THE POTENTIAL COST OF CONTRACTING IN CALIFORNIA WITHOUT A LICENSE

Written by Traci Mason Baldwin

Conflicts are a common occurrence between owners and contractors and California takes the regulation of contractors seriously to protect the consuming public, sometimes strongly favoring the consumer in ways that can be quite penal to the contractor. A contractor failing to adhere to certain California requirements can free other parties from their obligations, damaging the contractor’s investment in the project and potentially leaving the contractor with no recourse. This is especially true when it comes to contracting without a valid contractor’s license, which is required for any work (labor and materials) that is valued at $500 or more. (Bus. & Prof. Code § 7159.)

According to Business and Professions Code section 7031(a)-(c), a contractor must be licensed at all times during performance of the work under the contract and if the contractor is not licensed, one can sue to recover “all” compensation paid to unlicensed contractor and any security interest taken to secure payment for performance of any “act or contract” that requires a contractor’s license is unenforceable. Section 7031(d) mandates that if the licensure is disputed, the suing contractor must produce a certificate proving such licensure was in place “at all times during the performance of any act or contract covered by the action.” Together, these provisions provide that recovery for compensation for work requiring a contractor’s license will be denied if a valid contractor’s license was not in place when performance began, or if licensure lapsed at any time during the work. (MW Erectors, Inc. v. Niederhauser Ornamental & Metal Works Co., Inc. (2005) 36 Cal.4^th 412, 429; see also Panterra GP, Inc. v. Rosedale Bakersfield Retail VI, LLC.et al, (2022) 74 Cal.App.5^th 697.) As one general contractor recently learned, the inability to file a claim to collect payment and the potential disgorgement of received funds for the work performed is a significant price to pay for contracting without a license.

Panterra GP, a licensed general contractor, sued defendant developers seeking more than $2.6 million for unpaid work it allegedly performed on a large construction project. Although both parties intended for Panterra GP to perform the construction work, the contract between the parties mistakenly listed Panterra Development, the general partner of Panterra GP, as the contracting party. Panterra Development is not a licensed California contractor. Panterra GP performed the work under the contract, applied for the building permits, and the certificate of occupancy listed Panterra GP as the contractor. When the project was completed, Panterra GP requested final payment and defendants refused. Panterra GP filed a complaint to seek reformation of the contract to reflect the true parties to the agreement and to recover the millions of dollars it was owed.

Defendants challenged Panterra GP’s complaint, citing Business and Professions Code section 7031(a), which prevents an unlicensed contractor from bringing an action for compensation unless the contractor is duly licensed at all times during the performance of the work. Defendants asserted that the contract named Panterra Development and Panterra Development is not a licensed contractor in California. Defendants filed a cross-complaint seeking disgorgement of the $7 million they had paid to Panterra Development pursuant to section 7031(b), alleging Panterra Development illegally contracted as the contractor.

The trial court ruled in the defendants’ favor, holding that Panterra GP may not rely on equitable principles to reform a contract to overcome the failure of the party identified as the contractor in the construction contract to have a valid contractor’s license as required by law.

On appeal, the Fifth District Court of Appeal vacated the lower court’s decision and held that the application of section 7031(a) had no applicability to claims asserted by Panterra GP because Panterra GP was licensed as a contractor at all relevant times. The court found that despite the mistake in the written contract, defendants intended and agreed that Panterra GP would act as the general contractor and perform the work contemplated by the agreement, which is what occurred. The purpose of section 7031 is to encourage adherence to licensing laws and deter individuals from offering to pay unlicensed contractors. Allowing a contract to be reformed to correctly reflect that the parties agreed to hire a licensed contractor for the work does not undermine the purpose of section 7031.

The appellate court was additionally critical of the trial court’s standard of review and chastised the lower court for effectively turning the pleadings stage into an evidentiary hearing. The lower court was reminded that in reviewing the sufficiency of a complaint, the court is to assume the truth of all factual allegations in the pleadings and that a court’s function is limited to testing the legal sufficiency of a complaint and an early challenge to the complaint is not the appropriate vehicle for determining the truth of disputed facts. It appears the court of appeal was swayed by a “no harm, no foul” sense of equity in allowing Panterra GP to proceed with its lawsuit since the consumer received the services of a licensed contractor at all times (except for the signing of the contract itself) without prejudice to the consumer.

However, the appellate court’s opinion was not unanimous, with Justice Smith writing a powerful dissent stating Panterra’s actions are exactly what California’s state licensing laws are designed to preclude: an unlicensed contractor from filing a lawsuit to recover under the contract. “California courts have…long held that those who enter into construction contracts must be licensed, even when they themselves do not do the actual work under the contract. [Citation omitted.] Indeed, if this were not the rule, requirement that general contractors be licensed would be completely superfluous.” [Citations omitted.]

Judge Smith took a strict reading of the statute to argue that there is no dispute that the construction project required a valid contractor’s license, and the contracting party was Panterra Development, an entity that was not a licensed contractor. Panterra GP’s efforts to cure the defect by attempting to blur the distinction between the two entities by collectively referring to Panterra GP and Panterra Development as “Panterra” and asserting that Panterra GP was the representative for Panterra Development only served to undercut Panterra’s assertion that the reformation of the contract was based on mutual mistake because the contract did not reflect the true agreement of the parties, which was Panterra GP was contracting to perform the general contracting services under the agreement. The dissent found the Sham Pleading Doctrine applied requiring the court to disregard Panterra’s inconsistent allegations and deny Panterra GP’s complaint. Justice Smith was not swayed by the equities or the policies behind the statutory scheme and would have denied relief to Panterra GP.

Defendants have sought review by the California Supreme Court, and it is possible that the California Supreme Court follows Justice Smith’s dissent to deny relief to Panterra GP.

As it stands, this was a close call for this licensed contractor and an expensive lesson. Take aways: 1) Contractors who are also affiliated with development companies or other non-licensed entities must take care to separate their interests, especially when entering into contracts; 2) The consequences can be severe for contractors that do not follow California’s strict licensing requirements; and 3) Contractors must use the precise name of the actual licensed contractor person or entity in the construction agreement and include the license number as a reference.

Traci Mason Baldwin is an attorney with Porter Simon licensed in California, with offices in Truckee and Tahoe City, California, and Reno, Nevada. Traci’s practice areas include: real estate, construction, business and contracts .  She may be reached at baldwin@portersimon.com or www.portersimon.com.