Insurance and Liens

The Insurance and Liens section, which constitutes 12% of the law and business exam, focuses on key areas such as workers' compensation insurance, business insurance, and the understanding and application of liens as legal remedies. Contractors must be familiar with the various types of bonds and insurance required to protect their business, employees, and clients. Additionally, they must understand the procedures for filing and releasing liens to secure payment for services rendered. Mastery of this section is essential for ensuring that a contracting business remains compliant with legal requirements and effectively manages financial risks.

General Bond Information

In instances where a significant undertaking is funded by institutional lenders, insurance firms, or commercial banks, the contractor might be mandated to provide a bond. Bonds might be a necessity stipulated by owners, lenders, governmental bodies, and other contractors. These bonds can be acquired from bonding firms for a small fraction of the initial contract value, usually ranging from 1% to 2%. Such additional expenses should be factored into the contractor's bid submission.

The primary types of bonds a contractor might encounter are:

• Bid Bond: Before a contractor is given a job, a bid bond serves as a guarantee that the contractor will be capable of completing the job as per the stipulations in the contract. The bid bond filters out any bidders who are unqualified or not serious. The bid bond also serves as a safety net by covering the price gap between the failed contractor’s bid and the following lowest bidder.
• Performance Bond: Also known as a contract bond, a performance bond relates to the agreed-upon timelines and conditions. A performance bond ensures that a contractor will finish the project in accordance with the agreed-upon terms and conditions.
• Payment Bond: This bond ensures that the contractor will pay subcontractors and suppliers for work performed correctly. Federal government contracts above $35,000 require a payment bond.
• Fidelity Bond: A fidelity bond provides coverage to business owners in scenarios of employee dishonesty or theft.

Contractor's Bond

For an individual or a business to acquire a license in the State of California, securing a contractor’s license bond is an initial requirement. The contractor is obliged to file this bond or give a cash deposit to the Contractors State License Board (CSLB), and the amount should be $25,000. This bond functions to protect a worker, providing compensation in cases where the contractor fails to pay, or if the contractor breaches the Contractors Licensing Law involving a homeowner. The CSLB sets two prerequisites for accepting a contractor’s bond:

• The contractor’s bond should be valued at $25,000.
• Within 90 days from the bond's activation date, the contractor’s bond needs to be filed with the CSLB.

After securing a contractor’s bond or a cash deposit, a contractor is prohibited from describing themselves as “bonded” or “insured” in any promotional materials or official documents unless the insurance type is accurately specified.  This regulation only applies to the $25,000 contractor’s bond.

Bond of Qualifying Individual

Beyond the contractor’s bond, a business is required to submit an additional $25,000 bond for qualifying individuals, such as a responsible managing employee (RME) or responsible managing officer (RMO). The CSLB can offer an exemption from this requirement for a qualifying individual if the RMO can verify ownership of 10% or more of the voting stock or equity of the company where they serve as a qualifying individual.

Limited Liability Company (LLC) Bond

For Limited Liability Companies (LLCs) seeking a license, they must obtain an additional “Limited Liability Surety Bond” valued at $100,000. This bond is a prerequisite for the issuance, reactivation, and renewal of the LLC's license.

Disciplinary Bond

A Disciplinary Bond is necessary when applying for a new license, reissuing, or restoring an existing license that has been revoked or denied due to violations of the Contractors State License law. The key requirements for a disciplinary bond include:

• The disciplinary bond should not be used as a substitute for any other bond needed to maintain an active license and it should not be combined with any other bond. It should be considered as an extra requirement for issuing, re-issuing or restoring a company’s license that has been revoked due to a violation.
• The value of the disciplinary bond isn't fixed and depends on the nature of the violation. It ranges from a minimum of $25,000 to 10 times the amount of the contractor’s bond, with the Registrar having the authority to decide the bond amount.
• The disciplinary bond must be valid and filed with the Registrar for a minimum of two (2) years. The Registrar has the discretion to extend this period. The company's license also needs to remain active until the disciplinary bond is filed with the Registrar.
• The disciplinary bond must be filed with the CSLB within 90 days from the bond's effective date.

Alternative Bonding Options Approved

Contractors have other options besides filing a surety bond with the CSLB. These are the alternative choices a contractor can consider:

• Deposit certificates;
• Share accounts or investment certificates from a savings and loan association;
• Cash;
• Bearer bonds from the U.S. government.

It's important to note that the CSLB does not accept volatile investments like stocks as a surety.

License Suspension due to Bond Issues

A license can be suspended under several circumstances:

• When the surety company cancels one or more of the required bonds;
• When a judgement or payment claim reduces the bond amount;
• When there's a failure to keep the disciplinary bond or cash deposit fully effective for the required duration.

