BILL ANALYSIS
SB 392
Page 1
Date of Hearing: June 16, 2009
ASSEMBLY COMMITTEE ON BUSINESS AND PROFESSIONS
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
Law).
2)Defines "qualifying person," "qualifying individual," or
"qualifier" as an individual who qualifies for a contractor's
license.
3)Authorizes the issuance of a contractor's license to a LLC,
and adds license requirements that mirror those of a
corporation.
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
months;
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
required.
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
amount.
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
contractor.
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
authorized.
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
classifications.
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
LLC.
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
bond.
"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.
REGISTERED SUPPORT / OPPOSITION :
Support
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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
Opposition
None on file.
Analysis Prepared by : Joanna Gin / B. & P. / (916) 319-3301