BILL ANALYSIS                                                                                                                                                                                                    

                             SENATE JUDICIARY COMMITTEE
                           Senator Ellen M. Corbett, Chair
                              2009-2010 Regular Session

          SB 392                                                      
          Senator Florez                                              
          As Amended April 21, 2009
          Hearing Date: April 28, 2009                                
          Business & Professions Code; Corporations Code              

                 Limited Liability Companies:  Licensed Contractors


          This bill would allow a limited liability company to render  
          contractor's services that are "professional services" otherwise  
          prohibited by the Beverly-Killea Limited Liability Company (LLC  
          Act), by authorizing the issuance of a contractor's license to  
          the company under the Business and Professions Code. 

          Among other requirements, this bill would provide that a  
          contractor-LLC obtain and maintain a $1,000,000 insurance policy  
          or place on deposit or escrow $1,000,000 dollars  plus an  
          additional $100,000 per licensee in excess of five employed by  
          the LLC, up to $5,000,000 in total insurance, escrow, or  
          deposit.  In addition, if the LLC is suspended, each member of  
          the LLC who is licensed as a contractor would be liable for up  
          to $1,000,000 in damages occurring as a result of the licensed  
          activities of the LLC during the suspension.  Under these  
          conditions, a qualifying individual or group may form an LLC and  
          obtain a contractor's license as an LLC.

          Except for the liability coverage requirements stated above, SB  
          392 would treat a limited liability company in the same manner  
          as a corporation relative to the issuance, renewal, suspension,  
          reissuance, or termination of a contractor's license. 


          Generally, a limited liability company is a legal entity formed  
          under a statutory scheme (in California, the Beverly-Killea  
          Limited Liability Company Act) that allows one or more owners to  


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          conduct a business without any owner having personal liability  
          for the obligations of the business.  The salient nontax  
          characteristics of a limited liability company (LLC) are limited  
          liability for its owners (as in a corporation) and freedom to  
          structure management rights and financial interests in the  
          entity in virtually any configuration the parties wish (as in a  
          partnership).  An LLC most often elects to be treated as a  
          partnership for income tax purposes, so that the income, gains,  
          losses, deductions, and credits of the LLC generally will flow  
          through to its members for reporting on their personal tax  
          returns, the distribution depending on the terms of the LLC  
          agreement, not necessarily the ownership interest of the  
          individual members.

          Until the creation of LLCs, the limited partnership and the  
          subchapter S corporation were the primary forms of business  
          entity used to achieve the tax status and limited liability  
          features now offered by the LLC.  Each of those forms has its  
          drawbacks, but the LLC can provide the advantages of both  
          without the disadvantages of either.

          A limited partnership allows pass-through tax treatment,  
          flexibility in financial structuring, and limited liability for  
          the partners (as long as they do not take part in the control of  
          the business), but requires one person (the general partner) to  
          be fully liable for the obligations of the business.  Unlike a  
          limited partnership, no LLC member need be personally liable for  
          the company's obligations, and yet each member is permitted to  
          manage the company and to take part in the control of the  
          business without losing the member's limited liability. (Corp.  
          Code Secs. 17101, 17150.)

          Although an S corporation allows pass-through tax treatment and  
          limited liability for all owners, S corporation status limits  
          the parties' flexibility in structuring their financial  
          arrangements because of the requirements that the corporation  
          have no more than one class of stock and that items of income,  
          gain, loss, deduction, or credit be distributed among  
          shareholders on a pro rata basis.  Furthermore, only  
          individuals, estates, certain types of trusts, and certain  
          tax-exempt organizations are permitted to be S corporation  
          shareholders, and an S corporation will lose its pass-through  
          tax treatment if an ineligible entity becomes a shareholder.

          An LLC, on the other hand, can have different classes of  
          ownership, and income, gain, loss, and other items may be  


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          allocated disproportionately to ownership without affecting the  
          LLC's pass-through tax treatment.  Any person can be a member of  
          an LLC (thus sidestepping the restrictions on shareholders in  
          the case of an S corporation).

          While LLCs may generally engage in any lawful business activity  
          (except banking, insurance, or trust company operations), the  
          Beverly-Killea Limited Liability Company Act prohibits a foreign  
          or domestic limited liability company from rendering  
          professional services in this state unless expressly authorized  
          under applicable provisions of law. "Professional services" are  
          those services for which a license, certification, or  
          registration is required under specified statutes.

