Buying an Existing Construction Operation? Do Your Due Diligence

by Pepper Hamilton LLP
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This article was published in the November/December 2018 issue of AGC Law in Brief (Volume 4, Issue 6), Practical Construction Law & Risk Issues. It is reprinted here with permission.

While mergers and acquisitions have been a hot market for some time in other industries, in recent years, venture capitalist and private equity firms have been actively involved in the acquisition of construction operations in the United States. In handling these acquisitions, M&A counsel, in their due diligence, should remember to track one of the most important assets of the construction operation — its contracting license.

There appears to be a misunderstanding that any license held by a corporation can be easily transferred to the new owners or new acquiring company. But this is not the case in many states. Indeed, for the most part, a contractor’s state license is not transferable from one entity to the next without taking the appropriate measures. Thus the sale of a company could put the very assets being sold at risk unless proper due diligence and preparation is done before the sale to make sure there is a continuation of the license.

Contractors’ Licenses Are Not Transferable in Several States

In California, all contractors must be licensed, and contractors’ licenses are not transferable. See Cal. Bus. & Prof. Code § 7026. Accordingly, a new license is required whenever a business entity changes (such as sole owner to corporation, sole owner to partnership, partnership to corporation, etc.) or when specific changes occur within the business structure. Moreover, licenses are associated with a business entity and not the individual qualifier. Therefore, licenses are not transferable from one business to another, even if the qualifying individual is the same for both. See Cal. Bus. & Prof. Code § 7075.1. A corporate license number is issued exclusively to an individual corporate registration number assigned by the Secretary of State. If this registration number changes, a new contractor license number will be required for the new corporation. If a corporation dissolves, merges or surrenders the right to do business in California through the Secretary of State, the contractor license must also be canceled. The Contractors State License Board must be notified of any change to the license status within 90 days of the change. See Bus. & Prof. Code § 7083.

In Nevada, contractors must also be licensed, and contractors’ licenses are similarly nontransferable. Nev. Rev. Stat. § 624.700. Licenses may be issued to individuals, general partnerships, limited partnerships, corporations, limited liability companies or joint ventures. Nev. Rev. Stat. §§ 624.240; 624.250. Again, the license belongs to the entity rather than the qualifying individual. If a new entity is created, a new contractor’s license is required.

In Arizona, a contractor’s license is generally required for projects totaling more than $1,000. See Ariz. Rev. Stat. § 32-1123. A sole proprietorship (individual), a partnership, a limited liability company or a corporation may apply for a contractor's license if it has a regularly employed person with the necessary experience, knowledge and skills who serves as the qualifying party. Again, the license belongs to the business and not the qualifying individual and therefore may not be transferred from one business entity to the next. A corporation or a limited liability company must be registered with the Arizona Corporation Commission and in good standing with that agency before submitting an application for a contractor's license. The corporation or the limited liability company must remain in good standing in order to renew its contractor's license. Engaging in contracting without a license is prohibited. Ariz. Rev. Stat. § 32-1151. This section forbids unlicensed persons from offering to contract, a ban enforced by punishment as a misdemeanor under section 32-1164A(2). City of Phoenix v. Superior Court, 909 P.2d 502 (Ariz. Ct. App. 1995).

This is just an example of the various licensing requirements. Many states, such as Tennessee, Florida, Virginia, Oregon, New Mexico and Georgia, have similar licensing requirements. What is lesser known are the penalties for failing to have a license at all times during performance of the work. Thus, it is very important for the license status of the acquired corporation to remain in full effect from the date of closing.

Penalties for Contracting Without a License

If a new license number is going to be obtained for a contractor on an existing project, one must be cognizant of the timing of assignability of all contracts that are currently being performed by the merging or old entity. The assignment of a contract must occur so as to avoid any gap in the license because, in several states, contracting without a license has extreme consequences. Those consequences include losing the right to sue for payment for performed work, being ordered by a court to disgorge amounts already paid for work performed, and even potential criminal liability.

In addition, most contracts contain nonassignability provisions. Therefore, before any change in the corporate structure, the parties to each contract should agree that each of the current contracts will be reassigned to the new entity. The assignment must occur after the new entity is properly licensed so as to avoid any gap in the license.

