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Don't Let Improper Licensing Cost You Payment!
By Diane Dennis © 2004

Bonnie from Kenyon Plastering in Phoenix AZ wrote to me recently about an article she read in the CSLB Summer/Fall 2003 newsletter about a California State Appellate Court decision pertaining to "improperly licensed contractors" and Section 7031, Chapter 12 of The Contractors State License Board; License Law, Rules and Regulations, and Related Laws. She suggested that it might be a good topic for my newsletter.

One thing I find myself saying quite often when talking to folks about the pitfalls of contracting is "Been there, done that" and yep, this time is no exception... Me writing about this topic is more appropriate than most people know (I'll tell you about it a little later in this article :)

The aforementioned article in the CSLB Newsletter was about a Subcontractor who sued a General Contractor for nonpayment on a contract job. I don’t know why the GC chose not to pay the Sub, it could have been due to § 7031 (or something else entirely), but the judge ruled against the Sub based on § 7031.

Basically, § 7031 gives the customer, of an unlicensed and/or not properly licensed contractor, the legal right to refuse to pay that which would otherwise be due under the contract. In addition, § 7031(b) gives the customer the right to sue the contractor to recover any monies he did pay under the contract.

There is definitely very good reason for § 7031. It’s great when used to protect a homeowner from an unlicensed contractor that would contract with a homeowner, do a poor job and then sue the homeowner for payment.

Unfortunately though it appears to also be a legal way to get away with not paying a guy who has done a good job, but is improperly licensed.

[Even the trial and appellate courts recognized the capability of § 7031 to cause “harsh and inequitable results”.]

Now please note, I am not in any way condoning unlicensed contractors. I'm just pointing out how this law can be, in my opinion, misused, causing honest contractors doing honest work who for whatever reason are improperly licensed, to lose out in the end.

Wrote Bonnie:

"I do think that part of the problem is that so many (especially smaller) contractors may be very technically proficient in their trade, but not real "business savvy" -- and, after all, who wants to sit down and read a bunch of laws! I can understand that the law intends that your business entity registration and your license registration be "transparent" -- that you are easily "traced", and that your licensed entity reflect the proper financial setup that your business has. There is a great big difference between a sole proprietorship and a corporation as far as owner financial responsibility goes. So - the law makes sense, it's just that no one really thinks about the rationale behind it... especially if you are an honest contractor just out to do a good job."

Now some might say that we should all be responsible and make sure that we keep our licensing in order and I do agree with that however at the same time, we are all human and most of us have much more to do than we have time for and we do make mistakes.

I forget things every single day and I can imagine how easy it can be to miss something that might seem, at first glance, insignificant.

Truly, would you have ever thought that after doing a whiz-bang job for your General that he could legally not pay you on a technicality such as this, and that the license board and law would not back you up?

After all, the Subcontractor who lost the case did possess a valid, active, in-good-standing license; it was just the wrong license. The only problem was that he hadn't changed his license from Sole-Owner to Corporate.

This same scenario can play out between an Owner and a General Contractor (or any contractor the Owner directly contracts with), with the Owner legally refusing to pay the bill.

If you’ve made changes in your business financial setup, take some time now to make sure your contractor’s license is setup appropriately. It can be the difference between getting paid and not.

So, no worries you say, you haven’t made any changes and you know that your license is in good order and that you don’t stand any risk of losing out on payment due to improper licensing?

Not so fast...

Here’s another angle, as pointed out by Bonnie:

"I've been doing an update of our computer base of Contractors that we work for - comparing their "corporate entity" registration with the state, and the existence of a contractors license with the state of California. I have found many "improperly licensed contractors", and when you read about the court's decision, you can just imagine the jeopardy you can be in if you are a Sub working for one of them and something goes wrong on the job. The money can dry up fast!"

Suppose you’re a Sub and you have your license in good order, everything right and proper, but the General you’re contracted with forgot to change his license when he changed his company setup?

The way the law is applied right now, it would appear that the Owner of the property could legally not pay the improperly licensed General Contractor.

Where does that leave you, and your suppliers?

How is the General going to pay you when he hasn’t been paid? Plus now he’s tangled up with the license board and who knows how high his fines will be... Add to that the "pay when paid" clause that’s probably in your contract and it could be a l-o-o-o-n-g time before you collect any monies on that project (if ever) ...

Sure you might have mechanic’s lien rights, if you did your prelim, but I’d still rather turn down that job from the get-go and avoid the hassles, rather than have to deal with mechanic’s liens.

You know though, now that I'm thinking about it, I wonder if there might not be mechanic’s lien rights even if you did do your prelim.

Technically the contract between you and the improperly licensed General is not valid because he’s not properly licensed. Since you’re not contracted directly with the owner, technically you’ve done work on the Owner’s property without a contract. Might this kill, or seriously risk, those mechanic lien rights?

