2020-2021 Significant California Appellate Cases (Construction & Business Law)

Happy New Year!?

By popular demand, I am writing to supplement my prior post about new California Construction Law legislation by recapping some of the most important California appellate construction and contract court decisions that have come down within the last 18 months.?Though there have been dozens of noteworthy opinions that impact businesses across the State, the eight decisions I have selected to highlight below are the ones that have come most into play in my practice. The decisions have significant impact on businesses that use standard form agreements, employ mechanics lien and related remedies to ensure payment for labor or materials on construction projects, rely on website/online terms and conditions, and agree to resolve debts with customers through settlement agreements, promissory notes, or forbearance agreements. Feel free to let us know if you have any questions regarding any of these important California appellate decisions!

Contracts / Credit Agreements / Arbitration / Business and Commercial Law

Domestic Linen Supply Co., Inc. v. L J T Flowers, Inc., 58 Cal. App. 5th 180 (2020)

Inconspicuous Arbitration (and possibly other contract) Clauses May Not Be Enforced

?As we wrote about in an article published on April 6, 2021 (https://www.gibbsgiden.com/blog/inconspicuous-arbitration-agreements-will-not-be-upheld), the Domestic Linen case should encourage all distributors and manufacturers that utilize standard form credit, sales, or rental agreements to carefully review their form contract documents to ensure enforceability.?Although the case and Court of Appeal decision focused on the enforceability of an arbitration provision in a form contract, suppliers should consider using bold, italics, capitalization, and larger font size for important contract provisions such as arbitration, limitation of liability, warranty, guarantees, and other clauses. In addition, businesses should carefully consider the location of the customer’s signature and initials on their contract forms.

Mechanics Liens / Construction Law

Carmel Development Co., Inc. v. Anderson, 48 Cal.App.5th 492 (2020)

When a Debtor Makes Payments "On Account" and Fails to Direct the Creditor Regarding How Payments Should be Applied, the Creditor May Determine How to Apply Payments; Mechanics Lien Rights Extend to Properties Benefitted by Work Performed; Prejudgment Interest on a Mechanics Lien Claim is 7%

In Carmel Development, the Court of Appeal took on several important topics concerning the proper application of payments, the extent of real property to which mechanics lies attach based on the benefit provided by the work performed, and the appropriate measure of interest in mechanics lien foreclosure actions. As we more fully explored in our blog post at?https://www.gibbsgiden.com/blog/liening-the-life-of-luxury-a-review-of-carmel-development-co-inc-v-anderson/ , three distinct lessons came from this appellate decision.

Application of Payments

First, the court explored the application of Civil Code section 1479 which often is extremely important in the construction context when an owner or contractor owes amounts to other contractors or suppliers under several different invoices, payment applications, or job accounts.?Specifically: (1) If, at the time of performance, the debtor indicates that its performance is to be applied to a particular obligation, then the performance must be applied to the particular obligation specified; (2) If no such indication is made by a debtor, then within a reasonable time after performance by the debtor, the creditor may apply such performance to any obligation he or she desires (as long as the application is made before a lawsuit is filed); and (3) If no indication is made by a debtor, and a creditor does not apply a debtor’s performance to a particular obligation within a reasonable time after performance by the debtor, the performance is to be applied in the following order: (a) to interest due at the time of performance; (b) to principal due at the time of performance; (c) to the obligation earliest in date of maturity; (d) to an obligation not secured by a lien or collateral; and, finally (e) to an obligation secured by a lien or collateral. In this case, the Court of Appeal allowed the contractor to apply the owner’s payments to the project invoices that the contractor itself decided appropriate since the owner failed to designate how payments were to be applied and the contractor applied such payments on the owner’s account before it filed suit.

?Applicability of Mechanics Liens to Particular Lots

The Court of Appeal reiterated a principle previously articulated by the California Supreme Court that with respect to the extent of real property to which a mechanics lien attaches, the focus must be the amount of land to be improved or benefitted by the creation and use of the improvements. In this case, the appellate court found that the construction of a water treatment plant was intended to provide water to all of the lots in a subdivision and, therefore, the lien recorded for the water treatment plant work could not be only allocated to specific lots within the subdivision. On the other hand, the construction of roads and related infrastructure only benefitted lots constructed in two particular phases of the project and had little impact on the rest of the development.?As such, the separate mechanics lien recorded in connection with the construction of roads and related site improvement should only be allocated to the lots benefited by such work.

