Lack of Contractor’s License Wipes Out Millions in Bankruptcy Claims in Abeinsa

Saul Ewing Arnstein & Lehr LLP

Saul Ewing Arnstein & Lehr LLP

This week, a bankruptcy decision issued by the United States Bankruptcy Court for the District of Delaware in In re Abeinsa Holding, Inc. has provided another example of just how severe the implications may be for performing work without a contractor’s license.

The debtors in Abeinsa are U.S. affiliates of Abengoa S.A., a global enterprise specializing in clean energy and environmental sustainability, including solar energy developments, and related engineering, construction and procurement services.

The decision at issue resulted in the complete disallowance of claims asserted by three companies stemming from work performed at a power plant project undertaken by the Debtors in California: (i) Synflex Insulations, LLC ("Synflex"), which filed an $11 million claim against Debtor Abeinsa Holding for insulation materials, supplies and services provided; (ii) Orbital Insulation Corp. ("Orbital"), which filed a $1.1 million claim for its provision of labor, services, materials and equipment in connection with the project; and (iii) Crown Financial, LLC ("Crown"), which filed an over $2 million claim against the Debtors based on a factoring arrangement with Synflex and the Debtors under which it purchased Synflex’s interest in certain invoices issued by Synflex to the Debtors.

Synflex, a Texas insulation company, entered into three contracts with the Debtors to provide insulation services for the project. A valid California contractor’s license number was not provided at the time of its entry into these contracts, nor after the Debtors made attempts to obtain such information from Synflex.

Synflex argued that even though it held itself out as an entity authorized to provide services in California, it did so with full disclosure to the Debtors that it was operating under a third party’s California contractor’s license, and that it did not maintain its own license.

This argument, however, was not persuasive to the Court in light of language in the contracts between Synflex and the Debtors providing that Synflex, and not a third party, would maintain required licenses to provide services. The Court also pointed to a California law (section 7031 of the California Contractors’ State License Law), which generally provides that a contractor that performs work without a license may not bring an action or otherwise recover payment for its work. The law is interpreted broadly by California courts, and is applied even when the person for whom the work was performed knew that the contractor they hired was unlicensed.

The bankruptcy court, applying California law, further rejected Synflex’s remaining arguments that: (i) the Debtors induced it to perform without a license by falsely promising to pay Synflex for its services; and (ii) it "substantially complied" with the California statute so as to fall within an exception to the law that would permit Synflex to recover for the substantial work it performed. On this latter point, because Synflex never held a California license prior to its work at the site, the bankruptcy court determined that it could not qualify for the "substantial compliance" exception.

Unfortunately for Crown, because its claims stemmed from a factoring arrangement with Synflex, the invalidation of Synflex’s claims in turn led to the invalidation of Crown’s claims. More specifically, the Court treated Crown as an "assignee stepping into the shoes of the assignor; receiving no more and no less than the assignor." Because Synflex assigned its rights to payment to Crown under the factoring arrangement, and because Synflex’s rights to payment were unenforceable due to its lack of a contractor’s license, the court held that Crown’s claims were likewise unenforceable.

Orbital’s claims were likewise disallowed, albeit for slightly different reasons. Orbital was not a licensed contractor in California, but never actually claimed to hold such a license. Orbital’s challenge was that it did not have a direct contractual relationship with the Debtors and acted solely as a vendor to Synflex on the project. Orbital’s claims were therefore ultimately disallowed based on its failure to establish a right of recovery against the Debtors.

In the end, the bankruptcy court recognized that its ruling may be "harsh" but nevertheless pointed out that the relevant California law is clear in barring unlicensed contractors from recovery. The warning from Abeinsa is also clear: (1) make sure you have a license, and (2) at a minimum, make sure you are familiar with the licensing laws of the state in which you are working to ensure that you and/or your company do not share the same fate as the parties in Abeinsa.

A full copy of the bankruptcy court’s decision is available here.

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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