          In 1995, SB 513 (Calderon, Ch. 679, Stats. 1995) authorized the  
          establishment of limited liability partnerships (LLPs) for  
          licensed attorneys and licensed accountants, provided the LLP  
          purchased a liability insurance policy or maintained bank  
          deposits of at least $100,000 per limited liability partner (or  
          an aggregate of not less than $500,000 for fewer than five  
          partners and not more than $5 million for all others).  Only  
          partnerships with a net worth of $10 million or more were  
          allowed to become LLPs.  In 1998, the statute allowing  
          professional LLPs (Bus. & Prof. Code Sec. 16956) was extended to  
          architects, under the same conditions as accountants and  
          attorneys, for a trial period of ten years (AB 469, Cardoza, Ch.  
          504, Stats. 1998).  In 2006, the repeal date for architects was  
          extended to 2012 and the liability coverage requirement was  
          increased to $1,000,000 for partnerships of five or fewer  
          licensees, and an additional $100,000 per additional licensee up  
          to a maximum of $5,000,000. (AB 2914, Leno, Ch. 426, Stats.  
          2006.)  In 2007, SB 414 (Corbett, Ch. 80, Stats. 2007) updated  
          the liability coverage requirement for accountants and attorneys  
          to that applicable to architects.

          Under the Beverly-Killea LLC Act, unless permitted by the  
          Business and Professions Code, an LLC cannot provide  
          professional services.  To date, only attorneys, accountants,  
          and architects are permitted to operate as LLPs under the  
          conditions specified for liability coverage.  Last year, SB 1225  
          (Harman, Ch. 114, Stats. 2008) allowed a private cemetery that  
          is an LLC to operate as a licensed cemetery authority to own the  
          cemetery and to provide services by professionals licensed under  
          the Business & Professions Code.  SB 1225, however, prohibited  
          licensees of professional services rendered in connection with  
          the operations of a cemetery authority from having any ownership  


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          interest in the LLC.

          This bill would establish the rules by which a limited liability  
          company may provide services as a licensed contractor.

                                CHANGES TO EXISTING LAW
           Existing law  , the Beverly-Killea Limited Liability Company (LLC)  
          Act, prohibits domestic and foreign limited liability companies  
          from rendering professional services in California. (Corp. Code  
          Sec. 17375.)  
          Existing law  defines "professional services" as "any type of  
          professional services which may be lawfully rendered only  
          pursuant to a license, certification, or registration authorized  
          by the Business and Professions Code, the Chiropractic Act, or  
          the Osteopathic Act." (Corp. Code Sec. 13401(a).)  Only  
          attorneys, accountants, and architects have been authorized to  
          render professional services as limited liability entities in  

           This bill  would authorize the State Contractors' License Board  
          to issue a contractor's license to a limited liability company  
          provided a qualifying member of the LLC is licensed as a  
          contractor and the LLC meets all other requirements such as  
          bonding and  solvency of the LLC, and compliance by the LLC with  
          the liability insurance requirements, as specified.  This bill  
          would treat a limited liability company and a corporation  
          similarly as to the licensing process, as well as the renewal,  
          suspension, reissuance, and termination of the license for  
          specified reasons in the Business and Professions Code.

           This bill  would provide that notwithstanding the prohibition  
          under the LLC Act against a limited liability company providing  
          professional services unless pursuant to a license,  
          certification or registration, an LLC may render services if the  
          applicable provisions of the Business and Professions Code  
          authorize a limited liability company to hold that license,  
          certificate or registration.
            1. Stated need for the bill

           The author states:  


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            The existing contractors' license law is archaic as most  
            states in the country allow an LLC to hold a contractor's  
            license ? the current law is an impediment to established  
            nationwide businesses doing business in California.  The LLC  
            form of business has [the] needed flexibility for distribution  
            of profits and losses separate from control and ownership  
            which benefits commerce with no foreseeable detriment.

            The Contractors' State License Law ("CSSL") (sic) was adopted  
            in 1929, long before adoption of the Beverly-Killea Limited  
            Liability Company Act.  Thus, at the time the CSSL was  
            adopted, the legislature did not have the option of inserting  
            LLC's into its provisions.  The exclusion of LLC's from the  
            CSSL was not a calculated decision.

            Fourteen (sic) years after passage of the LLC Act, LLC's  
            comprise an indelible part of the business landscape in  
            California and throughout the United States.  This bill is  
            necessary so that LLCs may be utilized in the construction  
            industry just as they are in countless other industries  
            throughout California.  Notably, this is already the case in  
            other States.  Of the 29 states that license or regulate  
            contractors,  only California  imposes a complete ban on  
            operating as an LLC. 