Interest on Mechanics Lien Claims

The Court of Appeal finally held that while prejudgment interest is awardable in a mechanics lien foreclosure action, whether the applicable interest rate is ten percent (10%) or seven percent (7%) depends on who the defendant is.?Specifically, according to the court, the ten percent interest rate under Civil Code Section 3289 (which applies to breach of contract claims) would apply to claims between a mechanics’ lien claimant and a party with whom it is in direct contract (e.g., a direct contractor and project owner).?However, the lower seven percent (7%) interest rate under Constitution (which does not require that there was a contract) applies to claims between a mechanics’ lien claimant and a party with whom it is not in direct contract.

Licensing / Construction Law / Disgorgement

Eisenberg Village of the Los Angeles Jewish Home for the Aging v. Suffolk Construction Co., Inc., 53 Cal. App. 5th 120 (2020)

One-Year Statute of Limitations Held to Apply to Disgorgement Under California Business & Professions Code § 7031

Proper licensure remains a hot topic in California construction law. As we all know, contractors in California must be licensed by the Contractors' State License Board (CSLB) and if a contractor is a corporation, it must have qualified for a contractor’s license through a qualifier, who is “responsible managing officer (RMO) or responsible managing employee (RME). The RMO or RME is responsible for supervising the contractor’s construction projects and if a contractor is deemed unlicensed under the law (e.g., because it did not have a bona fide qualifier), the contractor is unable to collect compensation for any performance where a contractor’s license is required and, furthermore, compensation paid to such contractor may be disgorged and returned back to the payor without proof of any injury.

In Eisenberg, the project owner claimed that its contractor, Suffolk Construction, qualified through a particular RME at the time of construction.?However, prior to commencement of construction, the RME transferred offices from Irvine to Boston but remained as the RME on Suffolk’s California license. The owner alleged that the RME did not supervise their construction project and that because Suffolk did not have a bona fide qualifier as RME, Suffolk was not duly licensed as a contractor at all times during Suffolk's performance of the contract.

Luckily for Suffolk Construction, the Court of Appeal ruled that the disgorgement remedy provided in Business & Professions Code § 7031(b) is a penalty and therefore subject to a one-year statute of limitations pursuant to Code of Civil Procedure § 340(a).?The Court of Appeal further held that such claims accrue upon the completion or cessation of work and the delayed discovery rule does not apply.The court explained that it would absurd if an unlicensed contractor built a building for millions of dollars, then ten years later when the plaintiff’s business began to fail, they were able to collect the entire cost of the building from the contractor. Here, Suffolk finished construction in 2010, but did do some extra work in 2012, and Eisenberg did not file its second amended complaint, which included the disgorgement claim until 2015. Therefore, the court affirmed trial court’s holding that the case was barred by the one-year statute of limitations.

We issued an alert on this case in December 2020 which can be found at https://www.gibbsgiden.com/blog/contractor-alert ?

Collections / Settlement / Stipulated Judgments / Liquidated Damages

Graylee v. Castro, 52 Cal. App. 5th 1107 (2020)

Stipulated judgments will be unenforceable penalties when there is no meaningful effort to anticipate the amount of damages that may flow from a breach of the stipulation; however, stipulated judgments will be enforceable if the defendant admits that it owes the sum claimed by the plaintiff.

The Graylee appellate decision was the latest of several decisions on the enforceability of liquidated damages and, specifically, stipulations for entry of judgment. A stipulation for entry of judgment is often used in the settlement of collection-type cases as “the stick” to ensure the debtor follows through with installment payments required under a settlement agreement. In Graylee, the specific issue on appeal was whether a stipulation for entry of judgment by a tenant/debtor was an unenforceable penalty under Civil Code section 1671(b).

