WHAT’S NEW IN LICENSING LAW – 2011
1. Starting in 2012, LLC’s can hold a contractors license
LLCs had always been the one type of business entity that was precluded from holding a contractors license. The legislature finally changed this anomaly in 2010. Starting in 2012, an LLC can hold a license and the qualifier shall either be a Responsible Managing Officer (RMO), a Responsible Managing Manager, Responsible Managing Member or Responsible Managing Employee (RME). Bus. & Prof. Code §7068(a)(4). But the requirements of LLCs to hold a contractors license are more rigorous than what is required of the other traditional business entities such as corporations. For example, as a condition precedent to the issuance of a contractor’s license, the licensee must have on file a surety bond in the sum of $100,000 for damages arising out of employee wage and benefit claims. Bus. & Prof. Code § 7071.6.5. Corporations are not required to hold such a bond.
An LLC must also maintain liability insurance for errors and omissions and requires licensees to give notice of this policy to homeowners. The liability policy shall be issued for not less than $1,000,000 and not more than $5,000,000; for LLC’s of five or fewer members, a limit of not less than $1,000,000 is required. Bus. & Prof. Code §7017.19(b)(1). For an LLC of five or more, an additional $100,000 for each member with a maximum of $5,000,000. Bus. & Prof. Code § 7017.19(b)(2). And once the LLC is dissolved, the company shall be required to maintain a three-year extension of the liability policy. Bus & Prof. Code § 7017.19(e). No such insuring limits are required of corporations.
With all the new requirements, it will be interesting to see how many entities take advantage of the LLC option. Corporations can transfer its license to an LLC. An individual can change to an LLC or corporation and have the license number reassigned. Bus. & Prof. Code §7051.1(c)(5). The license can also be reassigned with the transfer of a corporate license to an LLC following the cancellation of the corporate license provided personnel are the same. Bus. & Prof. Code §7071.1(c)(7). Also, transfer pursuant to an asset sale provided there is a qualifier allowed as when an LLC creates a subsidiary to continue the business.
But with the new requirements coupled with the ease of transfer, it is questionable whether using an LLC a cost effective option for contractors. Further it opens up LLC licensee to more possibilities of license suspension if the requirements are not met risking exposure to §7031 liability. In the end, contractors wanting to convert to an LLC need to evaluate the risks and costs contrasting the benefits when deciding on using an LLC for its business entity.
2. License not required for indemnity action
In UDC-Universal Development, L.P. v. CH2M Hill (2010) 181 Cal. App. 4th 10, the developer on a residential condominium complex hired an engineer to provide services on the project, and the parties entered into a contract that obligated the engineer to indemnify and defend the developer against any suit, action or demand brought against the developer on any claim or demand covered by the contract. The condominium homeowners association eventually sued the developer seeking damages for soil instability, erosion, unsettling and drainage problems. When the developer filed a cross-complaint against the engineer for equitable, comparative, and express contractual indemnity, the engineer filed a motion for summary judgment, asserting that the developer’s failure to be properly licensed barred its claims against the engineer.
Ultimately, the appellate court denied the engineer’s summary judgment motion and held that a cause of action that does not seek compensation for construction work is beyond the scope of Business and Professions Code section 7031. When an unlicensed contractor files an action for indemnity and not for compensation for its services, then it is not barred by section 7031. However, for obvious reasons, contractors should still maintain proper licensure at all times.
3. License may not be required for part of contract for which license is not required
The absence of a contractor’s license also does not necessarily preclude the recovery of payment for those services for which no license is required. See MKB Management, Inc. v. Melikian (2010) 184 Cal.App.4th 796. MKB Management (“MKB”) and Melikian entered into a New Management Agreement (“Agreement”) in which Melikian, the owner, granted MKB the exclusive right to rent, lease, operate, and manage several apartment buildings. MKB filed a complaint against Melikian alleging that it failed to pay amounts due under the contract. Melikian demurred, arguing that MKB failed to allege possession of a real estate broker’s license and, without such a license, MKB could not recover payment for the alleged services. Melikian further argued that a contractor’s license was required for some of the services and, without such license, MKB could not recover payment. The trial court sustained Melikian’s demurrer, finding that MKB’s claims were barred because it was seeking to recover for services that required a license. The appellate court reversed.
