By: William L. Baggett, Jr., Smith, Currie & Hancock LLP
Over three decades ago, I obtained my first law license. After the bar exam, my sarcastic, long-time mentor remarked that passing the bar exam was like leaping over a ditch that was one-foot wide but infinitely deep: “Not much of an accomplishment, but the downside of failure is severe.” My mentor’s observation comes to mind when I read the periodic contractor licensing failure cases. Most successful contractors excel not only at contract performance, but also at pre-project planning. For a multi-state contractor, one such pre-performance detail is understanding and complying with licensing laws. Licensing failures can have dire consequences, and a recent bankruptcy decision from Delaware shows what perils await the inattentive. In In re Abeinsa Holding, Inc., a bankruptcy court disallowed over $13 million of claims by a contractor and its factor because the contractor was not properly licensed in the state in which it performed work. The Court acknowledged that the result was harsh, but it nevertheless strictly enforced the clear provisions of California’s Contractors’ State License law. Strict compliance is often the only option.
The Project
The dispute arose out of a solar power plant project in California. The contractor and claimant in bankruptcy was a Texas company that provided insulation services to the owner. The owner later voluntarily sought bankruptcy protection. The contracts between the contractor and owner specifically required that the contractor would maintain the required licenses to provide insulation services. Before the owner filed its Chapter 11 petition, its counsel wrote the contractor and requested correct license numbers. No license number or license was provided, because the contractor did not have a California contractor’s license. Nevertheless, the contractor performed over $12 million of work for the owner and received payment for some of it. The owner’s response to the claim indicates that the contractor was paid some $7.7 million. The contractor’s claim in bankruptcy was in excess of $11 million.
The Factoring Agreement
The contractor also entered into an account purchase agreement whereby a third-party would factor the contractor’s invoices upon the third-party’s approval. Eventually, and before the bankruptcy, the third-party factor signed a written agreement with the owner that obligated the owner to pay the amount of the contractor’s invoices to the factor without offset, backcharges, or disputes. Upon the owner’s bankruptcy, the factor also submitted a claim in excess of $2 million.
The Licensing Law
The Delaware bankruptcy court applied the law of the state in which the project was performed. Under California law, “no person . . . acting in the capacity of a contractor may bring or maintain any action or recover in law or equity in any action . . . the collection of compensation for the performance of any act or contract where a license is required by this chapter without alleging that he or she was 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 . . . .” The bankruptcy court examined California cases construing the licensing law and concluded that the obvious intent of the statute is to discourage persons who have failed to comply with the licensing requirement from offering or providing unlicensed services. The bankruptcy court determined that California law valued the deterrence of unlicensed contracting over any harsh results as between the parties. Thus, the unlicensed contractor’s claim failed.
The Factor’s Claim
The factor argued that its separate no offset agreement with the owner entitled it to compensation in spite of the contractor’s unlicensed status. The court rejected this argument, however, because it treated the factor as an assignee of the contractor’s rights against the owner. Because the contractor had assigned its rights to payment under an agreement that was unenforceable against the owner, the factor had no right to recover under an unenforceable contract. Because of the assignment, the court held that the validity of the independent contract between the factor and the owner was not relevant.
The Contractor’s Unsuccessful Arguments
The contractor attempted to save both its claim and the factor’s claim by arguing that it had substantially complied with the California licensing law by entering into a relationship with a third-party, which held a valid license. The contractor argued that it understood that it was authorized to operate under the third-party’s contractor’s license and that the owner confirmed that fact and used the contractor’s services with full knowledge and approval of the license situation. The court rejected this argument by pointing to the language of the contract which required the contractor to maintain the appropriate license. The third-party was not a contracting party in the transaction and, therefore, its license could not be relied upon by the contractor. The court also held that a contractor must have been licensed at some time before the performance of the work in order to argue substantial compliance. The contractor had never been licensed in California.
The contractor also tried to convince the court that it was induced to perform its services with the false promise to be paid by the owner. The court held that the contractor’s argument undercut the intent of the licensing statute – to prevent unlicensed contracting – and refused to recognize the fraudulent inducement of an illegal contract as an exception to the rule that an unlicensed contractor cannot recover payment.
Lessons
1. Failure to obtain appropriate licenses is generally not curable. In some states, a failure to obtain a license not only renders a contractor unable to sue or demand arbitration for payment on work that it has already performed, but also exposes it to liability for any money that it may have been paid on the project.
2. Licensing issues should be resolved before performance begins.
3. Licensing requirements vary significantly from state-to-state. For example, some states do not require general contractors to be licensed; other jurisdictions require specific trades to be licensed.
4. Some jurisdictions have criminal penalties for licensing failures.
5. The relevant rules in a particular state are important, but almost equally important is information about the manner in which the governmental bodies dealing with licensing laws operate. Contractors should learn as much about the relevant licensing board as possible.
Case: In Re Abeinsa Holding Inc., 2019 W.L. 1400175 (Bankr. D. Del. March 26 2019)
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