Subcontracting Without a License Can Be Risky Business

State Licensing Requirements and Penalties
Each state imposes its own licensing laws and regulations on subcontractors to help protect the public from substandard work caused by unlicensed and incompetent contractors. While each state may employ very different licensing standards, the penalties and consequences associated with performing unlicensed subcontracting work can also vary greatly from state to state.

A subcontractor's oversight on licensing requirements can lead to fines, civil penalties and criminal charges. Moreover, unlicensed subcontractors may find that, after performing substantial work on a project, they may not be able enforce their own contracts to recover payment. Similarly, unlicensed subcontractors may lose all lien rights typically afforded to them under state law.

Divergence of State Laws
Some jurisdictions, like the District of Columbia and Maryland, have very clear licensing laws with harsh results for subcontractors who fail to follow the rules. In Maryland, unlicensed subcontractors are not permitted to sue for breach of their subcontracts. In the District of Columbia, unlicensed subcontractors are not only prohibited from recovering payment under their subcontracts, but may also be forced to surrender money they have already received.

Other states, like Virginia, also apply standards similar to those in Maryland and the District of Columbia, negating contracts entered into by unlicensed subcontractors as illegal and therefore unenforceable. Virginia law, however, provides a "safe harbor" for unlicensed subcontractors. In essence, unlicensed subcontractors are permitted to recover payment for work performed, so long as the subcontractor can demonstrate a good faith belief that a license was not required. A good rule of thumb for subcontractors, however, is not to rely on a state's "safe harbor" laws, if any exist. After all, demonstrating your "good faith beliefs" can prove to be as costly as not getting paid in the first place.

In yet other states, unlicensed subcontractors may still recover payment despite failing to comply with licensing laws. For instance, in the recent Idaho Supreme Court case of Barry v. Pacific West Construction Inc., a subcontractor was not licensed in accordance with Idaho's public works law. As a result, the general contractor requested that the subcontractor perform extra work at no additional cost and it would make the problem "go away." When the subcontractor refused to perform the work, the general contractor barred the subcontractor from the construction site. The subcontractor sued for money it was owed.

The court held that the unlicensed subcontractor could not recover damages for breach of contract because its contract was illegal. Nevertheless, the court permitted the unlicensed subcontractor to recover payment up to the amount that it had benefited the general contractor. While the court permitted the subcontractor's claim for "unjust enrichment" to proceed, it did not permit recovery for the subcontractor's lost profits on the project.

Conversely, in MW Erectors Inc. v. Niederhauser Ornamental & Metal Works Company Inc., the California Supreme Court recently held that an unlicensed subcontractor could not recover unless it was licensed at all times during a construction project, regardless of whether the contractor had been unjustly enriched.

In Niederhauser, a subcontractor entered into two second-tier subcontracts with MW Erectors for certain steel work. At the time MW Erectors entered into the subcontracts, it was not licensed in California to perform the work. About three weeks after beginning its work, MW Erectors obtained the required contractor's license to perform the steel work.

After a dispute arose between the parties, MW Erectors filed a breach of contract claim seeking damages in excess of $1 million. The defendant contractor raised the defense that MW Erectors was unlicensed. The trial court accepted the defense and ruled against MW Erectors. In upholding the lower court's decision, the California Supreme Court held that MW Erectors could not recover any sums of money because it was not licensed at all times during the performance of its work, as required by state law.

Conclusion
While the risks associated with accepting work in other states may prove to be financially rewarding, it is clear that subcontractors who perform unlicensed work can face damaging consequences. As a result, subcontractors should fully educate themselves about the licensing requirements in every state they perform work. Compliance with the applicable statutes and licensing requirements will go a long way in keeping subcontractors out of costly litigation and could mean the difference between getting paid and losing a fortune.