In California, even a lapse of a license for one day has dire consequences. Indeed, a contractor forfeits compensation for all work performed under a contract when the contractor is unlicensed for any period during that contract. See Cal. Bus. & Prof. Code §§ 7031(a), 7031(b); Judicial Council of California v. Jacobs Facilities, Inc., 191 Cal. Rptr. 3d 714 (Cal. Ct. App. 2015). In Jacobs Facilities, Inc., although the contractor (Jacobs) was properly licensed when it began work on the contract, as part of a corporate reorganization, Jacobs transferred employees responsible for performing work under the contract to another wholly owned subsidiary. Id. at 718. In the process, the new subsidiary obtained a contractor’s license, and Jacobs’s license expired. Id. However, Jacobs remained as the signatory on the contract until nearly a year after the new subsidiary was formed, at which time the parties entered into an assignment of the contract. Id. The court held that Jacobs violated California State Licensing Law when it continued to act as the contracting party after its license had expired. Id.

Even though the other contracting party was aware of Jacobs’s lack of license, Jacobs was prohibited from asserting bad faith or unjust enrichment as a defense to forfeiture. Id. at 724. Indeed, forfeiture of all compensation for work performed by an unlicensed contractor is held to apply regardless of the equities, preventing contractors from asserting equitable defenses. See MW Erectors, Inc. v. Niederhauser Ornamental & Metal Works Co., 115 P.3d 41 (Cal. 2005). The intent behind the statute providing for forfeiture of all compensation for work performed by an unlicensed contractor is to discourage persons who have failed to comply with licensing law from offering or providing their unlicensed services for pay. See Cal. Bus. & Prof. Code §§ 7031(a), 7031(b).

Similarly, in Arizona, New Mexico, Florida, Georgia, Nevada and Tennessee, unlicensed contractors are barred from filing suit to recover monies for work performed. See Sanders v. Foley, 945 P.2d 1313 (Ariz. Ct. App. 1997) (unlicensed contractors may not bring suit to recover for work performed.; Fleming v. Phelps-Dodge Corp., 496 P.2d 1111 (N.M. Ct. App 1972) (unlicensed contractor was precluded under a licensing statute, which expressly prohibited unlicensed contractors from bringing actions on contracts for which a license was required, from recovering damages for a breach of the contract); Boatwright Const., LLC v. Tarr, 958 So. 2d 1071 (Fla. Dist. Ct. App. 2007) (construction company that was not licensed as a contractor in Florida was prohibited from bringing suit against an owner to recover monies for work performed); Baja Properties, LLC v. Mattera, 812 S.E.2d 358 (Ga. Ct. App. 2018) (homebuilding company's lack of a contractor's license barred its claims against property owners for breach of contract and quantum meruit and claim of lien, despite argument that statutory exemption allowed a property owner to act as his own contractor and to use unlicensed contractors); Tom v. Innovative Home Sys., LLC, 368 P.3d 1219 (Nev. Ct. App. 2016) (statute requiring proof that a contractor was duly licensed serves as an absolute bar on the recovery of contract claims brought by unlicensed contractors.); Kyle v. Williams, 98 S.W.3d 661 (Tenn. 2003) (trial court did not err when it held that a contractor who had not maintained a valid license throughout the entire contract period was deemed unlicensed and in violation of Tenn. Code Ann. § 62-6-103(b), and was therefore limited to recovery of the documented expenses proven by clear and convincing evidence).

Due Diligence Checklist

In undergoing a change in the corporate structure or entity, here is a brief checklist to ensure the new entity maintains its license:

  1. Investigate the target acquisition’s license status in all states of operation, and assess whether the licenses are in good standing.
  2. Consider including a representation and warranty in the acquisition documents that the licenses have been and remain in good standing and an indemnity protection if the status of any of those licenses creates issues after closing.
  3. Determine the appropriate steps for creating a new entity or change in the corporate structure, such as applying through a state registrar or a secretary of state.
  4. Determine whether the entity (new or changed) must have its own license.
  5. Take appropriate steps for obtaining a new license number, including steps for using am existing qualifier (if one exists).
  6. Ensure all contracts can be assigned to the new entity, and be cognizant of the timing of the assignment.

These steps should be part of any due diligence plan for the acquisition or corporate reorganization of a construction operation. The failure to ensure proper licensure can quickly turn a great deal into a great headache.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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