            LLCs are a desired entity for construction companies, as they  
            are with many other industries, primarily because LLCs provide  
            the flexibility to distribute profits and losses to owners  
            without double taxation, in a manner similar to corporations  
            electing "S" status under the Internal Revenue Code, but  
            without the shareholder qualifications ? This flexibility as  
            to the identity of shareholders is coveted for achieving  
            estate planning objectives ?

            This improved estate planning and profit sharing flexibility  
            will have no negative impact on consumers of construction  
            services in California.  An LLC provides liability protection  
            for the personal assets of owners equivalent to,  but not more  
            than  , that afforded a corporation.

          2.    The Beverly-Killea LLC Act: why professional services are  
            not a permitted business  

          Since its enactment, the rationale for the Beverly-Killea LLC  
          Act's exclusion of professional services from the business that  
          an LLC may undertake has been that service providers who harm  


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          others by their misconduct, incompetence, or negligence should  
          not be able to limit their liability by operating as an LLC or  
          limited liability partnership and thus potentially become  
          judgment proof.

          California's Limited Liability Partnership (LLP) law, however,  
          has always sought to strike a balance between allowing  
          professional licensed service providers to operate in a mode  
          offering both tax and liability-limiting advantages while  
          preserving to an appropriate degree the ability of a party  
          injured by professional negligence to recover damages for that  
          injury.  Thus, an insurance requirement has always been imposed  
          upon professional licensees wishing to operate as an LLP. 

          Because of the limited liability attributes of an LLP, an  
          injured person can no longer rely on the joint and several  
          liability of the partners and their personal assets, but must  
          look to the assets of the LLP.  To ensure adequate but not  
          necessarily complete recovery in all claims, the insurance  
          requirement is added as a condition of being able to operate as  
          an LLP.  Thus, even if the LLP has few assets because the  
          profits are regularly distributed to its members, the required  
          insurance is available to pay tort damages.

          Thus, current law authorizes attorneys, accountants, and  
          architects, all of whom provide professional services under the  
          Business and Professions Code, to organize themselves as LLPs  
          and to provide professional services, so long as the LLP  
          maintains a net worth of at least $10 million, and obtains  
          liability insurance coverage or maintains bank deposits of $1  
          million for partnerships of five or fewer licensees and an  
          additional $100,000 for each additional licensee up to a maximum  
          of $5 million for all others.  These figures were updated last  
          year by SB 414 (Corbett).  Limited liability partnerships are  
          required to register with the Secretary of State, and LLP  
          partners are only personally liable for those torts in which  
          they personally participated and are not jointly and severally  
          liable for any other torts or debts of the partnership.

          This bill would authorize the State Contractors' License Board  
          to issue to a limited liability company (LLC) a license to  
          provide contactor services, if the LLC meets the liability  
          coverage requirements provided in the bill (and meets other  
          licensing requirements).  Last year, SB 1337 (Correa) would have  
          done the same, but without requiring the LLC to provide any  
          additional liability coverage in the event of damages to a  


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          consumer.  That bill died in this Committee.  In the same  
          session, SB 1225 (Harman, Ch. 114, Stats. 2008) permitted an LLC  
          to obtain a license as a cemetery authority provided it  
          conformed to the insurance requirements for professional LLPs  
          and provided no licensee practicing his or her profession  
          becomes an owner-member of the LLC. 

          If SB 392 is enacted, contractors would be the first of 54  
          professional and semi-professional licensee groups that, until  
          now, could not be an LLC providing those services.  As mentioned  
          above, LLCs protect owners from liability to consumers yet allow  
          them full control to operate and manage the business and  
          distribute profits as they wish.  Especially because contractors  
          provide services that encompass not only large public and  
          private projects but also small home-improvement projects  
          ranging from a minor roof repair to full reconstruction of a  
          fire-damaged home, an incompetent or negligent contractor could  
          wreak havoc on a consumer's life, with the consumer having no  
          recourse if something goes wrong.   Thus, without the insurance  
          coverage now provided under SB 392, last year's bill to allow an  
          LLC to be licensed as a contractor (SB 1337), failed in this  
          committee.  SB 392 essentially cures the defect in SB 1337.

          3.    Professional v. nonprofessional services: Attorney General  

          The LLC Act prohibits an LLC from rendering professional  
          services and defines professional services as those requiring a  
          license, certification, or registration under the Business and  
          Professions Code, the Chiropractic Act, or the Osteopathic Act.  
          (Corp. Code Sec. 17375.)