A license that has been suspended can be reinstated if the surety company sends a “Rescission of Cancellation Notice” to the CSLB. Another way to reinstate a license is by acquiring a new bond and submitting it to the CSLB within 90 days of the new bond's effective date or within 90 days of the old bond's cancellation.

Insurance

Insurance serves as a safety net for a business and its personnel by providing coverage against unexpected dangers such as fire, theft, or injury. The contractor acquires an insurance policy and pays premiums in exchange for coverage of certain potential risks by the insurance company. Unlike bonds, the policyholder is not obligated to reimburse any claims paid out by the insurance policy. Many projects necessitate that a contractor maintain specific kinds and amounts of insurance coverage. The most frequently required type of insurance is workers compensation, but some projects may demand additional property, vehicle, or other insurance policies.

Workers' Compensation Insurance

As per the California Workers’ Compensation law, it is mandatory for all employers to provide workers’ compensation insurance for their workers. This insurance covers all employees, irrespective of their wage scale. It applies to regular, part-time employees, and employed minors. Known as a “no-fault insurance plan”, workers’ compensation insurance is purchased by the employer and governed by the state for the following purposes:

• To confine employer liability for compensation, thus avoiding expensive lawsuits for benefits;
• To assure that employees who get injured on the job receive immediate medical care and full benefits for work-related injuries.

Before a contractor’s license is granted, the contractor must provide one of the following:

• Evidence of workers’ compensation insurance;
• A license from the State Department of Industrial Relations to be a self-insurer;
• The contractor can declare on the “Exemption from Workers’ Compensation” form that the contractor has no employees, and therefore is exempt from the requirements of the workers’ compensation insurance.

All licensed contractors are obligated to provide the Registrar of Contractors with the name and address of the workers’ compensation insurer in writing within 90 days of procuring the insurance policy. The name of the insurer must be visibly displayed at the worksite. Employees must be given written information about their rights to receive workers’ compensation benefits.

The main contractor is responsible for ensuring that subcontractors also provide workers’ compensation insurance for their workers. The main contractor must keep a valid copy of the subcontractor’s Certificate of Insurance. If the subcontractor does not have valid workers’ compensation insurance, the main contractor will be held accountable by any employees of the subcontractor who may be injured.

Benefits of Workers' Compensation Insurance

If an employee experiences a workplace injury, they must deliver a written notice to their employer within a 30-day timeframe. Following the receipt of this notice, the employer has the responsibility to inform the employee about the benefits they are entitled to under the law. The employer must report the injury to the insurance carrier within 5 days from when the initial notice was received from the employee.

The coverage provided by workers’ compensation insurance includes:

• Medical Treatment: It guarantees necessary medical care at no expense to injured employees.
• Job Displacement: If needed, workers’ compensation offers re-skilling, placement in a new job, or skill enhancement.
• Temporary Disability: Employees temporarily unable to work due to disability receive wage compensation benefits.
• Permanent Disability: If an injury results in permanent disability, the worker is eligible for compensation. The benefits are calculated based on the employee’s earnings and can even extend to a lifetime pension, as per California law.
• Death Benefits: If a workplace injury results in the death of an employee, his/her dependents are entitled to death benefits.

An employee or their dependents who receive benefits through workers’ compensation insurance may not be allowed to sue the employer unless it can be proven that:

• The employer deliberately hid the employee’s injury;
• The injury was a consequence of defective products manufactured or distributed by the employer;
• The employee was physically attacked by the employer.

If an employer disputes any workers’ compensation benefits claim, a hearing will be conducted before the Workers’ Compensation Appeals Board. Defenses that an employer may use include:

• The employee's injury resulted from their own deliberate misconduct;
• The employee was under the influence at the time of the injury;
• The employee failed to deliver a proper written notification within 30 days following the injury;
• The injured party is an independent contractor, not an employee.

The Division of Labor Standards Enforcement can issue stop orders to employers who don't provide workers’ compensation coverage. Non-compliance with this order can result in a 60-day imprisonment, a  $10,000 fine, or both.

If an employer is found to be not providing workers’ compensation to their employees, the employer will face a penalty of $2,000 per uninsured employee. Work will be halted until insurance is procured. If this discovery happens after a workplace injury, the penalty increases to $10,000 per employee, with a maximum penalty of $100,000. Additionally, the contractor’s license may be suspended or revoked.

