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
GMO:jd
SUBJECT
Limited Liability Companies: Licensed Contractors
DESCRIPTION
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.
BACKGROUND
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
(more)
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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
California.
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.
COMMENT
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
Opinion
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
requirements
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
stock.
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
compliance
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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
HISTORY
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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