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California Contractor Licensing Law Update: Disgorgement Claims Against Unlicensed Contractor Expire in One Year

Author: Robert Bernstein

Guest Editor: Sean McGah

Related Articles: Property

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November 9, 2020 7:48pm

The California Legislature really wants construction contractors in California to be licensed. As we have written previously, public policy supporting California’s contractor licensing requirement is so strong that even if you know a contractor is unlicensed when you sign a contract with them, you are still entitled to not only to refuse to pay them, you may benefit from any and all work they have performed. It gets even worse for the contractor. You may also sue them to obtain a refund (“disgorgement”) of any funds you already paid them. Until a recent decision by California’s Second District Court of Appeal, no court had evaluated which statute of limitations applies to a disgorgement claim against a contractor and when the applicable limitations period starts to run. We now know that such a claim is ripe when the work is finished or the contractor leaves the job, and the disgorgement claim must be filed within one year.

California’s Contractor’s License Requirement and Penalties

California Business & Professions Code Section 7031(a) provides that a construction contractor who is not licensed may not bring or maintain a lawsuit in California to recover for the value of a commercial or residential construction contract signed when they were not licensed. Section 7031(b) establishes the right to pursue a disgorgement claim against an unlicensed contractor.  It states:

  1. Except as provided in subdivision (e), a person who utilizes the services of an unlicensed contractor may bring an action in any court of competent jurisdiction in this state to recover all compensation paid to the unlicensed contractor for performance of any act or contract.

Subsection 7031(e) establishes a limited exception to the law’s severe remedies, but only for a previously-licensed contractor who can prove they followed licensing requirements, believed they were licensed when they performed the work, and immediately corrected the problem upon discovery. The exception essentially applies to a contractor who met all of the qualifications but was technically unlicensed for a relatively brief period.

“The purpose of Section 7031 is to deter unlicensed contractors from recovering compensation for their work.”  (E.J. Franks Construction, Inc. v. Sahota (2014) 226 Cal. App. 4th 1123, 1129.)  The plain language of §7031(b) limits the recovery to compensation paid to the unlicensed contractor.  “Section 7031 is a regulatory statute designed to discourage persons who are not licensed from offering their services for pay.” (Hydrotech Systems, Ltd. v. Oasis Waterpark (1991) 52 Cal.3d 988, 995.)

Courts recognize preventing an unlicensed contractor from suing to recover unpaid funds, and allowing the customer to disgorge any funds already paid, effectively provides the property owner with an unjust enrichment.  They follow the Legislature’s determination, however, that deterring work by unlicensed contractors is sufficiently important (as a way to ensure construction projects are performed properly and to prevent consumers from being defrauded by unlicensed contractors) to justify the penalty imposed on unlicensed contractors not to be paid for their work, and the corresponding enrichment of property owners. (Executive Landscape Corp v. San Vicente County Villas IV Assn (1983) 145 Cal.App.3d 496, 498.)

Eisenberg Village v. Suffolk Construction

California’s Second District Court of Appeal, Division 4, issued an important decision relating to the contractor’s license law on August 26, 2020. The case is Eisenberg Village of the Los Angeles Jewish Home for the Aging v. Suffolk Construction Company (2020) 53 Cal.App.5th 1201.

Facts and History of the Case

In late 2007, Suffolk Construction Company (“Suffolk”) entered into a contract with Eisenberg Village of the Los Angeles Jewish Home for the Aging (“Eisenberg Village”) for Suffolk to be paid approximately $50 million to build a home for senior citizens.  In the contract, Suffolk provided its California contractor’s license number. The contract also included a provision in which Suffolk represented and warranted that all contractors and subcontractors who worked on the project would be validly licensed during performance of the work.  In addition, the contract contained the required statutory notices to Eisenberg Village advising of its rights to pursue claims related to defective construction and directing it to contact the Contractor’s State License Board with any questions regarding Suffolk.  Suffolk completed the project in June 2010.

After residents began to move into the senior housing complex, problems developed with the hot water supply. The hot water temperature was above the level allowed by law in a senior residential facility. Suffolk attempted to repair the problems, which ultimately reoccurred as additional residents moved into the complex. The California Department of Social Services issued a citation, and Suffolk agreed to work with Eisenberg Village to try to resolve the issue.

In June 2013, Eisenberg Village sued the project’s architect for breach of contract and negligence, alleging defects and problems with the hot water system, plumbing system, and HVAC system in the complex. Eisenberg Village did not sue Suffolk at that time, because it entered into an agreement that tolled applicable statutes of limitation/repose while Suffolk attempted to repair the problems. When the tolling agreement expired in 2014, Eisenberg Village amended its complaint to name Suffolk as an additional defendant.  The parties attempted to resolve the claim in mediation held in January 2015, but their settlement discussions were unsuccessful.

