Contractor’s Technical Violations of Contractor License Law During Corporate Reorganization Potentially Subjects It To Disgorgement of 18 Million Dollars in Compensation

The Judicial Council of California (JCC) entered into a contract with defendant Jacobs Facilities, Inc, a wholly owned subsidiary of defendant Jacobs Engineering Group Inc. (collectively Jacobs) to perform maintenance and repair of JCC facilities statewide. Performance of the contract required a license issued pursuant to the Contractors’ State License Law (Bus. & Prof. Code, § 7000 et seq.; CSLL). Jacobs was properly licensed when it commenced work. However, in the ensuing months Jacobs, as part of a corporate reorganization, transferred the employees responsible for performing the JCC contract to another wholly owned subsidiary. In the process Jacobs caused the new subsidiary to obtain a contractor’s license, while permitting the old subsidiary’s license to expire. Notwithstanding the lapse of its license, the old subsidiary remained the signatory on the JCC contract until nearly a year later, when the parties entered into an assignment of the contract to the new, licensed subsidiary.

After disputes arose between the parties, JCC sued Jacobs and the two subsidiaries under section 7031, subdivision (b), which requires an unlicensed contractor to disgorge its compensation. JCC sought return of all monies paid to Jacobs under the contract, some $18 million. Jacobs cross-complained seeking $4,669,376 from JCC as sums due and owing under the contract.

The matter was tried to a jury. The jury found that Jacobs had maintained a contractor’s license at all times while performing the contract; had “internally assign[ed]” the contract to its subsidiary prior to the expiration of the old subsidiary’s license; JCC was not “adversely affect[ed]” by the internal assignment; Jacobs was owed $4,669,376; and Jacobs was not required to disgorge the $18,331,911 paid by JCC for Jacobs work under the contract. The trial court entered judgment for Jacobs and JCC appealed.

The Court of Appeal reversed. The Court found that the evidence was essentially undisputed that Jacobs contracted to deliver services requiring a contractor’s license, allowed its license to expire, and continued to deliver the services while unlicensed. These facts appear to constituted a violation of the CSLL. The Court commented that Jacobs’ violation of the statute, clear as it was, appears to have resulted from the manner of execution of the corporate reorganization, rather than any attempt to evade licensure requirements. The Court viewed the jury’s verdict as an attempt to reach an equitable resolution, given the harsh consequences to Jacobs from the strict application of section 7031, However, in the final analysis, the question before the jury was whether Jacobs strictly complied with the statute, and Jacob’s failure of compliance, whether or not technical or de minimis, required reversal of the jury’s verdict.

The reversal of the judgment applies to both 1) Jacob’s claims for the balance of sums owed under its contract with JCC, and 2) JCC’s claims against Jacobs for disgorgement of compensation paid to Jacobs.

The Court of Appeal remanded to the trial court with instructions to hold a full evidentiary hearing on whether Jacobs substantially complied with section 7031, subdivision (e). To demonstrate substantial compliance, a contractor must show that it was licensed prior to performing, acted reasonably and in good faith to maintain its license, was unaware of any failure of licensure upon commencement of performance, and acted promptly and in good faith to reinstate its license upon learning it was invalid. According to the Court of Appeal, the trial court has 2 choices upon completion of the evidentiary hearing: If Jacobs is successful in demonstrating statutory substantial compliance, the trial court shall reinstate the judgment. If Jacobs is unsuccessful, the trial court shall enter judgment against Jacobs in the amount of $18,331,911, plus taxable costs and interest, if appropriate.

Implications of the Court’s Decision

This writer has stated on several occasions in the past that the law can be a harsh taskmaster, indeed. And this case, is a prime example. The future evidentiary hearing in San Francisco Superior Court will be a 22 million dollar, all or nothing proposition for Jacobs.

For contractors, the lesson to be learned from Judicial Council Of California v. Jacobs Facilities, Inc. is simple: take all possible precautions to ensure that your license is in good standing at all times during the progress of your construction projects. Otherwise, even a momentary lapse of licensure subjects you to potential disgorgement of all compensation received for all projects underway during the lapse in licensure, and the burden will be on you to attempt to prove substantial compliance with the license law. Do not take any chances with your license.

For owners, this case is a reminder that the California Legislature has provided you with a formidable weapon in your negotiations with your contractor. Remember to fully explore the contractor’s licensure status during the entirety of your construction project before making full payment on a project or concluding your negotiations over payment disputes.

For legal practitioners, in addition to being the most recent statement of California law on contractor licensure, the Judicial Council Of California decision contains a good discussion of California law on two tangential issues: 1) whether of determination of substantial compliance with the California license law is a court function or a jury function, and the corresponding rules of evaluating trial of equitable versus legal claims and defenses; (The Court’s holding: a Court function) and 2) whether indemnity or “guaranty provisions in a construction contract, in the absence of a prevailing party provision, can be interpreted to entitle the prevailing party to attorneys fees. (The Court’s holding: No attorneys’ fees recoverable)

The case is Judicial Council Of California v. Jacobs Facilities, Inc., et al., California Court of Appeal, First Appellate District, August 20, 2015, Nos. A140890, A141393, 2015 WL 4967258.

If you have any questions regarding the impact of this decision on contractors’ rights, please contact Ralph R Rhoades rrhoades@partonsell.com, who has 30+ years of experience representing contractors, owners and design professionals.

The Judicial Council of California (JCC) entered into a contract with defendant Jacobs Facilities, Inc, a wholly owned subsidiary of defendant Jacobs Engineering Group Inc. (collectively Jacobs) to perform maintenance and repair of JCC facilities statewide. Performance of the contract required a license issued pursuant to the Contractors’ State License Law (Bus. & Prof. Code, […]