Two weeks ago we wrote about a disgorgement case winding its way through the courts where a contractor who let its license lapse after assigning its contract to a related but properly licensed entity was still facing disgorgement of the entire contract amount. Judicial Council of California v. Jacobs Facilities, Inc. (Ct. of Appeal, 1st App. Dis., Div. One, A140890, A141393.)

Now another disgorgement case, Jeff Tracy, Inc. v. City of Pico Rivera (Ct. of Appeal, 2nd App. District, Div. 2, B258563), shows the risk of not having a genuine RMO/RME. The consequences of disgorgement are potentially devastating and would certainly cause some contractors to go belly-up. The good news for the contractor in this particular case is that the Court of Appeal reversed the trial court. The bad news for the contractor is that damaging facts were revealed during the process of the court trial that will make a victory very difficult to pull off.

In 2011, the City of Pico Rivera (“the City”) awarded Jeff Tracy Inc. dba Land Forms Construction (“Land Forms”) the contract to build a city park (“the Project”). The Project included landscaping, irrigation, and the construction of baseball fields and other structures. The bid package required each bidder have a Class A (General Engineering) license. Land Forms submitted a bid, stating that it had a Class A license and a Class C-27 license (general landscaping).

A dispute arose after the City withheld $518,154 to cover liquidated damages. Land Forms filed a lawsuit seeking payment of the withheld funds. The City filed a cross-complaint against Land Forms seeking disgorgement of the entire contract amount pursuant to Business and Professions Code (B&P) section 7031(b), on the grounds that Land Forms was not properly licensed since it “used a sham Responsible Managing Employee (‘RME’), James Nale, to obtain a Class A license....”

Over objection from Land Forms, the court conducted a bench trial on the issue of Land Forms’ license. Mr. Nale, the RME, testified he was never an employee of Land Forms and that he was supposed to be designated instead as a Responsible Managing Officer (RMO). He received stock worth 20 percent of Land Forms, but this stock had to be returned upon demand. Land Forms never provided him with an office, computer, e-mail address or business cards. He never saw the Project plans. He visited the Project three times. He could not name a single subcontractor on the Project. He did not know if the Project had a superintendent. He could not recall giving any direction or advice to Land Forms as to what needed to be done on the Project.

Based on this evidence, the trial court ruled that “James Nale was neither a Responsible Managing Officer, nor a Responsible Managing Employee” of Land Forms during its work on the Project.” In California, a license is invalid without an RME. Without a valid RME, Land Forms’ Class A license was invalid and void, and the City was entitled to seek disgorgement from Land Forms.

After an emergency appeal delayed the trial, the trial court took up the issue of the amount of money Land Forms had to give back. The City sought disgorgement of the entire contract sum. Land Forms argued it should be permitted to keep any money for work it could have performed with its C-27 landscaping license. Land Forms demanded a jury trial on these issues, which the court refused. The trial court then found in favor of the City, and ordered Land Forms to pay the City $5,487,370.05, which was the entire amount of the parties’ contract, as disgorgement. Land Forms appealed.

On appeal, the Court considered the requirements that must be met for an individual to qualify as an RME. For an individual to qualify, he or she must be a bona fide officer or employee of the corporation, and must be actively engaged in the work covered by the license. The qualifier must also exercise direct supervision over the work for which the license is issued to the extent necessary to secure full compliance with the provisions of the law. (§7068.1.)

The Court of Appeal recognized a “variety of activities can constitute direct supervision and control, including ‘one or any combination of the following activities: supervising construction, managing construction activities by making technical and administrative decisions, checking jobs for proper workmanship, or direct supervision on construction job sites.’” The Court of Appeal agreed with Land Forms that the issue of whether Nale was a true RME, were factual questions that should have been decided by the jury. The Court of Appeal therefore reversed the trial court and remanded the case for a jury trial on licensing.

The Court of Appeal also indicated that a contractor could not get around the CSLB’s strict licensing requirements by showing it held an alternative license. The Court of Appeal found that: “Land Forms was performing under a public works contract that specifically required the general contractor to have a valid class A license at all times during the project. We therefore hold that when a contractor does not have the specific license specified in the contract under which the work is performed, the contractor is “unlicensed” for purposes of section 7031, subdivision (b)." (Emphasis added.)

Finally, and although Land Forms has another chance at proving it was licensed, the Court of Appeal issued the following ominous statement regarding Land Forms request for an apportionment: “…in the event it is determined upon retrial that Land Forms must reimburse the City, Land Forms is not entitled to any apportionment or offsets.”

The Judicial Council and Jeff Tracy cases show the harsh and inflexible results that occur when a contractor fails to follow CSLB’s strict licensing requirements. Unless a contractor is able to meet the high burden of proving “substantial compliance,” a contractor who is found to have violated CSLB licensing requirements will face disgorgement of the entire contract amount. It does not matter if the failure to have a valid license was intentional, was the result of an unintentional oversight (assuming no substantial compliance), or was the result of a misunderstanding of the regulations. The cases also show that a licensed contractor must disgorge all payments if the contractor performed even a fraction of the work with an invalid license. The two cases are important reminders for contractors that the failure to follow licensing requirements to the letter will likely lead to draconian financial results. Contractors are charged with maintaining their licenses, and the courts will not be sympathetic to a non-compliant contractor, no matter the excuse.