Wilke Fleury welcomes Bianca Watts to its Summer Associate Program. Ms. Watts recently completed her second year of law school at the University of the Pacific, McGeorge School of Law. She is a staff writer for the McGeorge Global Business and Development Journal and an executive board member of the Black Law Student’s Association. Last summer, Ms. Watts participated in the Sacramento County Bar Association Diversity Fellowship Program. Ms. Watts is an avid fan of the New Orleans Saints and the Sacramento Kings, and is currently studying karate.

Construction contracts often contain indemnity provisions. Indemnity provisions generally allow one party to a contract who, if found liable in a lawsuit, may then seek reimbursement from the other contracting party. Indemnity provisions are commonplace in the construction industry, most significantly in contracts between general contractors and their subcontractors. When a developer or general contractor is sued by a commercial or residential property owner, they may seek indemnity, or reimbursement, from the subcontractors, who typically do most, if not all, of the actual work.

Indemnity Rights Can Be Assigned 
However, developers and general contractors are not always the only persons who can end up with indemnity rights. The law allows a person to assign their indemnity rights. While unusual, it is possible for a developer or general contractor to assign his or her indemnity rights to the plaintiff as part of the settlement of the lawsuit. Indemnity rights can be a valuable asset, but they can also be a liability.

Indemnity rights can become a valuable non-cash part of a settlement between a general contractor and a homeowner, for example. In a construction defect action, the homeowner may name the general contractor and certain subcontractors as defendants. The general may then, in turn, sue the subcontractors for indemnity, bringing them into the lawsuit as cross-defendants. If the homeowner settles with the general, he is relieved of liability, but the non-settling subcontractors are not. If, as part of the settlement, the general assigned his indemnity rights, the homeowner basically “steps into the shoes” of the general and may continue the lawsuit against the non-settling subcontractors for additional amounts and also based upon the indemnity rights in the contract between the general and the non-settling subcontracts.

For example, assume a homeowner sues a general contractor for negligence and breach of contract, and the subcontractor for negligence. The homeowner settles his lawsuit against the general contractor for $1.6 Million cash and an assignment of the indemnity rights in the contract. Further assume that the assignment has an estimated value of $200,000. The total settlement amount is thus $1.8 Million. The homeowner then continues the negligence lawsuit against the subcontractor and obtains a $3 Million judgment. At the same time, the homeowner also brings the general contractor’s indemnity action against the same subcontractor (based on the general contractor’s contract with the subcontractor) and the jury awards $1.5 Million. The homeowner’s $3 Million direct judgment against the subcontractor will be reduced by his earlier settlement amount, leaving the homeowner with $1.2 Million in his negligence action. The judgment based on the indemnity provision in the contract will not be reduced. The total judgment for the homeowner is $2.7 Million ($1.2 Million + $1.5 Million), which is less than the $3 Million in negligence damages the jury awarded him. Yet, when the homeowner adds the $2.7 Million judgment to the $1.6 Million cash from the settlement, the homeowner’s total recovery is $4.3 Million, or $1.3 Million more than the jury awarded him. Furthermore, if the assigned contract with the indemnity rights included an attorneys’ fees provision, the homeowner may also be entitled to attorneys’ fees.

Attorney Fees May Be Part Of The Claim
Consider however, that if the homeowner loses the lawsuit, the general contractor would not have been held liable for the work of the subcontractor. Therefore, the homeowner will not prevail on the assigned indemnity lawsuit making the indemnity provision worthless to the homeowner.

Although worthless to the homeowner, the indemnity rights may be quite valuable to the prevailing subcontractor since many contracts contain attorneys’ fees provisions that are also assigned with the contract. Attorneys’ fees provisions give the prevailing party, whichever party that is, the right to reimbursement for reasonable attorneys’ fees. When the lawsuit is based on a contract that contains an attorneys’ fees provision and other non-contract causes of action, the attorney fees can generally only be recovered for the contract cause of action. However, a court may grant attorney fees for the entire lawsuit, not just the contract cause of action, when the legal issues were common to the contract and non-contract causes of action.

