Contractor license laws vary state by state, but most are extremely strict on adhering to the licensing requirements and contain severe penalties for performing work without a proper license. Penalties can include a jail sentence, a fine, the inability to bring a lawsuit or collect on a claim and disgorgement of all payments made to the contractor. California, for example, takes a strong stance against any construction work performed without a proper license. In a recent California Court of Appeals decision, the court found that the public policy behind the license laws is so strong that it was grounds for vacating an arbitration decision.

Two owners formed a limited liability company to develop a condominium building in Los Angeles. The limited liability company hired Owner 1’s company to serve as the general contractor. Construction on the project suffered numerous setbacks, including the death of the architect, various plan revisions mandated by the city’s building and safety department and construction delays. The project was completed six years after work commenced. Owner 2 was unhappy with the construction delays and cost overruns, and made allegations of mismanagement by the general contractor. Pursuant to the limited liability company’s operating agreement, Owner 2 commenced an arbitration proceeding bringing 24 claims against Owner 1 and the general contractor. One of the claims sought disgorgement of the general contractor’s compensation pursuant to a provision of California’s licensing law claiming the general contractor did not have a class B general contractor’s license.  

The arbitrators denied the claim, finding that the general contractor was not required to disgorge its compensation because the general contractor had not performed work typical of general contractors and was thus not “engaged as a contractor” under the statute. Instead, the arbitrators determined the contracting work had been performed by licensed contractors who had contracted directly with the company. Owner 2 brought an action in state court to vacate the arbitration award on the ground that the arbitrators exceeded their authority by allowing the unlicensed general contractor to keep its compensation. The trial court denied the petition to vacate on the ground that it did not have the power to review the arbitrator’s decision for errors of fact or law. Owner 2 appealed the trial court’s decision.  

On appeal, the court found that, generally, courts have a very narrow scope of judicial review of arbitration awards due to the strong public policy in favor of arbitration and according finality to arbitration awards. However, the court held that there was a public policy exception to this rule that required a court to vacate an arbitrator’s award when the award violated a well-defined public policy. The court found that the purpose of California’s licensing law was to protect the public from incompetent and dishonest contractors and that licensing requirements provided some assurance that all persons offering contracting services in California had the requisite skill and character, understood local laws and codes and knew the rudiments of administering a contracting business. Further, the court found that the licensing law’s disgorgement provision was an explicit legislative expression of public policy regarding unlicensed contractors. Therefore, the court found that the trial court should have reviewed the evidence to determine whether disgorgement was required. The trial court’s judgment was reversed and the case was remanded for the trial court to review the evidence on the disgorgement claim.

State license laws are typically exceptionally punitive and contractors face harsh penalties for failing to be properly licensed. Here, the public policy behind California’s license laws trumps the well-recognized public policy behind the finality of arbitration awards. This, along with the crippling effects of disgorgement and other severe penalties, dictates that contractors closely monitor the applicability of its license on a project-by-project basis to ensure that it does not violate any license laws.

Ahdout v. Hekmatjah, 213 Cal.App.4th 21(2013).