Licensing Pitfalls for the Unwary

03.24.2023

It is well established in case law that the failure to maintain proper licensure as a contractor can result in draconian consequences. No matter how one may argue that the intent of the Contractor State Licensing Law is met, there are innumerable pitfalls. Examples of issues that turn on factual issues are plentiful and include, but are not limited to, the following: intercompany assignments of a contract; whether a project is public works where the types of licenses that must be held to perform the work have to be followed, which is different from private works; the scope of a specialty license; whether the Responsible Managing Employee or Responsible Managing Officer is a sham allowing a claimant to go behind the license; or whether the license should be retroactively suspended due to lack of worker’s compensation coverage. Such situations may constitute pitfalls for the unwary. If the licensing law is violated a general contractor may lose its right to seek compensation for work performed or may be forced to disgorge all the money its been paid.

However, what happens if the general contractor is properly licensed but it retains unlicensed contractors? In the recent case of Kim v. TWA Construction the Plaintiff, Kim, hired the defendant to build a home and a bridge on their property. A small portion of the project involved the removal of a large eucalyptus tree. Although TWA was properly licensed to enter into the contract, it retained an unlicensed individual, Hoffman, to remove the tree. Ultimately, the only work that was performed was some erosion control by TWA and the tree removal by Hoffman. Kim could not secure a construction loan using TWA so the contract was terminated. Kim had paid TWA $16,000 in total, of which $10,000 was for the tree work.

When a lawsuit was filed by Kim’s neighbor, a cross complaint arose where TWA sought damages for breach of contract. Kim then alleged that he was entitled to disgorgement of the money paid to TWA for the amounts paid for the unlicensed tree work. In a matter of first impression, the court held that the law under Business and Professions Code section 7031 does not preclude a properly licensed contractor from hiring unlicensed subcontractors, but does preclude the contractor from turning to the courts to recover compensation for those services if a suit arose. The evidence was that $10,000 of the $16,000 that Kim paid to TWA was for the tree removal and that amount was paid to Hoffman. The appellate court confirmed the well accepted principle that an entity cannot seek compensation for unlicensed work, that the intent of the licensing law was clear and that the tree removal was an act that required a proper license. The court confirmed the trial court’s ruling that ordered the disgorgement to Kim of the $10,000 paid to TWA attributable to payments to Hoffman.

There are still many unanswered questions that may theoretically arise. What if the subcontractor was properly licensed at the outset but then lost the license before its work was completed? In that case does the contractor not only lose the right to collect the amounts still owed for the subcontractor’s work or does the contractor also have to disgorge all amounts owed even for the period that the contractor was properly licensed? What if the subcontractor started out unlicensed for part of the work but subsequently became properly licensed? How the courts would apply the law in those situations as it applies to disgorgement is unclear. Needless to say, a contractor should scrupulously and continuously check the licensure of its subcontractors.

On a final note, an action for disgorgement is separate and distinct from contract claims. It is considered a forfeiture and not damages for breach of contract. Thus, it is subject to a one year statute of limitations that starts to run when the contractor completes or ceases all performance under any agreement. Thus, there may be situations where a contractor cannot sue for payment related to the unlicensed work but not be subject to disgorgement. Each case is fact intensive and has to be carefully analyzed.

If you have any questions concerning contractor licensing, please contact your AALRR attorney or the authors of this Alert.