LICENSED TO CONTRACT:
A Reminder About Licensing Pitfalls for Contractors and How to Avoid Them
James Bond, a.k.a. 007, was famously licensed to kill. Without this license, Mr. Bond would have been in serious trouble with the authorities. The same is true for a contractor. By performing construction work without a valid contractor’s license, a contractor is playing a very dangerous game and could lose it all.
It is well known that all contractors in California must be licensed by the Contractors’ State License Board (CSLB). If a contractor is unlicensed at any point while performing construction work for a project, the party for whom work was performed may recover all compensation paid to the unlicensed contractor for that work. Cal. Bus. & Prof. Code § 7031(b). Being unlicensed for even one (1) day of performance of a contract puts the contractor at risk of disgorgement of all monies earned under the contract – not just the monies earned while unlicensed. MW Erectors, Inc. v. Niederhauser Ornamental & Metal Works Co., Inc. (2005) 36 Cal.4th 412, 425. The law is quite clear and severe. Though this disgorgement cause of action has been codified, there has been limited guidance on when a disgorgement claim accrues and how long a potential plaintiff has to bring such a claim, until now.
Eisenberg Village v. Suffolk Construction Assigns a Clear Statute of Limitations to Disgorgement Claims
Tomorrow Never Dies…but a disgorgement claim does, one year after cessation of the work. A recent case, Eisenberg Village of the Los Angeles Jewish Home for the Aging v. Suffolk Construction Co., Inc. (2020) 53 Cal. App. 5th 1201, published on August 26, 2020 was one of the first to address accrual of and the statute of limitations for a disgorgement claim. In Eisenberg Village, the Court held that a disgorgement claim under Business and Professions Code (“BPC”) section 7031(b) is a penalty and, therefore, a one-year statute of limitations applies. The date of accrual for such claims is after the completion or cessation of the work, and the discovery rule does not apply.
In this case, Eisenberg Village of the Los Angeles Jewish Home for the Aging (“Eisenberg”) hired Suffolk Construction Co., Inc. (“Suffolk”) to construct an assisted living facility. The construction project began in 2008 and was completed in 2010, but Suffolk came back to do some repairs in 2012. Eisenberg first brought Suffolk into a lawsuit involving this project in 2014, then in 2015, Eisenberg discovered potential issues with Suffolk’s contractor’s license and amended its complaint to add a claim for disgorgement under BPC section 7031(b).
Suffolk’s responsible managing employee (“RME”) for its California license during construction on the project transferred offices from Irvine to Boston in 2008, but remained the RME on Suffolk’s California license. The RME did not supervise the construction project while in Boston, and Eisenberg argued that “Suffolk did not have a bona fide qualifier as RME, and therefore Suffolk was not duly licensed as a contractor at all times during Suffolk’s performance of the Contract.”
Suffolk moved for summary judgment on the grounds that Eisenberg’s disgorgement claim was subject to a one-year statute of limitations for penalties, and that the claim was time-barred because it accrued in 2008 when the RME transferred to Boston. Eisenberg opposed this motion arguing that its disgorgement claim was not barred by the one-year statute of limitations under the discovery rule, because they did not know or have reason to know who the RME was until they investigated Suffolk prior to trial in 2015. Eisenberg also argued for application of a three or four-year statute of limitation on other grounds.
The trial court granted summary judgment in favor of Suffolk, ruling the one-year statute of limitation for penalties applied. The court declined to decide the applicability of the discovery rule but found that “Eisenberg knew or easily could have discovered the facts making up the claim more than a year before” it filed its claim. Eisenberg appealed the decision.
a. The Appellate Court Held That the One-Year Statute of Limitation Applied
The Appellate Court ruled that disgorgement was a penalty as it required an unlicensed contractor to return any compensation regardless of whether there is any fault in the construction. The returning of compensation is meant to punish the unlicensed contractor, therefore, the one-year statute of limitations for penalties applies.
b. The Disgorgement Claim Accrues When the Work Is Completed
With respect to accrual, the Appellate Court held that there is no equitable reason to apply the discovery rule to disgorgement claims. It would be absurd to permit a party to enter into a large sum contract with a contractor that did not have a valid license, then recoup the entire cost of the work years later, especially where there were no issues with the work itself. Instead, the ordinary rule of accrual applies. In the case of a disgorgement claim, “the cause of action is complete when an unlicensed contractor completes or ceases performance of the act or contract at issue.” Here, Eisenberg’s claim was brought three years after the last work performed by Suffolk, and thus was barred by the one-year statute of limitations.
From Eisenberg Village with Love: Keep Your License’s RME or RMO Current
In Eisenberg Village, the re-location and failure of the qualifying individual to supervise the project caused an inadvertent lapse in licensure, and the contractor’s failure to update its license made it vulnerable to a disgorgement claim. In order to avoid the same fate, contractors need to be mindful of when to update the qualifying individual for their license.
a. Contractors Should Remind Themselves of the RME/RMO Requirements
If the contractor is an individual owner, the license may be qualified by either the owner or RME. If the contractor is a partnership, the qualifying individual may be either a partner or RME. A corporation or limited liability company may be qualified by either an RMO or RME. A limited liability company may also be qualified by a responsible managing member or responsible managing manager. (BPC § 7065.) Regardless of whether the qualifying individual is an owner, partner, RMO or RME, the qualifying individual needs to have direct supervision and control over construction operations, meaning supervising construction, managing construction activities by making technical and administrative decisions, checking jobs for proper workmanship, or direct supervision on construction job sites. (BPC § 7068.1; 16 CCR § 823(b).)
