In 2004, taking aim at what critics referred to as California’s “underground economy,” the California legislature enacted Labor Code section 2810 (“Section 2810”). The statute proscribes subcontracts in specifically enumerated industries—construction, farm labor, garment, janitorial, and security guard contractors—that do not provide “sufficient” funds to allow subcontractors to comply with applicable labor laws. In order to prevail, a plaintiff must show that the person hiring the subcontractor “knows or should know” of the contract’s insufficiency.

Section 2810 permits inquiry into the contractor’s “familiarity with the normal facts and circumstances of the business activity engaged in,” and the contractor’s knowledge of “additional facts or information that would make a reasonably prudent person undertake an inquiry” as to the sufficiency of the contract.

Violations of Section 2810 can be costly; damages are the greater of actual damages or $250 per employee for an initial violation and $1,000 per employee for subsequent violations, in addition to reasonable attorneys’ fees. An aggrieved employee may also bring an action for injunctive relief, and if successful, may recover costs and reasonable attorneys’ fees.

Employees of Construction Subcontractors Frame Class Action Against Toll Bros., Inc.

Castillo v. Toll Bros., Inc. and Hernandez v. Toll Bros, Inc. were class action lawsuits seeking damages from a home builder for alleged wage and hour violations by its subcontractors, Capaz Construction Corp. and Shannon Construction Inc. The alleged violations included failures to pay overtime, to provide meal and rest breaks, and to pay wages due on termination. The plaintiffs, former employees of Capaz or Shannon, alleged that Toll Bros. was liable under Section 2810 because it knew or should have known that the contracts with Capaz and Shannon were insufficient to allow compliance with the applicable wage and hour laws. The plaintiffs also asserted claims under other statutes, in addition to various common law claims. After Toll Bros. successfully moved for summary judgment in both cases, the plaintiffs appealed, and the cases were consolidated.

The Court of Appeal affirmed the granting of summary judgment against the Hernandez plaintiffs, but largely disagreed with the trial court as to the Castillo plaintiffs and reinstated their claims under Section 2810. Delving deeply into the language and purposes of the statute, the Court of Appeal answered four questions: (a) whether “sufficiency” under Section 2810 means more than compliance with the minimum wage laws; (b) how to determine whether a party “knows or should know” of a contract’s insufficiency; (c) whether a plaintiff must show causation in order to prevail; and (d) whether Section 2810 is preempted by the National Labor Relations Act.

Evidentiary Battle: Reasonable Reliance on Data from Subcontractors?

The court’s opinion devoted a great deal of attention to the evidence offered by the parties in the trial court. To better understand the opinion, and in light of the U.S. Supreme Court’s recent decision in Wal-Mart Stores, Inc. v. Dukes 564 U.S. ___ (2011), it is worth summarizing the evidence here.

Toll Bros.’ evidence highlighted the company’s ostensibly reasonable reliance on the information provided by the subcontractors at the time of contracting. Declarations affirmed that the bidding process generally is uncertain: bidders provide little evidence about the bases for their bids; and subcontractors have an incentive to minimize labor cost allocations in order to reduce the retention amounts for incomplete or inadequate work. For the contracts at issue here, declarations from the subcontractors’ principals confirmed that at the time of bidding the subcontractors could not be sure of the exact staffing needed or the amount of overtime, if any, needed to complete the projects. Therefore, the subcontractors had not provided Toll Bros. with information about the number of employees who would be used to perform the contract. All of the declarants affirmed their subjective belief that, at the time of contracting, the subcontracts with Toll Bros. included sufficient funds to pay the employees in compliance with legal requirements.

The plaintiffs offered evidence to show that it was possible to know prospectively that the contracts were insufficient under Section 2810. Some of the evidence was circumstantial, describing Capaz’s and Shannon’s reputations for submitting low bids, for allocating less to labor costs than the industry standard, and for paying low wages. Neither court deemed this evidence sufficient to create triable issues of fact.

The evidence that did grab the Court of Appeal’s attention came from declarations of the Castillo plaintiffs’ expert. Using information and techniques that are widely accepted in the construction industry for estimating construction contract costs, the expert’s first declaration strongly suggested gross underpricing by Capaz and Shannon. A second declaration using the same techniques but revised cost figures concluded that for two of the Capaz projects the cost of materials did not leave sufficient funds to pay labor costs even at the minimum wage (or, in one case, at all).

Regarding the actual sufficiency of the contracts, Toll Bros. relied on evidence that both subcontractors paid wages in excess of the legal minimum. The plaintiffs’ evidence disputed this evidence, and also detailed the subcontractors’ serious financial problems incurred, and numerous wage and hour violations committed, in the course of performing the subcontracts with Toll Bros. Two of the Capaz contracts could not be completed under the originally agreed terms; in one case Toll Bros. brought in a new contractor and in another Toll Bros. paid additional amounts to Capaz to cover significant overruns. For a third contract, Toll Bros. considered providing additional funding to Capaz but apparently nothing was done.

