In an opinion that should be a warning to all licensed contractors in California, the Court of Appeals held that licensed contractors cannot collect payment from project owners for unlicensed subcontractor work under California Business and Professions Code § 7031(a). (Kim v. TWA Construction, Inc. (2022) 78 Cal.App.5th 808.) Until the California Supreme Court or the Legislature clarifies or overturns the decision, all licensed contractors should be aware that hiring an unlicensed subcontractor may prevent the licensed contractor’s recovery of payment from the owner for the unlicensed work—even if the licensed contractor’s license would cover the subcontract work if they were to perform the work themselves. This Law Note explains the Court’s holding and give practical advice on how licensed contractors might protect themselves in the wake of this decision.

Executive Summary

In a matter of first impression, the Court of Appeals held that a general contractor who hires an unlicensed subcontractor cannot recover compensation from the owner for the unlicensed subcontractor’s work under California Business and Professions Code § 7031(a). The ruling expands the reach of B&P § 7031(a), which permits a plaintiff to recover back all monies paid to an unlicensed contractor, to now withhold amounts paid to a licensed contractor for work performed by an unlicensed subcontractor.

Facts of the Case

Sally Kim and Dai Truong (“Kim”) hired TWA Construction, Inc. (“TWA”) to build a home in Los Gatos, California (the “Project”). The Project required removal of a eucalyptus tree that—unbeknownst to Kim and TWA—straddled the property line between Kim’s property and the property of Todd, their neighbor. TWA obtained the required permits to remove the tree and hired an individual named Martin Hoffman as the tree-removal subcontractor. TWA did not verify Hoffman’s licensing status and did not know that Hoffman was unlicensed.

Hoffman began work on removing the eucalyptus tree, but Todd called the police and halted the removal. Later, Kim terminated their contract with TWA because they were unable to get a construction loan with TWA as the general contractor.

Todd sued Kim and TWA for trespass, negligence, and damage to the eucalyptus tree; Kim cross-complained against TWA for various claims, including indemnity; and TWA filed a cross-complaint against Kim for breach of contract. Todd settled with Kim and TWA. At the start of trial, Kim filed a motion in limine asking the trial court to require TWA to make an offer of proof as to the subcontractor’s license status. Kim asserted that Hoffman did not have a license1 for tree removal as required by the B&P Code, that TWA had the burden of establishing proper licensing, and that TWA should disgorge the $10,000 Kim contended they paid for the tree work.

The trial court ruled that TWA would be barred under section 7031(a) from “collecting compensation for services performed by the subcontractor for the tree trimming if, in fact, the subcontractor was unlicensed at the relevant time.”

Following trial, the jury found that TWA was liable for contributory negligence, indemnity, and express contractual indemnity. The jury also determined that Kim had paid $10,000 for the unlicensed tree removal. Lastly, they found that Kim did not breach their contract with TWA.

The Court awarded Kim $18,196 on their contributory negligence and indemnity claims, $10,000 for disgorgement, $137,821 in attorney fees, $22,505 in expert witness fees, and $18,273.59 in costs. TWA appealed.

Appellate Court Holding

On appeal, TWA argued that the trial court erred in deciding that section 7031(a) barred TWA from seeking recovery from Kim for the value of Hoffman’s work.2 In rejecting the argument, the Court highlighted that the Contractors’ State Licensing Law imposes strict penalties for “a contractor’s failure to maintain proper licensure” and the Legislature’s intent was “to discourage persons who have failed to comply with the licensing law from offering or providing their unlicensed services for pay.” The Court held that “section 7031 bars even a licensed general contractor in California from bringing an action for compensation for an act or contract performed by an unlicensed subcontractor where a license is required.”

Practical Takeaway

To protect their rights to payment, general contractors must now confirm that their subcontractors are licensed for their scope of work at all times for the length of the subcontract. Prudent general contractors may consider requiring proof of licensure to accompany every subcontractor payment application.

Further, Kim apparently did not raise the issue and the Kim opinion does not address whether TWA should have disgorged all the payments Kim made toward the Project. If TWA did not comply with section 7031(a) for the tree removal, would that not mean that TWA was not complying with section 7031(a) “at all times”? The concern is that future aggressive owner counsel may seek to invalidate a general contractor’s license for an entire project and seek disgorgement of all funds paid under the theory that disgorgement by section 7031(a) is all or nothing.3 At a minimum, this ambiguity will likely engender further litigation. Accordingly, this decision suggests the need for legislation overturning Kim or clarifying whether partial disgorgement is authorized under the B&P Code.

Special thanks to Smith Currie San Francisco law clerk Ross N. Steinbach who took the laboring oar on this Law Note.