Contractor eating lunch on bench

Every contractor in the country should be licensed to perform construction work, and each state handles licensure differently. Some states require a license to be able to file a mechanics liens, while some states go even further by barring any potential claims for compensation if the work was performed without the required license.

The latter is California’s approach to unlicensed contractors. Yet California takes it a step further by providing a potentially severe remedy for property owners: disgorgement.

A recent California Court of Appeals case shed some light on these types of claims, particularly the timeframe to bring such an action, and when such causes of action begin to accrue.

California contractor licensing and disgorgement

The California Contractors State Licensing Board (CSLB) is the entity that governs the licensing of contractors within the state. These regulations are taken very seriously. So much so, that under Cal. Bus. & Prof. Code §7031(a):

… no person engaged in the business or acting in the capacity as a contractor, may bring or maintain an action, or recover in law or equity in any action… for the compensation for the performance of any act or contract where a license is required…

In other words, an unlicensed contractor in California has no rights to payment whatsoever.

As mentioned above, there is also a potential claim for property owners against unlicensed contractors known as disgorgement:

… a person who utilizes the services of an unlicensed contractor may bring an action in any court… to recover all compensation paid to the unlicensed contractor for performance of any act or contract.

Essentially, disgorgement requires the contractor to return any and all compensation and profits received for performing the unlicensed contract work. This remedy is meant to punish an unlicensed contractor and prevent them from being “unjustly enriched” due to their illegal actions (i.e., unlicensed contractor work).

The limits of these types of claims have never been fully analyzed under California law — until recently.

Disgorgement claim against an “unlicensed” contractor

The case in question is Eisenberg Village of L.A. Jewish Home for Aging v. Suffolk Construction Co.

Project Snapshot:

  • Owner: Eisenberg Village of LA Jewish Home for Aging (Eisenberg)
  • Contractor: Suffolk Construction Co. (Suffolk)

Eisenberg hired Suffolk for the construction of a 108-unit assisted living facility in Reseda, CA. On the first page of the contract, under the “Contractor’s License” provision, Suffolk represented and warranted that all contractors and subs performing work on the project were licensed. The provision also included multiple notices warning that all contractors must be licensed by the CSLB.

When the project was completed, Suffolk was paid $49 million for the work performed. Shortly thereafter, multiple issues with plumbing and hot water began to arise.

Suffolk performed additional work to remedy the problems on more than one occasion. However, more issues kept arising, so the two parties submitted to mediation to try and resolve the issue. Mediation proved to be unsuccessful.

Issues with Suffolk’s “qualifying agent”

Since litigation seemed inevitable, Eisenberg began to investigate the claim in more detail, and discovered a potential issue with Suffolk’s licensure — specifically with issues concerning their qualifying agent.

In California, in order to get a contractor’s license on behalf of a construction company, it must qualify for a license through a “qualifying agent.”

This qualifying agent must be a “responsible managing officer” (RMO) or a “responsible managing employee” (RME). Suffolk’s qualifying agent was an individual by the name of Gregory Hescock who was an RME.

RMEs in California must be “an individual who is a bona fide employee of the applicant and is actively engaged in the classification of work for which the RME is the qualifying person on behalf of the applicant.”

Furthermore, the RME must be “responsible for exercising that direct supervision and control of his or her employer’s or principal’s construction operations.”

Eisenberg alleges that the RME was transferred to Suffolk’s Boston office, and was never present or involved in any of the project’s undertakings. Furthermore, there was no direct supervision and control over anyone at Suffolk in connection with the project.

Therefore, Suffolk lacked a bona fide qualifier as an RME, which consequently made Suffolk not duly licensed to perform the work.

Trial court dismisses claim as untimely

Accordingly, Eisenberg filed an action for disgorgement under §7031(b) five years after completion of the project. In response, Suffolk filed for a motion for summary adjudication of the claim.

The trial court granted the motion based on the fact that the one-year statute of limitations applied, and that Eisenberg knew or easily could have discovered the facts giving rise to the claim. A statute of limitations (SOL) is basically the timeframe in which a certain claim (cause of action) can be brought against a party.

Eisenberg appealed, contending that the court erred by applying the one-year SOL and also misapplied the “discovery rule” regarding when the claim began to accrue.

Appeals Court analyzes the timelines for disgorgement claims

On appeal, there were two main issues that needed to be determined.

  1. What is the statute of limitations for a §7031(b) disgorgement claim?
  2. When does such a cause of action begin to accrue?

Let’s break down each of these individually.

1. What is the statute of limitations for disgorgement claims?

Since the statutes that provide disgorgement as a remedy don’t specifically set a statute of limitations, the parties offered three different potential statutes of limitations that could apply, ranging from one year to four years.

