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

By on November 21, 2016

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.

Filed under Business and Professions Code, Contractors State License Board

California Prompt Payment Laws and the Non-Retroactivity of Retention Reduction

By on June 30, 2016
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Introduction

California’s prompt payment laws serve the important function of encouraging timely and orderly payment for work on construction projects. They impose statutory deadlines by which project owners must pay general contractors (who in turn must pay subcontractors and so on) or face exorbitant penalties. However, they have become increasingly confusing. Prompt payment statutes span the Business and Professions Code, Public Contracts Code, and Civil Code and their applicability varies depending on the type of project, the type of payment (i.e. progress payment or retention), and the identity of the payor (owner, public entity, direct contractor, etc.). As such, any opinions offering clarity to the interpretation of these statutes are welcomed with open arms.

Blois Construction, Inc. v. FCI/Fluor/Parsons (245 Cal.App.4th 1091) offers, albeit in a limited way, such clarity, particularly regarding retention payments. The decision is timely in an age where sophisticated commercial contractors negotiate for terms that reduce or eliminate retention amounts as projects near completion (the argument being that since costs decrease as completion approaches, and since owners can rely on the accumulation of previous retentions, additional security is unnecessary). Even the California State Legislature followed this retention-reduction trend by instituting a 5% cap on retention for public works projects.

Brief Summary of Public Contract Code §7107

Section 7107 of the Public Contract Code requires public entities to release retention proceeds to contractors within 60 days of completion of a project. Pub. Contract Code §7107(c). The original contractor must pay its subcontractor(s) their share of the retention received within seven days of receipt, or face penalties of 2% per month of the improperly withheld amount. Pub. Contract Code §7107(d) and (f).

Blois Construction Summary

In 2006, the Exposition Metro line Construction Authority (“Metro” or “owner”) contracted with defendant FCI/Fluor/Parsons (“FCI” or “general contractor”) to serve as general contractor of Metro’s light rail line (the “Project”). Id.at 1094. FCI contracted with plaintiff Blois Construction, Inc. (“BCI” or “sub-contractor”) to perform underground work. Id. Both the primary contract (between Metro and FCI) and the subcontract (between FCI and BCI) contained provisions allowing retention of 10% of payments owed to FCI and BCI respectively. Id. An additional provision in the primary contract allowed Metro to elect not to take further retentions from remaining progress payments after 50% of the work on the project had been completed, and if it determines that FCI’s work was satisfactory. Id.

Pursuant to FCI’s request, Expo stopped retaining portions of progress payments beginning in December 7, 2009. However, Expo held the retention funds that accumulated from prior progress payments. Id.

Over the course of the Project FCI withheld over $500,000 in retention. Id. BCI sued FCI, alleging non-payment for 1) extra work performed on the Project, and 2) withheld retentions. Id. FCI agreed to pay the full amount of withheld retentions, but disputed BCI’s entitlement to late payment penalties under Public Contract Code §7107(f). Id.at 1095.

The appellate court ruled that Metro’s decision to stop withholding future retentions did not equate to payments of past retentions under §7107. Id. Therefore, since FCI did not receive retention proceeds from Metro until 2014, months after paying BCI its retention amounts in full, BCI was not entitled to penalties under §7107(f). Id.at 1096.

The court reasoned that BCI wrongly interpreted “retention proceeds” to include any amount that Metro could withhold from FCI, regardless of whether it actually did so. Id. Such an interpretation contradicts the statutory language of §7107, which applies only to withheld payment amounts. Id. Since Metro stopped withholding retention from progress payments in late 2009 onward, §7107 did not apply to those payments. Id.

BCI argued that the court’s conclusion contradicted the statute’s purpose of ensuring timely payment by general contractors to subcontractors. Id. The court stated that §7107 and other prompt payment statutes merely ensure that subcontractors do not wait significantly longer than general contractors for their share of the proceeds. Id.at 1097. An interpretation supporting earlier payment would unfairly prejudice general contractors, who often wait years before receiving withheld retentions from owners. Id. When Metro ceased withholding retention, FCI began paying BCI the full amount to which it was entitled from each progress payment, without retaining any funds. At no point did FCI receive payments without distributing BCI’s share of the proceeds. Id. Since FCI’s payments were timely, BCI could not succeed on its claims for additional penalty amounts. Id.

Conclusion

The court’s ruling falls in line with the prompt payment laws’ intent to ensure orderly and time-appropriate payment, and applies its interpretation broadly, offering clarity to all prompt payment statutes. The judgment obviously favors all “upstream” contractors, and will likely stoke the trend towards retention-reduction. What then, is to be gleaned from this case? Namely, if general contractors (or other upstream contractors) seek to modify retention withholdings, they should clearly identify and record their payments as non-retention progress payments to avoid confusion and dispute.

Filed under Prompt Payment Laws, Public Contract Code § 7107