Assembly Bill No. 1793: A Step in the Right Direction, But Much More Can Be Done to Protect Contractors from Abuses of §7031’s Draconian Penalties

The Current Law

The Contractors’ State License Law (CSLL), Business and Professions Code §7000 et seq., comprises a series of statutes governing contractor licensing in California. The statutory scheme imposes strict requirements and harsh penalties in an effort to “protect the public from incompetence and dishonesty” in the industry by assuring that construction contractors have requisite skill, character, and knowledge. Hydrotech Systems, Ltd. v. Oasis Waterpark (1991) 52 Cal.3d 988, 995.

The statute governing civil penalties, §7031, institutes a dual “shield and sword” scheme that affects an unlicensed contractor’s right to receive or retain compensation for unlicensed work.  White v. Cridlebaugh (2009) 178 Cal.App.4th 506, 518.

70319(a), the defensive “shield” provision, prohibits a contractor from suing to collect compensation for any work requiring a contractor’s license unless proper licensure was in place at all times during such contractual performance. MW Erectors, Inc. v. Niederhauser Ornamental & Metal Works Co., Inc. (2005) 36 Cal.4th 412, 419.

In 2001, legislature enacted §7031(b), the offensive counterpart to §7031(a). The so-called “sword” provision allows persons who hire unlicensed contractors to recover all compensation paid to the unlicensed contractor for performing any act or contract. Cal Bus & Prof Code § 7031(b); White v. Cridlebaugh at 519. The provision permits reimbursement even if the hiring party knew the contractor was unlicensed. Alatriste v. Cesar’s Exterior Designs, Inc. (2010) 183 Cal.App.4th 656, 668.

However, these draconian suit-preclusion and disgorgement penalties can be counteracted by a showing of substantial compliance, requiring that the contractor “(1) had been duly licensed as a contractor in this state prior to the performance of the act or contract, (2) acted reasonably and in good faith to maintain proper licensure, (3) did not know or reasonably should not have known that he or she was not duly licensed when performance of the act or contract commenced, and (4) acted promptly and in good faith to reinstate his or her license upon learning it was invalid.” Cal Bus & Prof Code § 7031(e).

Owner/Developer Abuse of §7031 and Assembly Bill No. 1793

The stiff application of §7031 obviously inured to the benefit of developers and owners, who could exploit even the smallest instances of noncompliance. Brief licensure lapses and complications arising from internal license transfer (during mergers, acquisitions, and corporate reorganizations) became the subject of abuse by unscrupulous owners, who withheld payment or sought disgorgement from noncompliant contractors even when there was no issue with the work performed.

The California legislature began to notice the injustice afforded by such a rigid and unforgiving scheme. In response, it passed Assembly Bill No. 1793, which will take effect in 2017, and will soften the substantial compliance requirements by removing the condition that the contractor did not know or should not have reasonably have known that he or she was unlicensed during performance of the contract.

Suggestions for Further Amendment

Although the amendment posed by AB 1793 will prevent some of the most blatant abuses of the §7031, much more can be done to create an evenhanded statute that protects the interests of both owner/developers and contractors alike. The following suggestions should be considered in instituting a fairer penalty provision.

a.  Provide definitions to “duly licensed” and “unlicensed.”

As stated in AB 1793’s Senate Floor Analysis, these terms “are not defined in the [CSLL], but are decisive terms under BPC Section 7031. Consequently, the legal profession lacks clear guidelines when judging the license status of a contractor, and the disgorgement provisions authorized by subdivision (b) are being misinterpreted and maliciously applied for personal gain, even when there is no issue regarding the quality of work performed.”

b.  Hold evidentiary rulings to determine if owner/developer knew, or should have known that contractor was unlicensed.

The current rules place absolutely no responsibility on owner/developers to ensure that they hire properly licensed contractors. While the statutes purport to protect the public from incompetence and dishonesty, they overlook the fact that many owner/developers are sophisticated business entities that have the resources to ensure that their contractors maintain proper licensure. Therefore, before imposing the harsh penalties of §7031, courts should hold evidentiary rulings to determine whether owners/developers knew or should have known that they hired unduly licensed contractors. The determination of whether an owner/developer “should have known” would likely take several factors into consideration, including: 1) the wealth and sophistication of the owner/developer 2) the extent of the owner/developer’s involvement in the construction industry, 3) the owner/developer’s knowledge of licensing laws, and 4) whether the owner/developer is a business entity that can properly allocate risk. If the court finds that the owner/developer knew or should have known that it hired unlicensed contractors, it should mitigate the §7031 penalties by permitting actions for partial compensation, or by allowing only partial disgorgement.

c.  Partial compensation or disgorgement when there are no issues with the quality of the work.

If an owner/developer does not allege any problems with the quality of the contractors work or the court determines that the work itself (i.e. not licensure) complies with statutory, regulatory, and contractual requirements, then it should likewise mitigate the §7031 penalties by permitting actions for partial compensation, or by allowing only partial disgorgement.

d.  Institute the prorated or partial compensation scheme proposed by the CSLB.

In 2013, the Contractors State Licensing Board sponsored SB 263, which proposed to modify BPC Section 7031 by providing that a contractor may pursue payment for any work on the contract while duly licensed, but preclude payment for work performed in a classification in which the contractor was not licensed, was under license suspension, or was under an expired or inactive license when the work was performed. This scheme is obviously more just that the current “all-or-nothing” approach.