Other Insurance

Contractors can choose to secure extra insurance to safeguard against high-cost damages and property losses. The types of insurance available include:

• Vehicle Insurance: Necessary if business operations involve the use of vehicles. This insurance protects the business from the financial consequences of physical damage and accidents involving these vehicles.
• Property Insurance: This insurance shields the business's physical assets or equipment from losses due to theft or fire. All-risk coverage offers broad protection, while named-peril coverage protects against specific threats outlined in the policy. It is important to note that property insurance does not cover employee tools.
• Inland Marine Insurance: This type of insurance offers coverage for tools and other properties during land transportation.
• Builder’s Risk Insurance: This is a specialized property insurance mostly obtained by general contractors. It covers losses due to fire, storm, and vandalism to a building under construction, even when the contractor is not present at the site.
• General Liability Insurance: This insurance kicks in when a business's negligent actions or failures result in harm to a customer or damage to property. It offers coverage for injuries caused by a product the business manufactured or distributed, or if an individual is injured in the course of business activities.
• Employee health and life insurance: While workers compensation covers on-the-job injuries and illnesses, health and life insurance covers employees at all times. Companies with a staff strength of 50 or more are required to provide this insurance. For smaller companies, it is optional.
• “Key person” insurance: This is a life insurance policy on a key employee whose role is pivotal to the business's survival and operation. If this key employee dies, the company receives an insurance payout to cover the period until a replacement can be hired and trained.
• Umbrella Insurance (Excess Policy): This is a liability insurance that provides coverage beyond the limits of other specific policies, and primary insurance for losses not covered by other policies. If the insured is liable, the primary insurance policy pays up to its limits. Any additional amount due is covered by the umbrella policy, up to the policy's limit.

Mechanics' Lien

Mechanics' lien is a legal claim that can be filed against a property by a party who has contributed to the improvement of that property but has not been compensated for their work or materials. This lien acts similarly to a mortgage or home equity loan and is recorded against the property with the County Recorder. Any unpaid contractor, subcontractor, supplier, or laborer can record a mechanics' lien, which then facilitates a foreclosure action.

A contractor can leverage the California Mechanics’ Lien laws to secure payment for a completed project or to lodge a claim against a property where they performed work. If the contractor does not receive payment, they have the right to foreclose on the owner's property. However, before a contractor files a mechanics' lien, they must include a Mechanics’ Lien Warning (previously known as Notice to Owner) in the home improvement contract. This warning is not necessary for contracts that meet the service and repairs contract requirements.

To file a mechanics' lien, the contractor must lodge it against the property’s title where they performed the work. This filing must be done with the office of the County Recorder. The document must contain:

• The owner's name;
• The property's address;
• Details of the work;
• The amount owed.

A mechanics' lien operates similarly to a lien filed for a home loan or second mortgage. It can also be used to initiate a foreclosure against the owner's property, resulting in a public auction of the property. The contractor or subcontractor gets paid from the auction proceeds.

A mechanics' lien can only be filed against the property title where the unpaid work took place and cannot be filed against personal property or other real estate owned by the owner. While a mechanics' lien cannot be filed against public property, a contractor can use a stop notice when working on public property. Before filing a mechanics' lien, a contractor must first determine the property's location and its owner. The owner must be notified of any work that has been, or is currently being done, before the mechanics' lien can be filed.

A filed mechanics' lien places a burden on the property's title. The law stipulates that a mechanics' lien can only be filed within 90 days following the completion of work. A mechanics' lien, by itself, is not enough to enforce payment on a contract; a lawsuit must be lodged to enforce the lien. The lawsuit must be filed within the 90-day period following the filing date of the mechanics' lien. This ensures that the contractor's lien claim will remain valid until payment is received, or the lawsuit is settled.

Mechanics' Lien Release Bond

Owners can clear their property of a lien by posting a lien release bond equal to 125% of the original lien's value. This bond acts as a security measure for any lien claims, thereby preventing the property from being embroiled in legal disputes. This allows the owner to sell or further develop the property.

Notice of Completion

A Notice of Completion is an official document signed and verified by the owner or their representative. This document includes:

• The completion date of the project;
• The owner's name and address;
• The type of interest or estate of the owner;
• The property's location or sufficient identification;
• The name of the original contractor, if any, responsible for the part of the project that has been completed.

This notice is filed with the County Recorder to lessen the 90-day period during which a lien can be filed. This must be done within 10 days (15 days for homeowners) after the completion of a contract. The Notice of Completion is specific to a single contractor, not the entire project. So, if more than one contractor is involved, separate notices must be filed for each one.

If the Notice of Completion is filed, the time frame for filing a lien is reduced to:

• 60 days for a prime contractor;
• 30 days for a supplier or subcontractor after the notice has been filed.

Notice of Cessation

Similar to the Notice of Completion, a Notice of Cessation is an official document, submitted by the property owner to the County Recorder's office, indicating that all work on the property has been stopped. This declaration confirms that no work has been carried out on the property for at least 30 days before the notice was recorded and no further work is planned.

