Distinguishing License Bonds From Insurance: The Contours of California Contractor License Bonds

Sep 30 2016

By: Ravi R. Mehta
September 30, 2016

A commonly overlooked potential for recovery when a claim arises is the license bond. Distinct from insurance, a license bond is intended to respond to liability related to a contractor’s violation of Contractors State License law. It is mandatory for all California contractors to procure a license bond, or alternatively to place a cash deposit with the Contractors State License Board (“CSLB”). The license bond requirement is currently $15,000.00. However, in the event of license suspension or revocation, the CSLB may require a separate disciplinary bond in an amount between $15,000.00 and $150,000.00. The types of claims to which a license bond may be subject, as well as the types of persons who are eligible to submit a claim against a license bond, are limited. However, if a claimant’s circumstances fit within the confines of the following limitations, a license bond claim may be better suited to provide redress as compared to an insurance claim. The following list contains the most common types of allowable license bond claims.

Business & Professions (“B&P”) Code §7107: Abandonment of a construction project or operation without legal excuse.
B&P Code §7108: Diversion or misapplication of funds or property received for prosecution or completion of a construction project.
B&P Code §7108.5: Failure to pay a subcontractor not later than seven (7) days after the receipt of each progress payment, unless otherwise agreed to in writing or in the absence of a good faith dispute over the amount due.
B&P Code §7109: Willful departure from or disregard of accepted trade standards or plans and specifications.
B&P Code §7113: Failure to complete a construction project for the price stated in the contract or in any modification to the contract.
B&P Code §7114: Aiding or abetting an unlicensed person with an intent to evade the license law.
B&P Code §7117.6: Acting in the capacity of a contractor in a classification other than a classification currently held (by license).
B&P Code §7118: Entering into a contract with an unlicensed contractor.
B&P Code §7119: Willful failure or refusal to diligently prosecute a construction project without legal excuse.
B&P Code §7120: Willful or deliberate failure to pay money when due for materials or services rendered or false denial of any amount due or the validity of a claim with intent to secure a discount or delay.

As the above examples suggest, a colorable claim against a license bond may require intentional conduct on the part of the contractor licensee. Accordingly, where general liability or worker’s compensation insurance precludes coverage for intentional conduct, a license bond claim may be better suited to provide a remedy. Conversely, where a claim is based upon general negligence, an insurance claim may provide for greater potential recovery.

In addition, as noted above, the limited groups of persons who may bring a claim against a license bond further illustrate the distinctions between insurance and license bonds and how one may provide greater recovery than the other depending on the type of claimant. According to California B&P Code §7071.5, license bonds “shall be for the benefit of the following:

Homeowners contracting for home improvements on the homeowner’s personal family residence who have been damaged as a result of the contractor’s violation of the Contractors State License law.
Property owners contracting for the construction of a single-family dwelling who have been damaged as a result of the contractor’s violation of the Contractors State License law, but only if the single-family dwelling was not intended for sale or offered for sale at the time damages were incurred.
Persons damaged as a result of the willful and deliberate violation of the Contractors State License law.
Employees of the contractor damaged as a result of the contractor’s failure to pay wages.
Laborers to whom a portion of the compensation of the employee is paid by agreement with the employee or the collective bargaining agent of the employee, who have been damaged as a result of the contractor’s failure to pay fringe benefits.” (B&P Code §7071.5.)

As evident from the above list, license bonds are intended to benefit individual residential owners, as opposed to institutional commercial owners, with the notable exception being persons damaged as a result of willful and deliberate violation of the Contractors State License law. License bonds are also intended to protect a contractor’s (or subcontractor’s) employees from unpaid wages and withholding of union fringe benefits. Accordingly, it is important to keep in mind the allowable claimant groups listed above when contemplating whether recovery is best achieved by way of an insurance claim or, alternatively, a license bond claim.

It is important to note that license bonds require that claims be made during the effective period of the bond, which may be anywhere from one (1) to five (5) years. The claim must be made at the time the damage occurred. Claims for unpaid wages or fringe benefit violations must be made within six (6) months of discovery of the claim. All other claims must be made within two (2) years after expiration of the license period during which the act or omission causing the damage occurred.

While the amount of a license bond is generally $15,000.00, there are aggregate limits of $4,000.00 to claimants for wages and fringe benefits claims, and $7,500.00 to all other claimants. The only exception to these limits is for homeowners contracting for home improvements on a personal residence. These homeowners may submit claims for up to $15,000.00.

A claimant may submit a claim directly to the license bond surety or may name that surety as a defendant in litigation. Prior to paying a claim, a license bond surety must notify the bonded contractor, who then has fifteen (15) days to contest the payment, in which case the CSLB may initiate an investigation. If that investigation concludes that the license bond surety has or will sustain a loss as a result of a good faith payment to a claimant, then the CSLB may take disciplinary action against the bonded contractor. If that contractor does not contest the payment, then the license bond surety is required to notify the CSLB within thirty (30) days of payment, and the bonded contractor has ninety (90) days from the date of notification to provide proof to the CSLB that that license bond surety has been reimbursed for the amount paid to the claimant.

It is common practice for a claimant to name the license bond surety as a defendant in litigation only as a last resort. If a license bond surety denies a claim, then a claimant may name not only the license bond surety but also the bonded contractor as defendants in litigation. However, given the standard license bond limit of $15,000.00, claimants are well advised to consider the costs of pursuing a license bond claim via litigation.

License bonds provide a unique risk transfer option for unique circumstances. Unlike insurance, however, these bonds are designed to respond to liability beyond that of general negligence. Depending on the facts at hand, a license bond claim may be pursued in lieu of, or in conjunction with, litigation against the license bond surety and/or the contractor. As a result, careful consideration should be given to not only the technical requirements for initiating a license bond claim and the cost-benefit analysis, but also to the impact of any claim on the business relationship between the claimant and contractor.