Losing Party May Be Forced To Pay Attorney Fees Twice

Consequently, the losing homeowner may be liable for attorneys’ fees both in his negligence action and in the indemnity action against the subcontractor based upon the indemnity provision in the assigned contract. The indemnity provision required the general contractor to be found liable for negligence so that the general contractor could indemnify the subcontractor for the subcontractors’ defective work. In other words, the subcontractor was not liable unless the general contractor was liable. Therefore, when the homeowner brought his negligence and indemnity causes of action, both causes of action were intertwined and the court had discretion to award attorneys’ fees to the subcontractor in defending itself against both the negligence and indemnity claims. This result occurs even though the homeowner was not a party to the original contract.

In conclusion, contractual indemnity provisions can provide protection to developers and general contractors who are later sued for defective work. In the event of a lawsuit, the indemnity rights may be assigned and become part of a negotiated settlement. When accepting indemnity rights, the risks and benefits associated with any attorneys’ fees provision must be considered.

A mechanic’s lien is a remedial mechanism by which a contractor or subcontractor on a private work project can guarantee payment for services and work provided. The reasoning behind this is that since the contractor or subcontractor provided services which increased the value of the private property, they should have an enforcement tool toward guaranteeing payment for those improvements. Take, for example, a not-uncommon scenario in today’s economy: a general contractor contracts with a roofer but fails to pay and files bankruptcy. A valid mechanic’s lien held by the roofer will likely require the homeowner to pay the roofer for his or her services even though the homeowner may have paid the general contractor in full.

The law provides this remedy to a very broad spectrum of claimants, essentially any person or business entity who at the request of a private owner, or his agent, has furnished labor, material, leased equipment or furnished any special skills and/or services to a project for improving real property may be entitled to record a lien against that property. (See Civil Code §3110.)

Step 1: Preserve Your Right To A Mechanic’s Lien By Recording And Serving A Preliminary Notice
Pursuant to Civil Code section 3114, before you can enforce a mechanic’s lien a preliminary twenty (20) day notice must be served. The notice must be in writing and must contain at least the following information:

(1) A general description of the labor, service, equipment, or materials furnished, or to be furnished, and an estimate of the total price thereof.

(2) The name and address of the person furnishing that labor, service, equipment, or materials.

(3) The name of the person who contracted for purchase of that labor, service, equipment, or materials.

(4) A description of the jobsite sufficient for identification.

(5) A heading, set forth in boldface type, stating “Notice to Property Owner,” and the subsequent statements as spelled out in Civil Code section 3097(c)(5).

Any tradesperson that provides services to a general contractor who in turn is providing services to a private landowner must serve a preliminary notice within twenty (20) days of the time services are first provided on the project. A general contractor and/or a subcontractor with a direct contractural relationship with the owner is not required to provide preliminary notice. Additionally, this preliminary notice must be served upon the owner or reputed owner, the original contractor, or reputed contractor, and to the construction lender within the twenty (20) day time period. A preliminary notice must be served either personally, by registered or certified mail.

Step 2: Record And Serve The Lien
If you are not timely paid during the course of the project or at the end of the job, the recordation of a mechanic’s lien is a powerful remedy. Often, payment follows shortly thereafter. It is important to understand, however, that the lien must recorded within ninety (90) days after the completion or cessation of the work on the project. However, if the owner of the property records either a notice of completion or a notice of cessation, the contractor has only thirty (30) days from the time the notice is recorded to record his mechanic’s lien. The lien should be recorded in the County in which the real property is situated. Pursuant to Civil Code section 3084, the mechanic’s lien must include the following:

(1) A statement of the amount owed, after deducting all just credits and offsets.

(2) The name of the owner or reputed owner, if known.

(3) A general statement of the kind of labor, services, equipment, or materials furnished by the claimant.

(4) The name of the person by whom the claimant was employed or to whom the claimant furnished the labor, services, equipment, or materials.

