BILL ANALYSIS                                                                                                                                                                                                    

                                                                  SB 392
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          Date of Hearing:   June 16, 2009

                                 Mary Hayashi, Chair
                    SB 392 (Florez) - As Amended:  April 21, 2009

           SENATE VOTE  :   36-0
          SUBJECT  :   Contractors:  limited liability companies. 

           SUMMARY  :   Allows licensed contractors to organize their company  
          under the laws of a limited liability corporation (LLC).   
          Specifically,  this bill  :   

          1)Includes LLC within the definition of "person" for the  
            purposes of the Contractors State License Law (Contractors  

          2)Defines "qualifying person," "qualifying individual," or  
            "qualifier" as an individual who qualifies for a contractor's  

          3)Authorizes the issuance of a contractor's license to a LLC,  
            and adds license requirements that mirror those of a  

          4) Requires a LLC to provide security for claims with at least  
            one of the following:

             a)   The total aggregate limit of liability under the policy  
               or policies of insurance for a limited liability company  
               that employs five or fewer licensed persons shall not be  
               less than $1 million dollars, and for a LLC that employs  
               more than five licensees rendering professional services on  
               behalf of the company, an additional $100,000 of insurance  
               shall be obtained for each licensee except that the maximum  
               amount of insurance is not required to exceed $5 million  
               dollars in any one designated period.  Defines "designated  
               period" to mean a policy year or period less than 12  

             b)   Maintain in trust or bank escrow, cash, bank  
               certificates of deposit, United States Treasury  
               obligations, bank letters of credit, or bonds of insurance  


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               or surety companies as security for payment of liabilities  
               imposed by law for damages arising out of all claims. The  
               maximum amount of security for a LLC that employing up to  
               five licensed persons shall not be less than $1 million.   
               For each additional licensee employed beyond five  
               licensees, an additional $100,000 of security shall be  
               obtained up a maximum of $5 million; 

             c)   At the time of licensing, a LLC shall file with the  
               registrar all necessary information and documentation  
               demonstrating compliance with the financial security  
               requirements; and,

             d)   If the security requirements of this section are  
               satisfied wholly, or in part, with an insurance policy,  
               then a certification of coverage shall be submitted to the  
               commissioner by the licensee or applicant, and signed by an  
               authorized agent or employee of the insurer.

          5)Requires that if a LLC license is suspended, each person  
            within the company identified shall be personally liable up to  
            $1 million for damages against third parties in connection  
            with the company's performance during the period of  
            suspension, for any act or contract where a license is  

          6)Requires that if a LLC license has been suspended or revoked,  
            but stayed, the applicant or licensee must file or have on  
            file a contractor's bond in a sum fixed by the registrar.  The  
            sum shall not be less than $15,000 or more than 10 times that  

          7)Requires that the qualifying individual for a LLC shall not be  
            required to file or have on file a qualifying individual's  
            bond if he or she owns at least a 10% interest in the LLC and  
            certifies this fact on a form prescribed by the registrar.

          8)Requires a LLC to include information of the liability  
            insurance or security it maintains at a financial institution  
            for change orders and service and repair contracts. 

          9)Makes this Act operative on July 1, 2011.


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          10)Makes other technical and conforming changes.

           EXISTING LAW : 

          1)Provides for the licensure and regulation of contractors by  
            the Contractors State License Board (CSLB). 

          2)Defines "person" for the purpose of the Contractors Law to  
            include an individual, a firm, co-partnership, corporation,  
            association or other organization, and prohibits any  
            unlicensed person from engaging in business or acting as a  

          3)Authorizes the issuance of a contractors' license to  
            individual owners, co-partnerships, corporations, and joint  
            ventures, and requires applicants to demonstrate degree of  
            knowledge, experience, and qualifications. 

          4)Establishes the Beverly-Killea Limited Liability Company Act  
            (LLC Act), to provide for LLCs to organize and conduct  
            business in California, and allows foreign LLCs (any LLC  
            organized outside of California) to register to conduct  
            business in the state. 

          5)Provides that a LLC may engage in any lawful activity except  
            banking, insurance, or trust company operations or the  
            offering of professional services for which a license,  
            certificate, or registration is required, unless expressly  

           FISCAL EFFECT  :   Unknown

           COMMENTS  :   

           Purpose of the bill  .  According to the author's office, "The  
          existing contractors license law is archaic as most states allow  
          a LLC to hold a contractor's license - California law is an  
          impediment to established nationwide businesses doing business  
          in the state.  The LLC form of business has needed flexibility  
          for distribution of profits and losses separate from control and  
          ownership which benefits commerce with no foreseeable detriment.  

          "LLCs are a desired entity for construction companies, as they  
          are with many other industries, primarily because LLCs provide  


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          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 limited shareholder qualifications (i.e., 'S' corporation  
          shareholders must be individuals with very limited exceptions  
          and the number of shareholders is limited to 100)? Similarly, a  
          'S' corporation's largest shareholders receive the largest share  
          of profits.  LLCs allow owners to dictate how profits are split  
          and taxed without dictation by the percentage ownership.