The court began by stating disgorgement is a liability created by statute, thus accordingly, the applicable statute of limitations would be either:

  • Three years under CCP §338(a) if disgorgement isn’t considered a penalty/forfeiture; or
  • One year under CCP §340(a) if disgorgement is considered a penalty/forfeiture.

The court determined that disgorgement is indeed a penalty because it deprives a contractor of compensation for labor and materials used in construction while allowing the owner to retain the benefits.

Furthermore, a claim for disgorgement can be brought regardless of any fault in the construction. Thus, it falls under the Supreme Court’s definition of a “penalty” as a “recovery without reference to the actual damage sustained.”

Therefore, the appropriate statute of limitations for disgorgement claims against unlicensed contractors is one year.

When does a claim for disgorgement accrue?

In other words, now that the statute of limitations has been decided, when does the clock begin to tick on such claims?

Under California law of civil procedure, an action can only be commenced “after the cause of action has accrued.” This is generally interpreted as “the time when the cause of action is complete with all of its elements.” Eisenberg contends that the “discovery rule” should apply to these claims.

The discovery rule, used in claims such as construction defects, means that the statute of limitations begins when the party knows or should have known that the elements exist for the cause of action.

But the discovery rule also applies in claims 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.”

A disgorgement claim does not require any actual injury to the plaintiff. So, since there is no duty to investigate the validity of a contractor’s license, what would prompt the discovery?

Holding that the discovery rule applied to such claims would, in essence, mean there was no time limitation to bring an action. This would allow claims to be brought years later for a project that was otherwise problem-free.

Accordingly, the court declared that the discovery rule didn’t apply. Therefore, the ordinary title of accrual applies; i.e. “when the cause of action is complete with all of its elements.” In the context of disgorgement, this would be when the unlicensed contractor completes or ceases performance of work.

Therefore, a claim for disgorgement begins to accrue upon completion or cessation of the construction contract.

Holding: The one-year statute of limitations applies to claims for disgorgement under 7031(b). Also, the discovery rule does not apply; claims accrue upon completion or cessation of the performance of the act or contract at issue.

Eisenberg failed to bring the claim within one year of completion/cessation of Suffolk’s performance, and the holding is affirmed.

Disgorgement remedies are severe, but the statute of limitations is short

This is some welcome clarity for the penalty for disgorgement.

The licensing requirements in California can be a lot to keep up with: not just for maintaining a valid license, but also meeting the specific requirements — such as direct supervision by a qualifying agent (as it was in this case).

Disgorgement is a severe penalty for contractors, and those performing work in California without a license should be particularly wary — especially since no actual damage is required to give rise to this remedy.

Given how harsh this remedy is to contractors, it’s good news for contractors that the court decided on the shorter timeframe to bring such an action. Typically, if the work is performed in a satisfactory manner, the owner will not bring such a claim.

But that won’t always be the case. Owners who are educated and aware of this holding may be reviewing licensure more closely moving forward. Make sure you’re not caught without a license — or else you may find yourself working for free.

Additional thoughts from a California-based construction attorney

According to Brenda K. Radmacher, a California-based attorney of Gordon Rees Scully Mansukhani, LLP,

“It is particularly important for contractors to be vigilant with regard to their license to ensure that it is valid and up to date, and, as seen in the Eisenberg case, to pay careful attention to who the RMO/RME is and that the individual is indeed fulfilling their obligations including direct oversight and supervision of the work.” California Business & Professions Code Section 7031(b) establishes that if a contractor is not properly licensed at any point during the construction project, the party who paid the contractor who was unlicensed is entitled to sue that contractor to recover all sums it paid to that unlicensed contractor in relation to the entire project. “This rule was supported by the Eisenberg decision since, had Eisenberg brought its claim within the first year, there was exposure for Suffolk since its RME had moved in the midst of the project. Contractors should take careful note to ensure that the responsible managing officer or employee is indeed fulfilling their role of being “responsible” and for actually and actively managing the work.”

“In addition, the Eisenberg case is a clear wake-up call that disgorgement claims can be brought for a year after the unlicensed contractor completes or ceases performance of work – not from the date the license expires or is otherwise invalid or revoked. We recommend that contractors keep good records and track all of the details of the licensure validity and immediately take steps to cure any issue, including through the entire work until the contractor is completed in its performance. Be sure to look at your workers’ compensation insurance and keep it up to date, as well as any taxes that must be paid as these are two ways that the contractor’s license can be suspended often times without the contractor realizing it.”

For more on contractor licensing in California, see The CLSB: Understanding the California Contractor State Licensing Board.