(5) The location or a description of the site sufficient for identification.

(6) The claimant’s signature and verification that the claims made in the mechanic’s lien are true and accurate.

Frequently, the mere recordation of a mechanic’s lien will motivate payment of any outstanding balance. If not, then the lien must be perfected by filing a lawsuit in the Superior Court.

Step 3: Perfect the Mechanic’s Lien
If the contractor remains unpaid after the recordation of the mechanic’s lien, the claimant must file a lawsuit to foreclose the lien within ninety (90) days from the date the lien was recorded. A lawsuit is commenced by the filing of a complaint in the Superior Court. Failure to meet the filing deadline will result in the loss of your ability to enforce the lien.

While a contractor always retains the ability to proceed with a breach of contract action against the person or entity that actually hired you, (the homeowner or general contractor in most cases) the loss of lien rights through failure to file the preliminary notice or to perfect the lien may mean that you won’t get paid if the primarily responsible party has filed for bankruptcy protection or is otherwise judgment-proof. That is why it is always a good idea to have an attorney draft the paperwork and ensure that the filing deadlines are met. However, to save money, some contractors fill out the forms themselves and simply have the attorney review them before mailing or filing.

Construction law is constantly changing. A savvy contractor keeps abreast of those changes and adapts his business methods to conform to new requirements. Here are some recent legislative updates and court decisions that may affect your business.

Notice of Mechanic’s Liens Now Required 
As of January 1, Civil Code section 3084 now requires that lien claimants provide written notice to the property owner that the lien is recorded. The new law contains specific language and font size requirements. Most importantly, failure to provide the notice as required renders the lien unenforceable.

Notice of Pendency of Action to Become Mandatory
As of January 1, 2011, Civil Code section 3146 will mandate that a Notice of Pendency of Action (Lis pendens) be recorded within 20 days of the filing an action to foreclose a mechanic’s lien. Current law does not require the recordation of a Lis pendens. It is unclear if a failure to timely record the notice will affect the validity of the lien.

Unlicensed Contractors Ordered to Disgorge 
In White v. Cridlebaugh (2009) 178 Cal. App. 4th 506, the court of appeal recently held that an unlicensed contractor was required to reimburse an owner more than $80,000 for construction work performed while unlicensed. The appellate court found that Business & Professions Code section 7031(b) was designed to treat consumers consistently, regardless of whether or not they already paid the contractor for unlicensed work. Section 7031(b) protects an owner from suit for payment by an unlicensed contractor. This case now makes clear that unlicensed contractors cannot avoid the effect of the statutes by collecting prepayment before undertaking work or by retaining progress payments for completed phases of work.

Like it or not, if you have employees with access to the internet, they are likely using online social networking websites such as Facebook, Twitter, MySpace and LinkedIn. The explosion in the popularity and use of such sites creates a whole new (cyber)world of concern for employers trying to regulate and monitor the online activities of their employees. The ease with which users can now post information on the internet leads to the possibility that employees may damage their company’s reputation, reveal confidential information, or expose employers to claims of defamation or harassment. To deal with such risks, employers must consider creating a comprehensive set of policies to regulate and monitor the online activities of employees in the workplace, while at the same time remaining cognizant of privacy concerns and other limits on managing online activity and communications.

Liability for Harrassment
As most informed employers already know, federal and California anti-discrimination laws require that employers act to prevent or eliminate harassment in the workplace. With the advent of the online world, employers must now be aware of online activity such as posting unwelcome messages or statements which can form the basis of a hostile work environment claim. An employer may be held liable for such activity if the conduct has a sufficient nexus to the workplace and the employer has actual or constructive knowledge of the unwelcome conduct but takes no steps to stop it.

