ABA Construction Forums: Under Construction: Unlicensed Contractors Work for Free

August 01, 2005

Published in the ABA Forum on the Construction Industry newsletter Under Construction 

The California Supreme Court recently decided a case that could be catastrophic for contractors working in California and a further protection for anyone contracting with an unlicensed contractor.  In short, the Supreme Court held in MW Erectors, Inc. v. Neiderhauser Ornamental and Metal Works Company, Inc., 05 C.D.OS. 6163 (July 14, 2005), that contractors unlicensed at any time during a project cannot sue for payment, unless they satisfy a narrow statutory safeharbor for contractors substantially complying with licensing laws.  An unlicensed contractor's forfeiture is required even if equity - principles of fundamental fairness - might compel payment to the unlicensed contractor.

The MW Erectors Decision

On July 14, 2005, the California Supreme Court decided MW Erectors, a case in which a second-tier subcontractor (MW Erectors) sued the subcontractor (Neiderhauser) that hired it for more than $1.3 million for steel work performed under two contracts on a private hotel project.  The two contracts were signed by MW Erectors while it was unlicensed.  Additionally, MW Erectors' work on the first contract, which represented nearly $1.0 million of its claim, started before its specialty license was issued, and its work on the second contract, which represented the balance of its claim, started after it was properly licensed.  In response to the suit, Neiderhauser argued that the claims were barred under Business & Professions Code Section 7031(a), because MW Erectors was not licensed when the contracts were signed nor licensed for the first eighteen days of the year-long project in which it was involved under the first contract.  MW Erectors countered that while it was not "technically" licensed for part of its work under the first contract, it substantially complied with the contractor licensing requirements.  MW Erectors further countered that Neiderhauser was judicially estopped from complaining about the brief period it was unlicensed.  More specifically, Neiderhauser took, and benefited from, the opposite position in a lawsuit against the project's general contractor and owner, when Neiderhauser impliedly relied on MW Erectors' due licensure in recovering a "substantial amount" on a MW Erectors pass-through claim.

In reversing the Court of Appeals, which allowed payment for work performed while MW Erectors was licensed, the Supreme Court initially stressed that the equities favoring MW Erectors were trumped by Section 7031(a).  The Court explained this statute is a "stiff all-or-nothing penalty" that is "directly at odds with the premise that contractors with lapses in licensure may nonetheless recover partial compensation by narrowly segmenting the licensed and unlicensed portions of their performance."  As the Supreme Court further explained:

MW [Erectors] cannot invoke [the equitable doctrine of] judicial estoppel for the simplest of reasons.  Section 7031(a) expressly provides that "regardless of the merits," one may not "bring or maintain any action, or recover in law or equity in any action, . . . for the collection of compensation for the performance of any act or contract where a license is required . . . without alleging that he or she was a duly licensed contractor at all times during the performance of that act or contract."  (Emphasis in original.)

Based on this "strong and clear statutory mandate," the Supreme Court was also unswayed by the unrebutted assertion that Neiderhauser had already recovered "substantial amounts" from the project's general contractor and owner for MW Erectors' work, and would be unjustly enriched if payment were not passed on to MW Erectors.  Again, the Supreme Court stressed that:  "Section 7031(a) will be applied, regardless of equitable considerations, even when the person for whom the work is performed has taken calculated advantage of the contractor's lack of licensure."

After resolving MW Erector's equitable arguments, the Supreme Court examined the statutory substantial-compliance exception that could nonetheless allow MW Erectors to recover on its claims.  Focusing on the version of the statute in existence in 2000, which has since been amended, the Court noted that the substantial compliance exception "could apply only when, among other things, the contractor, despite a later lapse in licensure, ‘had been duly licensed as a contractor in this state prior to performance of the act or contract' for which compensation is sought."  It then determined that, because MW Erectors had never held the specialty license before it started work on the project, the substantial compliance exception did not apply, and MW Erectors was barred from recovering on its $1.0 million claim under the first contract.

Finally, the Supreme Court addressed MW Erectors' right to recover on its claim under the second contract.  Neiderhauser argued that construction contracts are illegal, void and unenforceable from the outset if the contractor is unlicensed when it signs the contract.  In support of its position, Neiderhauser pointed to the licensing laws, which define a contractor as one who, among other things, "undertakes to or offers to undertake to, or  . . . submits a bid to" perform construction work, and which make it a misdemeanor for unlicensed contractors to "act in the capacity of a contractor."  The Supreme Court acknowledged that although a number of California cases have held such contracts void on this basis, no "modern case" has "applied this principle to deny recovery where the contractor, though not licensed at the time he or she executed the agreement, was fully licensed at all times during its performance [on a private project]."  Relying again on Section 7031(a), the Supreme Court noted that "allowing suit on and recovery under such circumstances violates no express term of Section 7031(a)."  Accordingly, the Court allowed MW Erectors to recover under the second contract despite its failure to be licensed when the contract was signed.

Implications for the Construction Industry

The California Supreme Court's unequivocal pronouncement that unlicensed contractors work for free serves as a powerful reminder to carefully and routinely monitor the licensing status of all contractors and subcontractors with whom you work.  (The status of a contractor's license can be easily determined through the California State Licensing Board's website, which can be viewed at http://www.cslb.ca.gov/.)  If a contractor discovers that its license, or the license of any subcontractor with whom it has contracted, has been suspended, it must immediately take action to have the license reinstated.  Similarly, an owner should confirm at the outset that the contractor, and each of its proposed subcontractors, is licensed before entering into a construction contract.  Barring this up-front confirmation, owners should at least confirm licensing status of contractors and subcontractors in response to a contractor claim.