If a contractor is using an RME to qualify its license, the RME must be a bona fide employee of the contractor. This means that the RME must be regularly employed by the contractor and actively involved in the operation of the business at least 32 hours per week or 80 percent of the total business operating hours per week, whichever is less. (16 CCR § 823(a).) If a qualifying individual is an RME, they may not be the qualifier on any other active license.
RMOs are not subject to the same restrictions. An RMO may serve as the qualifier for more than one license at a time, provided certain conditions exist (such as common ownership of at least 20% of each company, or the companies share a majority of officers or partners). However, a qualifying individual cannot act as the qualifier for more than three firms in any one-year period. (BPC § 7068.1.)
b. Take Immediate Action When A Qualifying Individual Leaves the Company
When a qualifying individual leaves the company or can no longer serve as the qualifying individual, written notice to the CSLB is required within ninety (90) days through a Disassociation Request. (BPC § 7068.2.) Failure to notify the CSLB within 90 days after disassociation will result in the automatic suspension of the license or the removal of the classification. The RME or RMO continues to be responsible for all work performed by the company prior to the recorded disassociation date.
In the event the qualifying individual leaves the company, in order to continue conducting business, the company must replace him/her within ninety (90) days of the date of disassociation. Failure to replace the qualifying individual within that time results in the suspension of the license or removal of the classification from the license. The contractor must submit an application for replacing the qualifying individual, which may also serve as the notice of disassociation for the former qualifier. A contractor can also request one ninety (90) day extension if certain circumstances apply. These forms and applications should be submitted as soon as possible, as unforeseeable processing delays could result in suspension of the license or removal of the classification.
No Time to Die: Know Whether A Business Entity or Structure Change Permits License Reassignment or Requires A New License Entirely
Contractors should be also be aware of any updates that need to be made to their license in the event of change in corporate structure. Failing to properly license a new entity is a common pit fall former sole proprietors fall into when they incorporate their businesses. An entity must be licensed regardless of whether its owner is licensed. (See BPC § 7117.) Generally, when a change occurs in a business entity or business structure, a new license is required. However, reassignment of a license is permitted under certain conditions. (BPC § 7075.1)
a. Reassigning A License to a Different Corporation or New Corporate Structure
A contractor’s sole owner license may be reassigned to a corporation if the corporation was formed by the licensed individual who maintains at least 51 percent ownership of the new corporation. The contractor must submit a Licensed Sole Owner Applying for Corporate License form to the CSLB, along with an Original Application for Contractor License, and pay the appropriate fees. Once reassigned, the contractors’ license number belongs exclusively to the corporation, and cannot be assigned back to the sole owner at a later date.
If a new entity is being formed to continue the business of a formerly licensed corporation, the former corporation’s license may be reassigned to the new entity if a parent corporation has merged or created a subsidiary, the subsidiary merged into the parent corporation, or if a corporation has changed its filing status with the Secretary of State’s Office from a domestic corporation to a foreign corporation (or vice versa). A contractor must submit a written request for license reassignment, specifying which condition exists, along with an Original Application for Contractor License and the required fees, to the CSLB.
b. Again, Contractors Need to Act Fast
Similar to changes to RMEs and RMOs, the reassignment must be requested within ninety (90) days from any change in information or structure. Under BPC section 7083(a), a licensee must “notify the registrar, on a form prescribed by the registrar, in writing within 90 days of any change to information recorded . . .” This notification is required for changes in business address, personnel, business name, qualifying individual bond exemption, or exemption to qualify multiple licenses.
With Substantial Compliance, Contractors May Get to Die Another Day
If a contractor is up against potential penalties for a lapse in licensure, they still may be saved. Although not at issue, the Appellate Court in Eisenberg Village referenced BPC section 7031(e), which allows a contractor to avoid penalties arising from a lapse in licensure if the contractor substantially complied with state licensure requirements. If a contractor acted in good faith to maintain proper licensure and acted promptly to remedy any lapse in its license or other compliance failure, then a court could find that the contractor substantially complied with licensure requirements to avoid penalty or other disciplinary action. (BPC § 7031.) In order to invoke the substantial compliance defense, the contractor must have been duly licensed in the state prior to the failure. Contractors that have never been licensed in the state may not assert this defense. While this defense may allow you to “Die Another Day,” every California contractor should make it a priority to routinely confirm they are properly licensed. The consequences of performing work while unlicensed, even inadvertently, can be devastating.
Casino Royale: Don’t Gamble with These Licensing Requirements
Complying with California’s contractor licensing requirements can be high stakes. If you are feeling overwhelmed, the attorneys at Gibbs Giden are well-versed in navigating state licensing requirements and can help you plan for your business’ future. If you are considering a change in entity structure, personnel, or business name, our firm can help you avoid the common pitfalls above.
For more information contact:
Michele A. Ellison
Luke I. Landers
Michele Ellison is spearheading the newest Gibbs Giden office in San Jose, where she practices and represents clients in the areas of business, commercial and construction litigation. Ms. Ellison has experience representing general contractors, subcontractors, material suppliers and public agencies in a wide range of business, commercial and construction negotiations and disputes. Her primary emphasis is in construction litigation for both public and private projects involving delay and disruption claims, mechanics lien foreclosure and stop notice enforcement actions. Ms. Ellison participates in legal matters throughout the entire course of the case, from the initial pleading stage, discovery, law and motion work, case management and motion hearings, pre-trial preparation and through trial, and has obtained favorable settlements and results. In the commercial practice area, she has experience in securing preliminary remedies, specifically, writs of attachment, and enforcing judgments. Ms. Ellison also has experience with contractors licensing issues, including home improvement contract and licensure requirements.
Luke Landers is an associate in the Los Angeles office of Gibbs Giden where he represents clients in the areas of construction claims and litigation in addition to business and commercial transactions.