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

           Background  .  The CSLB licenses and regulates California's  
          construction industry. There are more than 316,000 licensed  
          contractors in the state, in 43 different licensing  
          The Contractors Law was adopted in 1929, prior to the adoption  
          of the LLC Act in 1994 that established LLCs.  The sponsors  
          contend that at the time the Contractors Law was adopted, the  
          Legislature did not have the option of inserting LLCs into its  
          provisions.  The sponsors argue that the exclusion of LLCs from  
          the Contractors Law was not a calculated decision and 14 years  
          after passage of the LLC Act, LLCs comprise an indelible part of  
          the business landscape in California and throughout the United  
          States.  The sponsors claim that therefore, this bill is  
          necessary so that LLCs may be utilized in the construction  
          industry just as they are in countless other industries  
          throughout California.  

          The rationale for the exclusion of professionals to organize as  
          a LLC was apparently that service providers who harm others by  
          their misconduct, incompetence, or negligence should not be able  
          to limit their liability by operating as an LLC and thus become  
          potentially judgement-proof.  Based upon these provisions of  
          law, it has been commonly understood that the boards and bureaus  
          under the DCA are prohibited from issuing a license,  
          certification, or registration to an entity organized as a LLC. 

          Currently, general contractors are allowed to organize as one of  
          the following legal entities:  sole proprietorship, general  
          partnership (GP), limited partnership (LP), C-Corporation, and  


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          S-Corporation.  Under current law, the CSLB 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 LLC to this list, with the CSLB 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  

          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.  LLPs 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.

          The sponsors claim that allowing contractors to operate as a LLC  
          will offer a flexible structure for owners and shareholders by:   
          removing the restrictions of the type and number of members  


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          allowed, removing compensation restrictions, removing  
          accumulated earnings penalty, distributing income and deductions  
          in percentages that differ from ownership, offering flexibility  
          in joint venture planning, and making it easier to pass a  
          business onto the next generation 

          In regular corporations, shareholders are subject to double  
          taxation because both the entity and the shareholders are taxed  
          on the increased value of the property when the property is sold  
          or the corporation is liquidated.  LLCs avoid this double tax  
          because the LLC does not pay a tax on its income; only members  
          are taxed.
          Support  .  According to the sponsors, "Existing law authorizes  
          businesses in California to be organized as LLCs with the  
          exception of professional services.  In order to do business as  
          a licensed contractor, a single person must successfully  
          complete the exam and serve as the 'qualifier' for the  
          construction entity.  This entity can be operated as a sole  
          proprietor, joint venture, partnership, or a 'C' Corporation.   
          Since contracting is considered a professional license,  
          contractors are not allowed to do business as a LLC? LLCs are  
          desirable to the construction industry because LLCs provide  
          business flexibility to distribute profits and losses to owners  
          without double taxation.  This is done in a manner similar to  
          'S' corporations without the limited shareholder qualifications  
          of a 'S' corporation.  Organizations such as LLCs also provide  
          improved estate planning and profit-sharing flexibility." 

          According to the California Landscape Contractors Association  
          (CLCA), "Several previous attempts to authorize the CSLB to  
          license LLCs have stumbled over two concerns.  First, that work  
          performed by a construction trades contractor could be construed  
          as a 'professional service' and therefore may be excluded under  
          the LLC Act from being provided by a LLC.  Second, that  
          consumers of construction services may be harmed if an  
          inadequately capitalized or underinsured LLC is found liable for  
          a construction defect or some other business-related tort claim.  

          "SB 392 addresses these concerns by amending the Contractors Law  
          to specifically include LLCs as eligible to be licensed as  
          contractors, and requiring licensed contractors who elect to  
          organize as a LLC to provide security for any claims by  
          maintaining at least $1 million of liability insurance or hold  


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          at least $500,000 in liquid assets and/or an equivalent surety  

          "Finally, we note that other professional service providers in  
          California, notably attorneys, accountants, and architects, have  
          been allowed to organize as LLCs subject to similar security  
          requirements as proposed in this measure.  There is simply no  
          reason that contractors should not be treated in the same way." 

           Prior Legislation  .  SB 1225 (Harman), Chapter 114, Statutes of  
          2008, authorizes the organization and operation of cemetery   
          authorities as limited liability companies as long as they carry  
          liability insurance policies or other security in the amount of  
          $1 million. 

          AB 2914 (Leno), Chapter 426, Statutes of 2006, extends the  
          sunset date on licensed architects' ability to organize as LLPs  
          to January 1, 2012, and increases the minimum liability coverage  
          requirements for architectural LLPs to $1 million (from  
          $500,000) as of January 1, 2008.

          SB 1337 (Correa) of 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 Senate Judiciary Committee.

          AB 2401 (Miller) of 1996 would have allowed contractors to  
          operate as LLCs.  The bill died in Senate Business and  
          Professions Committee.

          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.

           Double-referred  .  This bill is double-referred to Assembly  
          Judiciary Committee. 




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            Associated General Contractors (AGC) of California (sponsor)
          AGC-San Diego (sponsor)
          Associated Builders and Contractors (ABC) of California 
          Associated General Contractors of California (AGC) 
          California Fence Contractors' Association 
          California Landscape Contractors Association (CLCA) 
          Engineering & Utility Contractors Association (EUCA) 
            Engineering Contractors' Association 
          Flasher/Barricade Association          
          Golden State Builders Exchange (GSBE) 
            Marin Builders' Association 

          None on file. 

           Analysis Prepared by  :    Joanna Gin / B. & P. / (916) 319-3301