When the Notice of Cessation is recorded, the timeframe for filing a lien is shortened to:

• 60 days for a main contractor;
• 30 days for a material supplier or subcontractor from the date the notice was recorded.

Please note: The requirement to serve a notice of completion or cessation does not apply to an owner of a residential property comprising four or fewer units.

Refer to the below image for the timeline of mechanics’ lien/stop notice.

Mechanics' Lien and Stop Notice Procedure

Preliminary Notice

A Preliminary Notice is a formal document designed to inform a property owner about ongoing work on their premises that they might not be aware of. This notice can be issued by either a subcontractor or a supplier to the property owner or the construction lender, as the situation demands. In cases where the main contractor is hired by a tenant or owner's representative, it is their responsibility to provide this notice to the owner. The notice must be issued within 20 days from the time the subcontractor or supplier commences their job. Upon receipt of a Preliminary Notice from a subcontractor, the owner is obliged to acknowledge it within 10 days from the time of its recording.

Subcontractors required to issue a Preliminary Notice include:

• A subcontractor who signs a contract worth $400 or more;
• If the contractor is working with tenants or architects (not the owner);
• If the project is financed by a construction loan;
• If the project is a public works assignment.

The details that should be included in an issued Preliminary Notice are:

• The name and address of the individual providing the labor, materials, or service;
• An estimated total cost and a broad description of all labor, materials, equipment, or services that have been or will be provided;
• The name of the contractor or subcontractor;
• A description of the job site for identification purposes;
• A statement from the claimant asserting their right to file a mechanics’ lien against the property for any unpaid balance;
• If a construction lender is involved, the total price of the claimant’s contract must be disclosed.

A subcontractor can deliver the notice either in person or via certified or registered mail (requesting a return receipt). A Declaration of Proof of Notice must be completed and retained for record purposes. This signed and dated document can serve as evidence of notice delivery in case of any disputes.

A contractor might opt to file a Preliminary Notice with the Office of the County Recorder to be notified of any Notice of Cessation or Completion filed pertaining to a specific contract.

Notice of Non-Responsibility

Should an owner wish to avoid being held accountable for contractor payments, they can file a Notice of Non-Responsibility. This typically happens when a tenant initiates a contract without the owner's consent, or after the owner receives a preliminary notice. The owner has 10 days from the date of receiving the preliminary notice or from noticing work on their property to file this notice with the County Recorder. Once this notice is filed, the owner is absolved from any payment obligations to contractors, and contractors or suppliers cannot file a mechanics’ lien.

Note: This notice, once filed, must be visibly posted at the worksite.

Lien Release

An owner has the right to request a conditional or unconditional lien release from prime contractors, subcontractors, or suppliers when making payment. A conditional lien release outlines specific criteria that need to be fulfilled before the lien is released. For instance, a subcontractor might waive all lien rights upon receipt of a final payment of $1000. A unconditional release, on the other hand, releases a property from the mechanics’ lien without any conditions to be met. Once an owner has an unconditional release, a mechanics’ lien cannot be filed against their property.

Stop Notice

A stop notice serves as a lien on financial resources, similar to how a mechanics’ lien functions as a lien on property. Stop notices can be issued within the same 90-day period as a mechanics’ lien, which is after the completion of work. For instance, if a contractor has been delivering service but hasn't received payment from the prime contractor, they can issue a stop notice. This notice compels the owner, construction lender or public entity to reserve enough money to fulfill the stop notice claim.

Note: A stop notice should not be confused with a stop order. A stop order ceases all work due to a breach of state law (such as not having workers' compensation).

In scenarios where work is carried out on public property and a mechanics’ lien cannot be issued, a stop notice becomes the sole mechanism for contractors to claim unpaid dues. However, a prime contractor working on a public works project cannot issue a stop notice to the awarding entity. Only suppliers or subcontractors can issue this notice. Information required in a stop notice includes:

• The contractor's name, address, and signature who is making the claim.
• The name of the person for whom the services were rendered.
• A description of the work, materials, and equipment supplied.
• An estimate of the work value and the total contract amount.

To finalize a stop notice, a lawsuit must be filed between 10 and 90 days after the date the stop notice was issued. Refer to the above image for the mechanics’ lien/stop notice timeline.

Stop Notice Bond

If a stop notice bond of one and a quarter times the stop notice claim amount is provided, it will validate a stop notice for a contract that involves a construction lender. This bond ensures that all parties will be paid if the stop notice claim is unsuccessful. Without this bond, the stop notice is deemed invalid. For public works, this type of bond is not necessary.

Stop Notice Release Bond

A release bond can be utilized by a contractor to free up funds that have been held due to a stop notice. This bond must be one and a quarter times the amount of the stop notice. If the stop notice claim is successful, the claimant will go after the release bond, rather than the funds that the stop notice has held.

‍