According to the President and CEO of Eisenberg Village, it was not until after the 2015 mediation failed that the company, “began to investigate the merits of its claims against Suffolk . . . and discovered for the first time . . . a potential issue with Suffolk’s license during the period when work on the complex was underway.”  Specifically, Eisenberg Village discovered Suffolk’s licensed RME (Responsible Managing Employee) had moved from California to Massachusetts in 2008, and was no longer directly supervising the construction process from 2008 through completion. Based upon its investigation, Suffolk filed a second amended complaint in May 2015 in which it added a claim under Section 7031(b), seeking disgorgement of funds paid to Suffolk.

Competing Dispositive Motions and Success By Suffolk

Both Suffolk and Eisenberg Village pursued dispositive motions related to the disgorgement claim. The trial court overruled a demurrer filed by Suffolk regarding the disgorgement claim. Among the arguments raised by Suffolk was that the claim was barred by the one-year statute of limitations applicable to claims for penalties or forfeitures. The trial court held it was not possible to determine, based on the pleadings, when Eisenberg Village should have been aware of the facts supporting its disgorgement claim. The court also denied a motion for summary adjudication filed soon after by Eisenberg Village, which sought to foreclose further proceedings related to the disgorgement claim.

Suffolk then filed its own motion for summary adjudication on Eisenberg Village’s disgorgement claim.  The trial court agreed with Suffolk, concluding Eisenberg Village knew or easily could have discovered problems with Suffolk’s licensing status more than one year prior to filing its related claim against Suffolk. Consequently, the claim was time-barred and Suffolk could not be compelled to refund the money paid to it for its construction work. Eisenberg Village appealed.

The Court of Appeal’s Analysis

On appeal, Eisenberg Village contended the disgorgement remedy in Section 7031(b) is not a penalty but instead provides restitution. In support of its contention, Eisenberg Village cited a decision from the California Supreme Court in which the Court provided a definition for “restitution,” as follows:

The word `restitution’ means the return of money or other property obtained through an improper means to the person from whom the property was taken. [Citations.] `The object of restitution is to restore the status quo by returning to the plaintiff funds in which he or she has an ownership interest.’

Clark v. Superior Court (2010) 50 Cal.4th 605, 614.

Eisenberg Village argued that three-year and four-year statutes of limitation in Code of Civil Procedure Sections 338, 340 and 343 applied to the claim. The Court of Appeal properly framed the ultimate issue in dispute as follows:

[W]hether a section 7031(b) disgorgement is a penalty or a forfeiture.

The Court concluded disgorgement is in fact a penalty, because it “deprives the contractor of any compensation for labor and materials used in the contraction while allowing the plaintiff to retain the benefits of that construction.”

The Court of Appeal then evaluated when a section 7031(b) disgorgement claim accrues, again relying upon decisions from the California Supreme Court. It examined the “discovery rule,” which essentially provides a plaintiff’s claim does not accrue for purposes of triggering statutes of limitation, “until the plaintiff discovers, or has reason to discover, the cause of action, until, that is, [the plaintiff] at least suspects, or has reason to suspect a factual basis for its elements.” (Nogart v. Upjohn Co. (1999) 21 Cal.4th 383, 389.)  In another relevant case, the Supreme Court explained “the discovery rule most frequently applies when it is particularly difficult for the plaintiff to observe or understand the breach of duty, or when the injury itself (or its cause) is hidden or beyond what the ordinary person could be expected to understand.”  (Shively v. Bozanich (2003) 31 Cal.4th 1230, 1248.)  The Court of Appeal then concluded that, because the discovery rule is based on equity and on concepts of fairness, it makes little sense to apply it to a disgorgement claim under Section 7031(b), which is not designed to compensate the plaintiff, but instead to punish the unlicensed contractor.

The Court of Appeal found Suffolk’s initial efforts to remedy problems with the complex extended commencement of the one-year limitations period, but it concluded the one-year period started, at the latest, on March 25, 2014, when Suffolk had completed any and all repair work which was arguably done under the original contract with Eisenberg Village. Because the claim for disgorgement was not filed until May 18, 2015 – more than one year later – the Court held Eisenberg Village’s disgorgement claim barred by the one-year statute of limitations in Code of Civil Procedure Section 340(a). The trial court’s decision was affirmed and Suffolk was allowed to keep the funds paid to it, although it remained subject to liability due to defective construction.

Takeaway

The best practice for any business or consumer who enters into an agreement with a construction contractor is to check the contractor’s license status with the California State Contractor’s License Board, not only before signing the contract, but periodically during the work.  Certainly, the contractor’s license status should be checked as soon as any problems are discovered, whether the contractor attempts to repair them or if litigation starts right away.  In addition, every customer should calendar a reminder to check the status of their contractor’s license 11 months or so after all work is finished.  If it is determined there may be a problem with the contractor’s license, there is still time before the one-year statute of limitations lapses to pursue a disgorgement claim.

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