The risk of liability from employee conduct was illustrated in Blakey v. Continental Airlines, Inc., where the New Jersey Supreme Court found that an employer could be held liable for a hostile work environment claim arising out of derogatory statements posted on an Internet bulletin board designed for continental employees. While the bulletin board was provided by an outside vendor and not Continental itself, the board was available to all pilots and crew members. Continental argued that because the harassment did not occur at a workplace under its direct control, it should not be liable. The Court disagreed, finding that although the electronic board may not be located at a physical site, it may have been so closely related to the workplace and beneficial to the employer that harassment in the forum could be regarded as a part of the workplace. The Court recognized that privacy concerns were implicated by its ruling and emphasized that employers are not required to monitor all private communications of their employees, but that employers still have a duty to stop co-worker harassment in settings related to the workplace if they know or have reason to know that harassment is taking place. This case demonstrates that employers can no longer turn a blind eye to harassment in the virtual world.

Liability for Monitoring
Given the myriad risks associated with employee online activity, employers clearly have an interest in monitoring social networking activities that relate to an employee’s work. While it’s true that employers cannot turn a blind eye to the virtual world, they must cautiously approach any type of online monitoring they undertake. Of primary concern is the employee’s right to privacy. In California, the courts balance the employee’s reasonable expectation of privacy against the employer’s business justification for the monitoring to determine whether an employee’s privacy has been violated. While it used to be well-settled that an employer in the private sector could monitor email and internet activity on equipment provided by the employer (so long as there was an explicit policy which called for such monitoring), the law is becoming increasingly unclear, particularly where an employee has restricted access to his or her online social network.

The Stored Communications Act (“SCA”) is a federal statute that prohibits third parties (i.e. employers) from accessing electronically stored communications – for example, email or Facebook entries – without proper authorization. While the SCA creates an exception where the conduct is “authorized”, most courts have construed that exception narrowly. Two recent cases are illustrative.

In Pietrylo v. Hillstone Restaurant Group, two employees were fired after posting derogatory comments about their employer on a MySpace user group that the employees had created to complain about their jobs. The user group was by invitation only and required a password to view, but the employees’ supervisor requested and received the password from another employee and viewed the postings. The employee who provided the password later testified that she feared her refusal to give the password to her supervisor would have affected her job negatively. The jury found that the employee was coerced into providing the login information and returned a verdict against the employer for violating the SCA. Similarly, in Konop v. Hawaiian Airlines, Inc., a pilot created and maintained a website wherein he posted entries critical of his employer. Access to the site was restricted by the pilot and he only allowed access to “authorized users.” Two of the users provided their login information to a Hawaiian official, who then accessed the site. The creator of the site sued Hawaiian under the SCA and the court held that Hawaiian was liable because there was no evidence that either of the authorized users who provided the login information had ever accessed the site themselves; and therefore, they were not “users” who could authorize the Hawaiian official’s access. These cases illustrate the confusing and unsettled waters employers must navigate when monitoring online activity.

Steps to Take
A final consideration for employers is what they may do once monitoring has uncovered unsavory information. California law prohibits employers from discriminating against employees for lawful conduct that occurs away from the workplace during non-work hours. There is also concern that certain employee online activity may be protected by the National Labor Relations Act. Further, even if an employer were to determine that it could (and should) take action, such action should be taken consistently so as to avoid claims that the employer has discriminated against a protected group by not imposing the same disciplinary action on other similarly situated employees.

So what is an employer to do?
Start by developing a comprehensive set of policies to regulate and monitor employee online behavior in the work context. An employer must consider the goals of these policies, which should include protection of the company’s reputation, confidential information, trade secrets, and the privacy of its employees. Such policies will be most effective if they (1) urge employees to go to human resources before venting online, (2) establish a disciplinary framework for misuse of social networking sites related to employment, (3) establish a reporting system for suspected violations of the policy and, (4) reiterate that the company may monitor email and internet use on company equipment. Above all, the policies must be enforced uniformly.

Wishing the internet away or eliminating its use by employees is, respectively, impossible and increasingly infeasible. Gaining control of the issue proactively through education and a well written policy allows employers to harness the good that can come from the internet while minimizing the bad.

