It seems that almost weekly, and certainly monthly, I receive a call or inquiry from colleagues and/or prospective clients as to whether a license is really required if the prospective “contractor” is not actually building anything but is merely facilitating a “deal” or is hiring otherwise qualified and licensed contractors and trades. Virtually every time I run through the laundry list of the key questions – the nature of the proposed project, the varying holdings and interests in the project or land by the prospective “contractor,” and what representations and actions may be or are represented to be undertaken by the prospective “contractor” – I find that the inquisitive party is incredulous at the restrictive nature of the governmental licensing scheme put in place by California (as well as the various states where I get this same question). And at least 90 percent of the time, I recommend that securing proper licensing with a qualified officer or employee is the safest way to avoid the harsh draconian penalties that accompany unlicensed work. A thorough evaluation of the law is too extensive for this blog, but I’ve highlighted the top three questions that reveal the risky nature of unlicensed work in California:
- Who Must Be Licensed? AKA You Don’t Actually Have to Build Anything to Be Deemed a Contractor.
Every entity must be licensed as a contractor in California if the entity offers to or does construct or alter any structure on real property in the state for a total cost greater than $500 (Business and Professions Code § 7026). Business and Professions Code § 7026 broadly defines the term “contractor” to include one who acts in the capacity of a contractor and “any person who undertakes to . . . or does himself or herself or by or through others” work that a contractor would undertake. For instance, if the prospective “contractor” pulls together a “deal” and represents to the buyer that the “contractor” will secure the performance of the construction work through others – whether it actually performs the work or not and whether it actually hires truly qualified contractors to perform the construction work – it will still be deemed to be a contractor. Banis Rest. Design, Inc. v. Serrano, 36 Cal. Rptr. 3d 532 (Ct. App. 2005). This definition also includes master developers under Business & Professions Code §§ 7026 and 7031, which must therefore be licensed themselves even though they furnish labor and material through licensed, third-party general contractors. Vallejo Dev. Co. v. Beck Dev. Co., 29 Cal. Rptr. 2d 669 (Ct. App. 1994).
- Aren’t There Any Exemptions That Apply?
Occasionally (see Business & Professions Code § 7040, et seq.), but if a contract for an unfinished product that is not a trade fixture includes installation, the most common exemptions may not apply (e.g., Business and Professions Code §§ 7045, 7052). One should thoroughly evaluate whether the prospective contractor will legitimately qualify for a categorical exclusion, as the risk of being wrong is very costly.
- What Are the Penalties for Contracting Without a License?
CA: Civil, Administrative and Criminal Penalties
- First-time offenses for contracting without a license are usually a misdemeanor, carrying a potential sentence of up to six months in jail and/or a $500 fine, along with a potential administrative fine of $200 to $15,000.
- The penalties go up with subsequent violations. A second conviction can mean a fine of 20 percent of the contract price of the work performed, or a $4,500 fine. Also, the unlicensed contractor shall be confined to jail for no less than 90 days.
- Business and Professions Code § 7031 prohibits the unlicensed contractor from bringing or maintaining an action to collect compensation for the act or contract (law or equity), and requires disgorgement of all sums already paid.
Two recent decisions highlight the concerns:
In Judicial Council of California v. Jacobs Facilities, Inc., 191 Cal. Rptr. 3d 714 (Ct. App. 2015), the California Court of Appeal determined under the Business and Professions Code § 7031 that a contractor was required to disgorge all monies received on a project – to the tune of $18 million – when its parent company allowed the subsidiary’s contractor’s license to lapse when it rebranded a new company to perform the work of the old company but never formally, although required by the contract requirements, assigned the contract. This disgorgement included the monies it earned WHILE it was properly licensed and holding the contract.
Just days earlier, in Jeff Tracy, Inc. v. City of Pico Rivera, 192 Cal. Rptr. 3d 600 (Ct. App. 2015), the California Court of Appeal discussed whether the general contractor properly maintained its Class A license when the City claimed disgorgement of payments based upon the general contractor’s alleged failure to maintain licensure. This challenge related to the actual qualification of the license holder, as the City was seeking to prove that the general contractor had a sham Responsible Managing Employee (RME) or Responsible Managing Owner (RMO), and whether the purported RME or RMO participated in activities constituting direct supervision and control as required by law. If a sham, the general contractor’s failure to properly maintain the license would require it to disgorge even the part of its compensation attributable to work it could have performed under its valid Class C-27 general landscaping license, including disgorgement of sums received for all materials, fixtures and non-labor.
A simple review of the risks reflects that a wise contractor will properly and diligently protect its right to collect the compensation it worked hard to estimate and bid and incurred time and expense to perform.