Performing construction work without the necessary license can have significant repercussions on a contractor’s business. California in particular has become known for its imposition of “strict and harsh” penalties for a contractor’s failure to maintain proper licensure. In the realm of public works projects, any contract with an unlicensed contractor is deemed void. See Business & Professions Code Section 7028.15(e). On private projects, California’s Contractors’ License Law prohibits contractors from maintaining any action to recover payment for their work, and more severe, may require a contractor to disgorge all funds paid to it for performing unlicensed work. See Business & Professions Code Section 7031). These methods of deterrence are referred to as the “shield” and “sword” of the Contractors’ State License Law. Loranger v. Jones, 184 Cal. App. 4th 847, 854 (2010).
In any discussion surrounding licensure, it is important to review the language of the Business and Professions Code (“Bus. & Prof.”). Section 7031(a) states:
Except as provided in subdivision (e), no person engaged in the business or acting in the capacity of a contractor, may bring or maintain any action, or recover in law or equity in any action, in any court of this state for compensation for the performance of any act or contract where a license is required by this chapter without alleging that they were a duly licensed contractor at all times during the performance of that act or contract regardless of the merits of the cause of action brought by the person…
Bus. & Prof. Code § 7031(b) states:
Except as provided in subdivision (e), a person who utilizes the services of an unlicensed contractor may bring an action in any court of competent jurisdiction in this state to recover all compensation paid to the unlicensed contractor for performance of any act or contract.
Until recently, many were left wondering the consequence, if any, these rules of deterrence would have on a contractor if one of its subcontractors was not duly licensed. Would a contractor be required to disgorge its contract funds to a project owner if one of its subcontractors is unlicensed? Would a contractor be able to turn to the courts to recover compensation for the services performed by an unlicensed subcontractor? These important questions have now been answered in the recent decision in Kim v. TWA Construction, Inc., 78 Cal. App. 5th 808 (2022).
Factual Background
In Kim, Sally Kim and Dai Trong (“Kim”) hired TWA Construction, Inc. (“TWA”) to construct a home. The parties’ contract required the removal of trees, including a large eucalyptus tree, which, unbeknownst to Kim, partially resided on Kim’s neighbor’s property. TWA hired a tree trimmer, Marvin Hoffman, who was unlicensed to perform the tree removal work. During the trimming of the tree, Kim’s neighbor ordered Mr. Hoffman to cease his work. Later, Kim terminated the contract with TWA due to their inability to secure a construction loan.
The neighbor brought suit against Kim and TWA for wrongfully cutting the tree. In response, Kim filed a cross-complaint against TWA for indemnity and breach of contract. TWA likewise brought a cross-complaint against Kim for breach of contract.
Before trial, Kim filed a motion which sought to require TWA to make an offer of proof as to Hoffman’s license status. Kim argued that “unless TWA could prove the subcontractor it hired for the tree work had the requisite license, TWA was barred from recovering from Kim and Truong any money paid or owed to the unlicensed subcontractor,” and argued that without its subcontractor maintaining a contractor’s license, TWA should disgorge the $10,000 they had paid for tree work since it was performed by an unlicensed subcontractor. The court granted the motion and at trial, TWA failed to introduce evidence of Hoffman’s licensure.
Following the trial, judgment was entered in Kim’s favor where it was awarded $10,000 in disgorgement from TWA for the amount it paid to TWA for the tree trimming work, and the court found in favor of Kim as to TWA’s cross-complaint. TWA subsequently appealed the judgments, arguing, among other things, that the trial court’s pre-trial ruling on the application of Bus. & Prof. Code § 7031 erred as a matter of law.
Appellate Court Ruling
The appellate court rejected TWA’s argument that the trial court ruling “effectively caused TWA to forfeit its claim for compensation from [Kim] for the tree work.” In doing so, the appellate court emphasized California’s “legislative determination that the importance of deterring unlicensed persons from engaging in the contracting business outweighs any harshness between the parties.” (citing Lewis & Queen v. N.M. Ball Sons 48 Cal. 2d 141, 151 (1957)) “[The legislation’s] purpose […] is to provide some assurance that persons offering contractor services in California meet baseline qualifications and discourage noncompliance with the licensing law.” The court also stated that “to narrowly construe section 7031(a) to allow TWA’s claim for compensation to proceed under the circumstances here […] would undermine certain other provisions of the statutory scheme governing contractor licensing and contravene the policy behind the statute.” Moreover, the court understood that permitting TWA to “recover compensation for the performance of unlicensed work, simply because the work was accomplished by hiring a subcontractor, would circumvent the purpose of section 7031.”
With the policy behind Section 7031 guiding its decision, the court confirmed that “it would be unreasonable to permit TWA to collect compensation for work performed by an unlicensed subcontractor when all facets of the Contractors’ State License Law are directed at ensuring licensing compliance.”
In sum, as a result of TWA’s use of an unlicensed subcontractor, TWA was barred from maintaining an action to recover payment and was further required to disgorge all sums paid to it for the unlicensed subcontractor’s work.
Conclusion
The case is a reminder to owners, contractors, and subcontractors alike of the importance of contractor licensing. California courts place great emphasis on the policy behind Section 7031 and will seek to protect the public from “incompetence and dishonesty” in those who provide building and construction services. California contractors must use prudence before entering into subcontracts to ensure their subcontractors are properly licensed. Importantly, however, the Kim holding indicates that while a contractor who utilizes an unlicensed subcontractor may be required to disgorge funds, such disgorgement may be limited to the amounts paid for that subcontractor’s scope of work, as opposed to all sums paid to the contractor for the project.
Additionally, while some aspects of Section 7031 have now been resolved, the Kim holding raises new questions. Will this ruling impose a new duty on contractors to ensure their subcontractors are duly licensed throughout their time on the project? What impact will Section 7031 have on a contractor if a subcontractor’s license lapses during the performance of its work on the project? While the answers to these questions are currently unknown, if the Kim decision is any indication, California contractors should act cautiously, understand California’s tendency to uphold its strict licensing laws, and act diligently to monitor their subcontractors’ license status.
Watt Tieder is one of the largest construction boutique law firms in the United States, with a diverse and experienced team of attorneys representing many of the world’s leading corporations, developers and contractors on both domestic and international projects. We represent more than half of the Top 30 Engineering News Record contractors and most of the nation’s top sureties. With offices in six cities in the United States, the firm is a dynamic, mid-size boutique that provides knowledgeable and practical legal representation to the construction, surety, government contracts and bankruptcy industries world-wide.
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