In March of this year, the IRS began the Employment Tax National Research Program, the first comprehensive employment tax compliance study in 25 years. The IRS will randomly select 2,000 taxpayers each year for the next three years to conduct comprehensive audit examinations. Taxpayers selected for audit will receive notices describing the National Research Program process.

In these random audits, the IRS will focus on worker classification and fringe benefit policies. A fringe benefit is a form of compensation for the performance of services. However, a person who performs services for an employer for purposes of fringe benefit compensation does not have to be an employee. A person may perform services as an independent contractor, partner, or director. Furthermore, for fringe benefit purposes, a person who agrees not to perform services (such as under a covenant not to compete) is also considered to be performing services. An employer is considered the provider of a fringe benefit even if the benefit is actually provided by a client or customer of the employer. The key is that the benefit is provided to the employer’s employee, contractor, director, or partner for services performed for the employer. Similarly, the employee, contractor, director, or partner is still considered the recipient of the benefit even if it is actually provided to someone who did not perform the services for the employer, such as a family member. Again the key is that the benefit is provided for and because of services performed for the employer. Absent a specific exclusion, fringe benefits are taxable and must be included in the recipient’s pay, and therefore, creates an obligation on the employer to withhold, deposit and report employment taxes relative to fringe benefits.

Fringe benefits, though, are distinguishable from expense reimbursement plans. Generally an advance, reimbursement or other expense allowance received under an “accountable plan” is not income to an employee and does not create employment tax obligations on the employer. An advance reimbursement, or other expense allowance, is treated as made under an “accountable plan” if:

1. the employee receives the advance reimbursement or other expense allowance for a deductible business expense that the employee paid or incurred while performing services as an employee of the employer,

2. the employee adequately accounts to the employer for the expense within a reasonable period of time, and

3. the employee must return any excess reimbursement or allowance within a reasonable period of time.

If an advance, reimbursement or other expense allowance to an employee does not satisfy all three of these conditions, it is treated as paid under a nonaccountable plan. All advances, reimbursements or other expense allowances paid under a nonaccountable plan are taxed to the employee and create an obligation on the employer to withhold, deposit and report employment taxes relative to all such nonaccountable plan payments.

Similarly, improper classification of employees or independent contractors could have a significant impact on federal and state tax liabilities (including unemployment tax liability), health and welfare benefit obligations, Code-qualified benefit plan participation and funding, as well as IRS penalty exposure for an employer. Worker classification can be a complex area as each case requires careful analysis of the facts and circumstances in light of general common law principles and divergent IRS and case rulings. In very general terms, classification depends on the degree of control by the employer versus independence of the worker. Factors that provide evidence of the degree of control and independence generally fall into three categories:

1. Behavioral: Does the company control or have the right to control what the worker does and how, when or where the worker does his or her job?

2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship be ongoing? Is the work performed a key aspect of the business?

However, there is no “magic” factor or set number of factors that will tip the determination one way or the other. In fact, more likely than not, there will be some factors indicative of employee status, while other factors indicate that the worker is an independent contractor. Furthermore, factors which are relevant in one situation may not be relevant in another. An in depth discussion of this issue is beyond the scope of this article, but the general recommendation is to pay careful attention to worker classifications because, again, mis-classification can result in significant liabilities for an employer.

Even if not randomly audited as part of the current IRS study, employers should be on notice that the IRS is giving greater scrutiny to employer practices and will ultimately use the information gathered through this study to focus on particular types of employers and employment tax and benefits issues. As such, it is prudent for employers to review their fringe benefit and expense reimbursement policies and procedures as well their independent contractor relationships for correct classification. Identification and correction of any errors, omissions or inconsistencies relative to employment tax and benefits is much easier and less costly if done proactively as opposed to after coming under IRS scrutiny.

In the event you receive a notice of audit pursuant to the Employment Tax National Research Program or would otherwise like assistance with compliance review of your employment tax and benefits policies and procedures or employee classifications, the employment and tax attorneys at Wilke Fleury are happy to assist you.