In California, higher-tiered contractors can find themselves paying subcontractors’ employees if the subcontractors’ subcontractors fail to pay their workers.

With some limitations, higher-tiered contractors on private works projects are liable for their lower-tiered subcontractors failing to pay their workers. With its enactment in 2019, Labor Code section 218.7, which applies to contracts entered into between January 1, 2018 and December 31, 2021, and later enactment of Labor Code section 218.8, which applies to contracts entered into on or after January 1, 2022, “direct contractors” who enter into contracts for the “erection, construction, alteration, or repair of a building, structure, or other private work” are jointly liable for “any debt owed to a wage claimant or third party on the wage claimant’s behalf, incurred by a subcontractor at any tier acting under, by, or for the direct contractor for the wage claimant’s performance of labor included in the subject of the contract between the direct contractor and the owner.”

Both Labor Code sections 218.7 and 218.8 are limited to “direct contractors” (i.e., parties in direct contract with the project owner), not to all higher-tiered parties who have lower-tiered subcontractors, and only apply to wage debts owed by subcontractors not material suppliers. However, direct contractors are liable for wage debts owed by lower-tiered subcontractors of all tiers, whether a 1st tier subcontractor, a second-tier subcontractor, or lower, and it applies broadly to all private construction works.

Under Labor Code sections 218.7, which applies to contracts entered into between January 1, 2018 and December 31, 2021, direct contractors are liable for unpaid wages, fringe or other benefit payments or contributions, and interest but not penalties or liquidated damages. However, under Labor Code section 218.8, which applies to contracts entered into on or after January 1, 2022, direct contractors are liable for unpaid wages, fringe or other benefit payments or contributions, and interest as
well as penalties or liquidated damages.

The California Labor Commissioner, in response to a complaint filed by an unpaid worker, can bring an administrative wage enforcement action, issue a citation, or bring a civil action against the direct contractor for unpaid wages and interest. In addition, unions owed fringe or other benefit payments or contributions, can bring a civil action against the direct contractor, and if they do, are also entitled to recover their reasonable attorneys’ fees and costs as well as expert witness fees.

Finally, joint labor-management cooperation committees established under the federal Labor Management Cooperation Act of 1978 can bring a civil action against the direct contractor and offending subcontractor for unpaid wages, and if they do, are also entitled to recover their reasonable attorneys’ fees and costs as well as expert witness fees. However, they must first provide the direct contractor and offending subcontractor 30-days’ notice of such claim by first-class mail describing the general nature of the claim, the project name, and the name of the employer.

If the direct contractor does not have sufficient assets to pay for the wage debts owed by a subcontractor on a private works project, their property can be attached and sold to satisfy any judgment rendered against the direct contractor.

A claim against a direct contractor must be filed within one (1) year of the earliest of the following: (1) recordation of a notice of completion; (2) recordation of a notice of cessation of work; or (3) actual completion of the project.

Direct contractors can protect themselves against such claims on private works projects. Labor Code section 218.8, which, unlike Labor Code section 218.7, makes a direct contractor potentially liable for penalties or liquidated damages, includes a “safe harbor” from penalties and liquidated damages. Under Labor Code section 218.8, a direct contractor is not liable for penalties or liquidated damages unless (1) the direct contractor had knowledge of the subcontractor’s failure to pay wages, fringe or other benefit payments or contributions; or (2) the direct contractor complies with the following:

• The direct contractor monitors the subcontractors’ wage, fringe or contributions through periodic review of the subcontractor’s payroll records;
• Upon becoming aware of the subcontractor’s failure to pay wages, fringe or other benefit payments or contributions, the direct contractor takes corrective action to halt or rectify the failure, including, but not limited to, retaining sufficient funds from the subcontractor; and
• Prior to making final payment to the subcontractor, the contractor obtains an affidavit from the subcontractor, signed under penalty of perjury, that the subcontractor has paid all wage, fringe or other benefit payments or contributions.

Under both Labor Code sections 218.7 and 218.8, upon request by a direct contractor to a subcontractor, the 1st tier subcontractor and any 2nd-tier subcontractors must provide: (1) payroll records showing the last four (4) digits of the social security numbers of workers working on the project with information, as applicable, of fringe or other benefit payments or contributions (“Payroll Information”); and (2) award information including the project name, name and address of the subcontractor, the contractor with whom the subcontractor is under contract, anticipated start date, duration, and estimated journeymen and apprentice hours, and contact information for its subcontractors on the project (“Award Information”).

Withholding payment is considered a good faith or bona fide “dispute” for purposes of the state’s prompt payment laws. However, Labor Code section 218.8 states that a payment withholding is considered “disputed” for purposes of the state’s prompt payment laws but only if: (1) the subcontract provides that the subcontractor must provide upon request (or automatically) Payroll Information or Award Information; (2) such information is not provided; and (3) money withheld is released upon submission of such information.

Contractors can also mitigate the risk by contract. Contractors can include right of approval provisions in the subcontract giving the direct contractor the right to approve 2nd tier and lower subcontractors to help ensure that only reputable subcontractors, who are more likely to pay their workers, are hired.

They can also require inclusion of provisions requiring that subcontractors provide the Payroll Information and Award Information discussed above, or be subject to withholding, so that the direct contractor has the right to withhold payment from the subcontractor without fear of being subject to prompt payment penalties.

Contractors can also include a flow-down provision requiring that subcontractors include the same requirements in their subcontracts with 2nd-tier subcontractors and a requirement that their subcontractors include the same requirements in any subcontracts with their lower-tiered subcontractors. Such provisions should specifically state that a direct contractor can withhold payment from a subcontractor, not only if Payroll Information and Award Information is not provided, but if a subcontractor does in fact not pay wages when due or if the direct contractor has an objective good faith believe that the subcontractor has not or will not pay wages when due.

Contractors can should also ensure that indemnity provisions are broad enough to cover “wage claims” including claims for “penalties” and “liquidated damages.”

Although not always feasible, contractors can require that 1st tier subcontractors obtain a payment bond and the right of the direct contractor to make a claim on that payment bond for unpaid wages, fringe or other benefit payments or contributions, including, interest, penalties, and liquidated damages.

If you are a direct contractor that hires subcontractors it is not only prudent, but also imperative, to have your legal counsel review your contracts and revise them to provide protection in case a subcontractor does not pay its workers.

The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.