the required amount "payable upon default by the contracting owner of any undisputed amount under the contract that has been due and payable for more than 30 days." Again, while the intended purpose of the statute is to secure payment to the contractor, many owners may "dispute" their alleged late payments, thereby preventing timely payment to the contractor through the payment bond.