Court of Appeal’s Analysis

Sufficiency of a Contract Is Measured by Minimum Legal Wage Rate

Turning to the legal issues raised on appeal, the court first considered the plaintiffs’ argument that, in the construction industry, payment of minimum wage rates could not support a finding of sufficiency. They argued that the statutory language allowing consideration of “the normal facts and circumstances of the business activity,” meant that sufficiency must be measured by the nature of the activity and prevailing wage rates specific to that activity. And while the minimum wage may be the norm in other industries subject to Section 2810, the skilled labor required for construction work demands higher wage rates.

The Court of Appeal rejected this argument, finding that the statute unambiguously requires nothing more than compliance with minimum wage laws, unless a local law or regulation mandates payment of more than the minimum wage. The court noted that a contrary result would unduly burden contractors, creating uncertainty as to what wage rates applied in any specific instance.

Duty to “Know” Sufficiency Extends to Life of Contract

The court next considered the question of knowledge—the meaning of the phrase “knows or should know,” and whether the plaintiffs’ evidence created triable issues of fact. On these questions, the Castillo plaintiffs met with greater success.

First, the court accepted their argument that the statute required inquiry not only into the contracting party’s prospective knowledge, but also into the actual sufficiency of the contract.The court explained that with complex subcontracts combining materials, labor and overhead, prospective sufficiency would be clear only in unusual circumstances. Moreover, a focus on the time of contracting only might allow a contracting party to escape liability by “cultivating ignorance in its contractual relations.” Therefore, whether the contract proved, in fact, to be sufficient must be part of any determination whether a party “knows or should know” that a contract is insufficient. In effect, the duty to “know” whether a contract is sufficient extends throughout the life of the contract.

Reviewing the evidence offered by the plaintiffs, the court determined that the Castillo plaintiffs did create triable issues of fact both as to Toll Bros. ex ante constructive knowledge and as to the actual sufficiency of the contracts. The court found that the information and techniques used by the expert were “generally available and accepted in the construction industry,” and thus within Toll Bros.’ constructive knowledge. In addition, the court was not persuaded that payment of wage rates in excess of the minimum wage conclusively established actual sufficiency. The court noted that above-minimum wage rates could be undercut by other wage and hour violations, and that there was evidence of such violations here, including failure to pay overtime, denying rest breaks and failing to pay wages due on termination.

Plaintiffs Need Not Show Causation To Prevail

Toll Bros. had also argued that it was entitled to summary judgment because establishing liability under Section 2810 required a showing of causation. Thus, a contractor’s wrongdoing would be excused if an intervening factor, such as malfeasance by the subcontractor, caused the violation of applicable law. The Court of Appeal disagreed. Once the employee is “aggrieved” through a violation of law, and can show that the contract was insufficient, then he has met his burden of proof. The court did leave the door open for a causation requirement where the alleged violations of applicable law are not so directly related to the price of the contract. Thus, for example, if a plaintiff alleges a contract is insufficient to prevent safety violations, causation might be an appropriate consideration.

Section 2810 Is Not Pre-Empted by the NLRA

Finally, Toll Bros. claimed that Section 2810 is pre-empted by federal labor law. Toll Bros. raised both Garmon preemption and Machinists preemption, arguing either that the statute sought to regulate an area regulated by the NLRA (see San Diego Building Trades Council v. Garmon (1959) 359 U.S. 236), or that the statute sought to regulate in an area that Congress had intended to leave unregulated (see Machinists v. Emp. Rel. Comm’n (1976) 427 U.S. 132). The court rejected both of these arguments.

Conclusion

The Toll Bros. decision provides some important lessons for contractors in the construction industry in California. First, contractors who do not evaluate bids based on objective industry standards do so at their own peril. Second, a subcontractor’s history of cost overruns or failures to complete projects should put a contractor on notice of possible suspect bidding practices. Third, a contractor must pro-actively monitor contract performance, not only to prevent delays and cost overruns, but also to ensure compliance with applicable wage and hour laws. For large projects, this may be impossible to manage. In addition, representations and warranties and indemnification provisions in subcontracts may be worthless if the subcontractor is insolvent. Thus, contractors may need to turn to insurance policies, if available, to insulate them from liability.

The Court of Appeal considered this case following motions for summary judgment and thus did not address the adequacy of evidence necessary to establish liability. We expect that this and many other questions will be answered as other California courts of appeal consider the meaning of Section 2810.

Castillo et al. v. Toll Bros., Inc., Alameda County Superior Court Case No. RG 06290188

Hernandez et al. v. Toll Bros., Inc., Alameda County Superior Court Case No. RG 06302769