Business and Professions Code §10136 states that a plaintiff seeking to recover compensation for which a real estate license is required must allege that she or she possessed the requisite license at the time the cause of action arose. However, Section 10136 does not prevent a plaintiff from recovering for acts for which no real estate license is required. For the same reason, while §7031 requires a plaintiff to possess a contractor’s license in order to recover compensation for certain work, it does not prevent a plaintiff from recovering for acts for which no contractor’s license is required.
In this case, the court of appeal found that some of the services provided under the Agreement required either a real broker’s license or a contractor’s license, while others did not. Therefore, MKB’s claims were not barred as a matter of law and MKB could proceed in attempting to recover for the services which did not require a broker’s or contractor’s license.
It is questionable that this holding will be extended beyond this case. Contractors perform services that do not require a license such as supplying materials. Will courts extend this to unlicensed contractors for recovery of materials supplied to a project? Doubtful, considering that §7031 requires a proper license for recovery of any “act” or “contract” and since materials are normally part of a contract then it would be considered precluded from recovery. One way to hedge against any preclusion of recovery due to §7031 is to separate contracts – one for labor, the other for material. But considering that no one generally plans for a §7031 action, this is not very practical.
4. Disgorgement awards dischargeable in bankruptcy
The only dim light at the end of the tunnel for an unlicensed contractor suffering from a disgorgement award under section 7031(b) is that such awards are dischargeable in bankruptcy. In re Sabban (9th Cir. 2010) 600 F.3d 1219. However, contractors should note that any monetary awards to penalize the unlicensed contractor for obtaining money by fraud, false pretenses or false representations are not dischargeable in bankruptcy.
In Sabban, Homeowner entered into a remodeling contract with Sabban, a general contractor, who falsely represented that he was a licensed contractor. Homeowner paid $123,000 to Sabban for the work performed. Sabban in turn paid $129,000, for the homeowner’s benefit, to licensed subcontractors and other material and labor providers. Homeowner sued Sabban, alleging violations of Business and Professions Code sections 7061 and 7031(b). The trial court found that the homeowner had been induced to sign the contract in reliance upon false and fraudulent representations made by Sabban and awarded the homeowner the $500 penalty provided by section 7061. The trial court also awarded the homeowner $123,000 as disgorgement of compensation paid, pursuant to section 7031(b). Sabban subsequently filed for bankruptcy and the homeowner filed an action to determine whether the award was dischargeable in bankruptcy. The United States Bankruptcy Court ruled that the $500 penalty was not dischargeable, but that the $123,000 debt was dischargeable. The Court of Appeals confirmed.
Section 523(a)(2)(A) of the Bankruptcy Code prohibits the discharge of any enforceable obligation for money to the extent that that money was obtained by fraud, false pretenses or false representations. Liability under section 7031(b) requires only that compensation have been paid to an unlicensed contractor. Fraud and actual harm are irrelevant to an award under section 7031(b). Because of this, the court of appeals held that the award of $123,000 is not a debt for money obtained by fraud within the meaning of the Bankruptcy Code. Therefore, the court found that the award under section 7031(b) was dischargeable bankruptcy.
5. Hiring of unlicensed subcontractor does not automatically suspend license due to worker compensation issue.
Where a contractor presents sufficient evidence showing he obtained worker’s compensation insurance, his contractor’s license will not be automatically suspended for hiring unlicensed subcontractors. See Loranger v. Jones (2010) 184 Cal. App. 4th 847.
In Loranger, homeowners hired a licensed contractor to build a single family residence on their property. When the homeowners failed to pay the contractor’s final billing, the contractor brought suit for breach of contract. The homeowners filed a cross-complaint, alleging that: (1) the contractor hired unlicensed subcontractors; (2) said subcontractors are treated as de facto employees under Labor Code section 2750.3; (3) the contractor failed to provide worker’s compensation coverage to these subcontractor employees; (4) such failure resulted in the suspension of the contractor’s license under Business and Professions Code section 7125.2; and (5) without a license, the contractor could not recover for his construction services and had to disgorge all money paid to him under section 7031.
While the contractor admitted that he employed subcontractors without proper licenses and they would be considered his employees, the contractor also testified that he was a licensed contractor and had obtained a worker’s compensation policy for his construction employees. Since the contractor provided sufficient evidence to show his subcontractors and employees were covered by his worker’s compensation insurance, the contractor’s license was not automatically suspended and he could recover for his construction services.
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