In California, the lapse or absence of a contractor’s license can be catastrophic:
- The contractor is not entitled to further payments, California B & P §7031(a), and;
- The contractor must disgorge earlier payments, B & P §7031(b).
Furthermore, the California Legislature has greatly restricted the ability of contractors to claim “substantial compliance” with the licensing law, B & P §7031(e).
Let’s say a $500 million suspension bridge is at issue. If the contractor is unlicensed, the owner keeps a piece of spectacular infrastructure, while the contractor gets stiffed and must disgorge all prior payments.
Most legal and industry commentators agree the intended outcome is draconian. Such a disgorgement can bankrupt a large contractor and lead to large losses by sureties.
A common strategy of contractors in that situation is to favor arbitration, thinking that an arbitrator might be less inclined to grant a license defense, as it will not only defeat the contract claims, but likely put the contractor out of business. And to some degree, that might be right to the extent arbitrators think about the economic consequences.
The flaw in this thinking is woven into the licensing statute: An arbitration decision on the contractor license issue is subject to trial de novo in the California Superior Court, Ahdout v. Hekmatjah (2013) 213 Cal.App.4th 21. Further, a party need only prove its disgorgement case under section 7031(b) by a “preponderance of the evidence.” Once in Superior Court, there is a significant chance that a finding of contracting without a license will become known to the Contractors State License Board (CSLB).
And on the license issue, the Superior Courts have a policy mandate:
“Because section 7031 constitutes an explicit legislative expression of public policy regarding unlicensed contractors, the general prohibition of judicial review of arbitration awards does not apply. The fact that section 7031 reflects an explicit expression by the Legislature of its public policy objectives sets this case apart from Moncharsh, which concerned alleged violations of the [Lawyers] Rules of Professional Conduct that are approved by the Supreme Court, not the Legislature.”
“Thus, in the instant case, the trial court should have conducted a de novo review of the evidence to determine whether disgorgement of compensation for [the contractor’s] construction work was required by section 7031. The arbitrators’ finding that [the contractor] did not function as a general contractor on the Project is not binding on the trial court.” Ahdout, supra.
The strict interpretation of the law employed by California Superior Court judges under § 7031 is exemplified in WSS Industrial Construction, Inc. v. Great West Contractors, Inc. (2008) 162 Cal.App.4th 581, 587, [“…courts may not resort to equitable considerations in defiance of section 7031. That is because the statute represents a legislative determination that the importance of deterring unlicensed persons from engaging in the contracting business outweighs any harshness between the parties….”].)
But, you may ask, what if you are the party seeking to invalidate the contractor’s license?
You might consider that an arbitrator might sidestep your valid license defense, thinking a disgorgement outcome would be grossly disproportionate to the equities of the case. In that case, you will get a trial de novo and a finding by the arbitrator that the license was in good standing. In either case, the parties will face many years of appeals (perhaps a retrial as well), just to resolve the license issue.
In a Mediation, both sides can balance these risks and come up with a settlement that reflects the true equities, as well as merits, of the license issue.
Where a license issue exists, a Mediation strategy is a wiser course.
*This post was written by Ernest C. Brown, Esq. PE and has been published here with his permission. Mr. Brown has the distinction of being endorsed as one of the top five construction lawyers in California, according to Chambers & Partners, the premier independent ranking publication for lawyers across the globe. His Chambers & Partners profile praises him as a “very, very experienced construction attorney” with a “very smart and practical” approach.
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