INSIGHT: Due Diligence Is Key When Buying a Construction Operation

The pandemic has had an unprecedented impact on businesses, but one area of the economy that is stronger than expected is the construction sector. This strength translates into strong balance sheets and cash balances that make construction companies ripe for acquisition.

For those involved with the acquisition or restructuring of construction operations, especially during this unpredictable time, it is vital to perform the proper due diligence. M&A counsel should remember to track one of the most important assets of the construction operation—its contracting license.

It is a common misunderstanding that any license held by a corporation can be easily transferred to the new acquiring company. In many states, a contractor’s state license is not transferable without taking the appropriate measures.

In California, all contractors must be licensed, and contractors’ licenses are not transferable. Accordingly, a new license is required whenever specific changes occur within the business structure. Moreover, licenses are associated with a business entity and not the individual qualifier. Therefore, licenses cannot be transferred from one business to another, even if the qualifying individual is the same for both.

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. If a corporation dissolves, merges, or surrenders the right to do business in California, the contractor license must also be canceled and the Contractors State License Board must be notified of any change to the license status within 90 days of the change.

In Nevada, contractors must also be licensed, and contractors’ licenses are similarly nontransferable. Licenses may be issued to individuals, general partnerships, limited partnerships, corporations, limited liability companies or joint ventures. 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 over $1,000. A sole proprietorship, partnership, limited liability company or corporation may apply for a contractor’s license if a regular employee with the necessary experience can serve as the qualifying party.

Again, the license belongs to the business, not the qualifying individual and is not transferrable. A corporation or limited liability company must be registered with the Arizona Corporation Commission and in good standing before applying for or renewing a contractor’s license.

Tennessee, Florida, Virginia, Oregon, New Mexico, and Georgia, have similar licensing requirements.

Penalties for Contracting Without a License

If a new license number is to be obtained for a contractor on an existing project, the timing of assignability of all contracts currently being performed by the merging or old entity is vital.

The assignment must occur so as to avoid any gap in the license because, in several states, contracting without a license has extreme consequences, such as 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 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.

In Judicial Council of California v. Jacobs Facilities Inc. (Cal. Ct. App. 2015), although the contractor Jacobs Facilities was properly licensed when it began work on the contract, as part of a corporate reorganization it transferred employees responsible for performing work under the contract to another wholly owned subsidiary.

In the process, the subsidiary obtained a contractor’s license, and Jacobs’s license expired. However, Jacobs remained 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. The court held that Jacobs violated California licensing law when it continued to act as the contracting party after its license had expired.

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. 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. The forfeiture statute is intended to discourage persons who have failed to comply with licensing law from offering or providing their unlicensed services for pay.

Similarly, in Arizona, New Mexico, Florida, Georgia, Nevada, and Tennessee, unlicensed contractors are barred from filing suit to recover monies for work performed.

Due Diligence Checklist

The followingt 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.

1. Investigate the target acquisition’s license status in all states of operation to ensure good standing.

2. Consider including a representation and warranty in the acquisition documents that the licenses remain in good standing and an indemnity protection if the status of those licenses creates issues after closing.

3. Determine whether the entity (new or changed) must have its own license.

4. Take appropriate steps for obtaining a new license number, including steps for using an existing qualifier (if applicable).

5. Ensure all contracts can be assigned to the new entity, and check the timing of assignments.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

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Author Information

Marion Hack is a partner in the Los Angeles office of Troutman Pepper and is a first-chair trial lawyer specializing in multimillion-dollar claim disputes involving high-profile, complex construction projects.