          In 2004, the Attorney General (AG) issued an opinion, in  
          response to a request from the Secretary of State, on the  
          question of whether a business that provides services requiring  
          a license, certification, or registration pursuant to the  
          Business and Professions Code may conduct its business as a  
          limited liability company.  The AG opinion concluded that "a  
          business that provides services requiring a license,  
          certification, or registration pursuant to the Business and  
          Professions Code may conduct its activities as a limited  
          liability company if the services rendered require only a  
          nonprofessional, occupational license." (Op. No. 04-103, 87 Ops.  
          Cal. Atty. Gen. 109 (July 23, 2004).)

          The AG opinion is quite clear on this point: an LLC is not  


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          permitted to render professional services, and an LLC would be  
          permitted to perform "nonprofessional occupational services"  
          without violating the Beverly-Killea LLC Act.  However, the  
          opinion also recognized that for some purposes, the term  
          "professional services" has been broadly construed to include  
          more than the traditionally considered "learned" professions  
          such as medicine, law, or engineering, but includes such skilled  
          services such as plumbing. (Amex Assurance Co. v. Allstate Ins.  
          Co. (2003) 112 Cal.App.4th 1246, 1252; Hollingsworth v.  
          Commercial Union Ins. Co. (1989) 208 Cal.App.3d 800, 806.)

          Thus, the question for licensed contractors is whether or not  
          the services they render are professional services otherwise  
          prohibited by the Beverly-Killea LLC Act from being rendered by  
          a limited liability company.  If the services are professional,  
          then the LLC Act prohibits a limited liability company, though  
          licensed under the Business and Professions Code as a  
          contractor, from rendering contracting services.

          This bill attempts to get around the question by simply  
          authorizing the issuance of a contractor's license to a limited  
          liability company under the Business and Professions Code, and  
          stating that "notwithstanding [Corp. Code] Section 17375" a  
          limited liability company may render services that may be  
          lawfully rendered only pursuant to a license, certificate or  
          registration authorized by the Business and Professions Code if  
          applicable provisions of the Business and Professions Code  
          authorize a limited liability company to hold that license.  The  
          logic is circular, but the bill does contain consumer  
          protections, in the form of the requirements for insurance or  
          escrow deposits imposed on contractor-LLCs.

          4.    Liability coverage in addition to contractor's bonding  
          An applicant for a contractor's license must pass a written  
          examination designed to show that the applicant possesses the  
          necessary degree of knowledge of building, safety, health, and  
          lien laws of the state and of the administrative principles of  
          the contracting business as the board deems necessary for the  
          safety and protection of the public.  The examination must be  
          taken by an individual or a qualifying responsible managing  
          employee, or by a general partner or qualifying responsible  
          managing partner or employee (if the applicant is a  
          copartnership or limited partnership), or by a responsible  
          managing officer or responsible managing employee (if the  


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          applicant is a corporation) or, under SB 392, by a responsible  
          managing member of the LLC.  The applicant must also show  
          evidence of solvency (i.e., has an operating capital of greater  
          than $2,500) and good moral character, as well as documentation  
          of experience in a particular class of contractor's license,  
          particularly if the experience is from out of state.

          Under current law, the State Contractor's Licensing Board may  
          issue a license to an individual, a partnership, a corporation,  
          or a joint venture that has met the requirements enumerated  
          above.  SB 392 would add a limited liability company to this  
          list, with the board treating a license applicant in almost all  
          respects as a corporation, including that the qualifying  
          individual must own at least a 10% ownership interest in the LLC  
          in order to qualify for the license for the LLC. 

          The board requires, as a condition precedent to the issuance,  
          renewal, or maintenance of a license, the licensee to have on  
          file a contractor's bond in the sum of $12,500, at least $7,500  
          of which is dedicated for the benefit of a homeowner with a  
          homeowner improvement contract for his or her personal family  
          home, and whose home was damaged as a result of a violation.   
          The rest of the $12,500 is available for payment to any person  
          damaged by a violation or by fraud in the performance of a  
          construction contract, any employee damaged by nonpayment of  
          wages, any person damaged by the licensee's failure to pay  
          employee's fringe benefits or other compensation.  The board may  
          increase this pre-licensing bond to twice the value under  
          specified conditions.