Civil Code section 1671(b) states that a liquidated damages clause will be valid unless it “bears no reasonable relationship to the range of actual damages that the parties could have anticipated would flow from a breach.” To determine whether the tenant’s stipulated judgment was an unenforceable liquidated damages clause the Court of Appeal analyzed other recent cases including Greentree Financial Group, Inc. v. Execute Sports, Inc., 163 Cal.App.4th 495 (2008) and Jade Fashion & Co., Inc. v. Harkham Industries, Inc., 229 Cal.App.4th 635 (2014).?Taken together, these cases provide valuable guidance on using a stipulated judgment to secure payment of a settlement.

In Greentree, the parties settled a $45,000 contact claim by the defendant agreeing to pay $20,000 in two installments. The stipulation provided that if the defendant missed either payment, the plaintiff was entitled to a $45,000 judgment, plus attorney fees and costs. After defaulting on the first payment, the court entered a $61,000 judgment. The appellate court found the judgment included an unenforceable penalty because of attempting to anticipate damages flowing from a breach of the stipulation, the parties simply selected the amount the plaintiff claimed as damages in the underlying lawsuit, plus interest, attorney fees and costs.

In Jade Fashion, a defendant admitted to owing plaintiff $341,628 and agreed to make monthly payments that would amount to a discount of $17,500 if they were all timely. Although several of the payments were late, the defendant still deducted the $17,500 from its final payment. The court in Jade Fashion found for the plaintiff holding that the discount was neither liquidated damages for a breach, nor was it an additional payment above any debt that was owed. Instead, the $17,500 was part of the $341,000 obligation, which the defendant admitted to owing. Thus, the appellate court held that the Civil Code Section 1671 restrictions did not apply and ruled that the agreement was a “forbearance agreement.”

The key takeaway for creditors that want the ability to use the carrot and stick of a stipulation for entry of judgment? Make it clear in the settlement documents and stipulated judgment that the parties agree to a discount for the timely payment of an admitted debt.?As Judge Brian Currey of the Second Appellate District noted in Red & White Distribution, LLC v. Osteroid Enterprises, LLC, 38 Cal.App.5th 582, 589 (2019):

?“Based on Jade Fashion, if the parties stipulate that the debt is a certain number, they may agree that it may be discharged for that number minus some amount. They may also agree that in the event the debtor does not timely make the agreed payments, a stipulated judgment may be entered for the full amount….?We publish [this case] to remind practitioners whose clients settle a dispute involving payments over time how to incentivize prompt payment properly, and what may happen if done incorrectly.”

Creditors should consider the following: (1) use the title “Forbearance Agreement“ rather than “Settlement Agreement”; (2) require the debtor/defendant acknowledge in the settlement documents that the full amount is due and owing and the amount to be paid reflects an undisputed debt, as distinct from a compromise of disputed claims; (3) if the debtor makes each payment when due, then it may deduct the agreed-upon discount amount from the final payment due; (4) time of the essence with respect to each payment due and the discount is conditioned upon timely full payments, otherwise the remaining balance due shall be immediately due and payable; (5) the discounted amount due is an inducement for prompt and earlier payment of the agreed-upon debt and not a compromise of the actual amount owed; (6)?breach will result in the cessation of the creditor’s forbearance and enforcement of the debtor’s agreement to pay the full amount actually due; (7) the payments should add up to the total amount due without discount; and (8) ensure that any surcharge is proportional to the damages resulting from the payment default (i.e., limited to a reasonable estimation of interest for loss of use, attorney fees and costs of collection -- damages arising from the breach of the underlying contract are irrelevant).

Contracts / Change-of-Terms Provision

Stover v. Experian Holdings., No. 19-55204 (9th Cir. Oct. 21, 2020)

In order to bind parties to new terms pursuant to a change-of-terms provision, both parties must have notice that the terms have changed and an opportunity to review the changes.