Looking at it from yet another angle, what about properly licensed Contractor A’s risk of being disciplined by the CSLB for contracting (or attempting to contract) with unlicensed, or not properly licensed, Contractor B?

I decided to dig further into Chapter 12, to see what I could find. Please remember that I am not an attorney and that everything I’ve written here is based upon my own opinions and understandings (or lack thereof ;) of the various laws...

Section 7118 of Chapter 12 states that:

“Entering into a contract with a contractor while such contractor is not licensed as provided in this chapter constitutes a cause for disciplinary action.”

That’s pretty cut and dry. As a licensed contractor subject to Chapter 12, contract with an unlicensed or improperly licensed contractor and risk disciplinary action. But what if Contractor A didn’t know that Contractor B wasn’t properly licensed?

Here’s what Section 7118.5 says:

"Any contractor, applicant for licensure, or person required to be licensed, who, either knowingly or negligently, or by reason of a failure to inquire, enters into a contract with another person who is required to be, and is not, certified pursuant to Section 7058.5 to engage in asbestos-related work, as defined in Section 6501.8 of the Labor Code, is subject to ... (penalties) ..."

Basically that means that ignorance won’t save Contractor A; that it’s his responsibility to make sure those contractors he contracts with are properly licensed. The only thing is, because Section 7118.5 specifically mentions asbestos-related work, it makes one wonder if the same applies to all construction work and not just asbestos-related construction work.

Here’s what Section 7118.6 says:

"Any contractor who, either knowingly or negligently, or by reason of a failure to inquire, enters into a contract with another person who is required to be, and is not certified pursuant to Section 7058.7 to engage in a removal or remedial action, as defined in Section 7058.7, is subject to ... (penalties) ..."

This section specifically mentions hazardous waste, so again I’m left wondering if the same would hold true for all types of construction work...

Can properly licensed Contractor A be disciplined for contracting with improperly licensed Contractor B, when “A” was not aware that “B” wasn’t properly licensed?

I cannot seem to locate anywhere within Chapter 12 any text, that addresses this specific question, that doesn’t also include specific references such as asbestos and hazardous waste.

Is the lack of this specific information an oversight of the lawmakers or does it mean simply that “A” will not be disciplined since he was “ignorant” of the other contractor’s improper licensing status?

Unfortunately I do not have the answers to several of the questions here but I do know one thing... I like Bonnie's of contractors checking up on contractors' licensing and keeping track of it.

Contractors, now might be a good time to take a look at your licensing and make sure it accurately reflects your business. Also check your General Contractor’s licensing if you’re a Sub or your Sub’s licensing if you’re a General.

Suppliers, you might want to look into tracking your customers’ respective licensing status. If one of your customers doesn’t get paid because his licensing is improper it’ll no doubt be that much harder for you to get paid.

In addition, Suppliers might want to educate their customers about this and encourage those customers to keep track of their customer's license status.

I'm considering creating a tracking form for this. Any suggestions are always more than welcome! :) And if you have any feedback on this article I'd love to hear it! :) Click here to send me an email...

**Note: Because the Subcontractor was found to be an unlicensed contractor, technically that puts the General Contractor in violation of Labor Code Section 1021.5 which dictates that if you are a licensed contractor and you "enter into a contract with any person ... for which a license is required ... and that person does not ... hold a valid state contractor's license" then you are subject to civil penalty... We'll chat about that in an upcoming article. :)

And now for that "Been there, done that" story...

Shortly after we started our construction business in 1995 we found ourselves on the non-payment end of § 7031. What a learning (and totally not fun) experience that was!

Curtis (my hubby) and his buddy opened their new construction business, in 1994, on a license they thought was a partnership license.

Unfortunately it wasn't, it was only a sole-proprietorship license, in Curtis' buddy's name...

We were contracting without a license, and the projects were big, way over the $500 maximum allowed for unlicensed contractors. I kid you not, every single time the phone rang or someone came through the door I was expecting it to be the License Board coming to take Curtis away...

And then things got worse... It was then that we learned about § 7031. It was a General Contractor that we had literally just finished up a job for that very day that told us about § 7031... right before he told us that he wouldn't be paying us.

Here we were, just starting out a construction business, no operating capital to speak of, and now we had to pay our supplier even though we wouldn't be getting paid. Thank goodness our supplier (Cal-Ply Redlands) hung in there with us.

Plus we had to pay a fine to the CSLB. Fortunately they realized that although we were operating illegally we were honest and we weren't out ripping off people. Because of that they charged us the lowest fine amount that the law allowed.

We closed up our newly opened company and Curtis went to a contractor school, took his test, got his own contractor's license in January 1995 and it's been full speed ahead since then. :)