          In addition, a licensee who is not the sole proprietor, a  
          general partner, or a joint venture licensee is required to post  
          a "qualifying individual's bond" in the amount of $12,500, of  
          which $7,500 is reserved for the damaged homeowner as described  
          above, and the rest available to other beneficiaries named above  
          (employee, other persons).  This bond may be waived if the  
          qualifying individual owns 10% or more of the corporation's  

          Under SB 392, an LLC would be required to post, in addition to  
          the total of $25,000 in bonds, at least $1,000,000 in insurance  
          coverage or escrow deposit, for the benefit of homeowners and  
          other consumers damaged by the contractor licensee. 

          5.    Liability in the event of suspension, unless in substantial  


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           As is the case with other professionals allowed to exist as  
          limited liability entities, non-compliance with the insurance or  
          escrow deposit requirements could trigger the suspension of the  
          limited liability company's contractor's license.  In this  
          eventuality, this bill would provide that each member shall be  
                                                                liable up to $1,000,000 for damages or injuries resulting from  
          acts and omissions of the LLC in providing contracting services.  
           A safe harbor would be provided in that, pursuant to Section  
          7031, substantial compliance, which requires good faith efforts  
          to comply, would exonerate the LLC members from such liability.

          This additional coverage for liability is required for the  
          benefit of damaged consumers who would otherwise have no  
          recourse if an injury occurs during the time of suspension.  In  
          the case of a sole proprietor, a damaged consumer may attempt  
          recourse against the contractor's personal assets.  As well, the  
          consumer has recourse against a partner in the case of a  
          partnership, or a general partner in case of a limited  
          partnership.  If the contractor is a corporation, the consumer  
          may go after the corporate assets, or try to pierce the  
          corporate veil to reach the shareholders' assets.  There is a  
          long line of cases allowing the corporate veil to be pierced to  
          remedy wrongs inflicted by corporations on others.

          Cases involving LLC veil-piercing have just recently reached the  
          higher courts of other states that have had LLC statutes longer  
          than California.  Although some courts have suggested that  
          veil-piercing liability will be the same for members of LLC's as  
          for shareholders in a corporation (See, e.g., Kaycee Land and  
          Livestock v. Flahive, 2002 WY 73 (Wyo.2002)) especially if there  
          was an inadequate capitalization and representations that other  
          entities would be responsible for the LLC's debt, there are  
          other courts that would provide more protection for the LLC (See  
          Bonner v. Brunson (2003) 262 Ga.App.521, 585 S.E.2d 917, cert.  
          denied, (Jan. 12, 2004), suggesting that the veil of an LLC  
          should not be pierced absent an "abuse" of the LLC).  Some  
          states have LLC statutes that expressly provide for application  
          of the corporate veil-piercing standard to LLCs, e.g., Colorado,  
          Georgia, and Montana.

          Under the Beverly-Killea LLC Act, no person who is a manager or  
          officer or both a manager and officer of an LLC is personally  
          liable for any debts, judgments, or obligations of the LLC.  A  
          manager may however agree to be personally liable if this is set  
          out in the LLC's articles of organization or other writing.   


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          (Corp. Code Sec. 17158.)  As to the personal liability of other  
          members of the LLC, the LLC Act is silent; thus, it is not clear  
          that it would be easy to reach assets of LLC owners, who benefit  
          from the tax advantages as well as the shield provided to their  
          personal assets in the course of managing their business with  
          much less formalities than a corporation, to remedy wrongs done  
          to consumers.  SB 392 would remove this uncertainty, at least  
          when the LLC is in suspension, by making the members liable for  
          up to $1,000,000 in damages during that period.

           Support  :  None Known

           Opposition  :  None Known

           Source  :  Associated General Contractors of California and  
          AGC-San Diego

           Related Pending Legislation  :  None Known

           Prior Legislation:  

          SB 141 (Beverly, Chapter 57, Statutes of 1995) would have added  
          numerous categories of state regulated professional service  
          providers to the types of businesses that could operate as LLCs.  
           However, opponents of SB 141 and that bill's sponsor were  
          unable to agree as to whether or not professional or licensed  
          LLC service providers should carry adequate insurance to ensure  
          their financial ability to respond to legal judgments for  
          contract or tort claims.  Consequently, those additional classes  
          of businesses were amended out of SB 141 prior to its enactment.

          SB 1337 (Correa, 2008) was similar to SB 392, but lacked the  
          insurance and/or escrow deposit requirements for the LLC and its  
          members.  The bill died in this committee.

          AB 2401 (Miller, 1996) would have allowed contractors to operate  
          as LLCs.  The bill died in this committee.




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