Although the Stover decision may be important for consumer credit rights, the recent Ninth Circuit Court of Appeals decision is a reminder that businesses that use online terms and conditions should be wary of relying on unilateral change-of-terms clauses in their online terms and conditions.?The issue before the court was whether a single website visit after assent to a contract containing a change-of-terms provision was enough to bind the parties to the terms of the newly revised contract. The 9th Circuit Court of Appeals determined that it was not and applied the original contract terms. The Ninth Circuit noted that in Douglas v. United District Court for the Central District of California decided in 2007, the court determined that lack of notice will make changed terms unenforceable even if a plaintiff visited the website where the new contract was posted. This is because contracting parties have no obligation to check the terms on a periodic basis to see if anything has changed

So what lessons can businesses take away from the Stover decision? For new customers, make sure the customer is properly presented with your up to date terms as part of the initial credit agreement/sales contract including through a proper incorporation by reference clause.?For existing customers, businesses should consider written notices or specific email alerts (or both), letting customers know that your terms, conditions, and/or policies have been updated and changed.?It may be best practice to enclose the entirety of the new updated terms, or at least include a brief summary of the revisions, in addition to links to the updated terms or policies themselves. It is also important to reference the revision date of the new terms and to be sure to keep a copy of a complete set of terms and conditions for each such revision date. Finally, ensure that each change-of-terms are documented/recorded in a way in which the business could prove that the change occurred if and when it has to.

Mechanics Liens / Anti-SLAPP / Litigation Privilege

RGC Gaslamp, LLC v. Ehmcke Sheet Metal Co., Inc., 56 Cal.App.5th 413 (2020)

Mechanics liens are a protected petitioning activity under the litigation privilege even if they are invalid and duplicative of former liens; a slander of title claim to remove a mechanic’s lien can be struck down by an anti-SLAPP motion.

The result of the RGC Gaslamp case may be surprising to many based on the facts of the case. RGC Gaslamp, LLC (“RGC”) hired Ehmcke Sheet Metal (“Ehmcke”) to perform sheet metal installation and fabrication on a hotel project. Ehmcke claimed that it was not being paid by RGC and filed and recorded a mechanics lien for $257,978. The following month, RGC secured and recorded a bond from Liberty Mutual for $322,473 to release the lien. Ehmcke then filed a second mechanic’s lien identical to the first one. A few months later, Ehmcke filed and recorded a series of documents in which it withdrew the first and second liens and filed a third identical lien. RGC then obtained another bond from Liberty Mutual, which led Ehmcke to release the third lien and file a fourth. After the fourth lien, RGC filed a lawsuit against Ehmcke for quiet title, slander of title, and declaratory and injunctive relief. RGC argued that the fourth lien was untimely and would damage its property in excess of $2 million. Ehmcke immediately removed the fourth lien and filed an anti-SLAPP motion contending that its liens were protected petitioning activity under the litigation privilege. The trial court granted Ehmcke’s anti-SLAPP motion holding that the fourth mechanic’s lien was protected by the litigation privilege because that privilege “is absolute and applies irrespective of Ehmcke’s evil motives or total lack of merit of the recorded lien.” Ehmcke received $30,000 in attorney’s fees and $1,062 in costs.

The Court of Appeal affirmed the trial court’s ruling in favor of Ehmcke and determined that Ehmcke’s anti-SLAPP motion was properly granted because the filing of mechanics liens constitutes protected activity, even if the liens are invalid or otherwise improper. While the appellate court noted that RGC could have proceeded with its quiet title action if the mechanics lien had remained on the property, RGC could not attack Ehmcke with a claim of slander of title.?The court also suggested that RGC could have sought declaratory or injunctive relief allowing it to post a single bond to release all duplicative liens. Also, it should be noted that the RGC Gaslamp decision puts in doubt a previous appellate decision (A.F. Brown Electrical Contractor, Inc. v. Rhino Electric Supply, Inc., 137 Cal.App.4th 1118 (2006)) and may in the future allow a stop payment notice claimant to successfully use the litigation privilege to protect service of a stop payment notice since it is a prerequisite?to a stop payment notice enforcement action.

Contracts / Arbitration / Construction Law

Remedial Constr. Servs., LP v. AECOM, Inc., 65 Cal.App.5th 658 (2021)

Incorporation by Reference of a Contract is Not Absolute

?In this appellate case handed down on June 15, 2021 (https://www.courts.ca.gov/opinions/archive/B303797.PDF ), the California Court of Appeal highlighted the importance of ensuring consistency between a prime contract and subcontract. The appellate court’s deep dive into the enforceability of a document incorporated by reference will likely lead to future challenges to the enforceability of contractual provisions that are incorporated by reference from another document. In this case, the court provided several reasons why an arbitration provision contained in a 151-page prime contract was inapplicable to a dispute between the prime contractor and subcontractor, including: (1) the subcontract expressly included a litigation provision (not an arbitration provision); (2) the subcontract’s “order of precedence” clause specifically gave precedent to the subcontract and amendments thereto over the prime contract; (3) the subcontract expressly incorporated particular provisions of the prime contract (such as force majeure events), but not the prime contract’s arbitration provision; (4) the subcontract’s joinder provision required the subcontractor to consent to joinder in any arbitration, mediation, or litigation between the prime contractor and owner, but was silent regarding arbitration of claims between the prime contractor and subcontractor; and (5) the incorporation by reference clause was limited to the subcontractor’s work. At the end of the day, prime contractors should ensure that the dispute resolution clause in its subcontracts are consistent with the clause in its prime contract rather than just relying on an incorporation by reference provision, and careful consideration should be given to whether the incorporation by reference provision should be limited to the disputes concerning the subcontractor’s work and whether the order of precedence provision should apply to certain provisions of the subcontract or the entirety of the document. On the other hand, subcontractors are reminded to secure a copy of the prime contract when it is incorporated by reference into the subcontract so that they can familiarize themselves with the duties and obligations that they may unintentionally and unknowingly agreed to.

Contracts / Pay-When-Paid Provisions / Construction Law

Crosno Construction, Inc. v. Travelers Casualty and Surety Co., 7 Cal. App. 5th 940 (2020)

Pay-When-Paid: A Reasonable Time Must be "Reasonable"

Although the Crosno case is now more than 18 months old, we would be remiss if we didn’t reemphasize the importance of the appellate decision to contractors and subcontractors in the California construction industry. We previously blogged about this case here: https://www.gibbsgiden.com/blog/pay-when-paid-courts-hold-a-reasonable-time-now-has-to-be-reasonable/

Of course, it is well-settled that “pay-if-paid” clauses are unenforceable as contrary to public policy in California pursuant to the landmark California Supreme Court decision in Wm. R. Clarke Corp. v. Safeco Ins. Co. 15 Cal.4th 882 (1997).?In that case, the Supreme Court distinguished an unenforceable pay-if-paid provision from a pay-when-paid provision, by explaining that a pay-when-paid provision does not establish a true condition precedent, but “merely [fixes] the usual time for payment to the subcontractor, with the implied understanding that the subcontractor in any event has an unconditional right to payment within a reasonable time.”?Subsequent to the Wm. R. Clarke case, general contractors throughout the State of California amended their form subcontract agreements so that the parties would agree to the definition of what constitutes a “reasonable time.”?In most sophisticated subcontract agreements, that “reasonable time” is defined as the length of time it takes the general contractor to pursue its remedies against the owner.?Crosno held that a “pay-when-paid” provision in a subcontract is void and unenforceable against a subcontractor’s payment bond claim when the provision purports to delay payment for as long as necessary for the direct contractor to pursue its claim against the project owner.?In sum, the key to the court’s decision was the particular language used in the subcontract, which defined a “reasonable time” as an unreasonable indefinite period.?The court determined that such a definition was unacceptable because that provision “has the effect of the delaying payment to the subcontractor for what may be—and in this case was—an unreasonably long period of time.”?And while this case concerned a payment bond claim and the surety’s obligations, the court’s reasoning seems easily translatable to a subcontractor’s claim against a direct contractor.?Therefore, as a result of the Crosno case, not only will sureties not be able to rely on unreasonable definitions of “reasonable time” for payment, but also direct contractors should amend their subcontract form agreements to redefine a “reasonable time” as something that is not indefinite and unreasonably long.

Christopher Eric Ng, Esq.

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