What Happens When You Change Your Entity Status
by John McGill
In the last article, we discussed E.J. Franks Construction Inc. v Bhupinder Sahota and how the change from a sole proprietorship to a corporation affected the theories of recovery available to a contractor, but not the right to recovery by the contractor.
Recall that in the Franks case, E.J. Franks started a project for the Sahotas as a sole proprietor but then incorporated and continued working on the project in that capacity. There was a dispute during the work and Franks was terminated before completion. The parties sued each other and one theory advanced by the Sahotoas was that Franks was not properly licensed during the entire time he worked on the project. Under California law, if you are not properly licensed during the course of the work, you do not need to be paid and you can be forced to disgorge (return) all of the money that you were paid.
In Franks the court ruled that for the work that Franks performed as a sole proprietor under the contract, he was entitled to bring a breach of contract action. However, for the work that his new corporation performed, there was no contract and so there was no breach of contract claim available. Franks was not without a remedy though because he could bring a quantum meruit claim.
Quantum meruit is an equitable cause of action, which means that it is based on a determination of fairness. If you perform work, then you should be paid- that’s the basic premise. But there are some prerequisites that need to be met. First of course is that you are properly licensed.
Next is that you need to have performed work that adds value so that if you were not paid, the owner would be unjustly enriched. Conversely, and importantly, “if for whatever reason failure to compensate the contractor will not result in the unjust enrichment of the owner, there will be no recover, regardless of what the contractor might have been entitled to collect under a contract which conformed with the requirements of [the Code].” There has to be some value added not just work performed.
For example, if you fail to provide a written contract for a home improvement project and then tag on a lot of change orders for work that would ordinarily be included as part of the work, a claim of quantum meruit entitlement would fail, especially if the owners are unsophisticated and not experienced in construction; your typical client in other words. In this example, the lack of a written contract for home improvement work is a violation of the Code. (You need a written contract with specific language if you are doing a remodel, aka, home improvement project.) The demand for change orders for work that is not a change would doom any quantum meruit claim. The owner is not unjustly enriched at all; the contractor is just taking advantage.
On the other hand, if a contractor like Franks performs work on a project as a sole proprietor and then as a corporation, the owner would be unjustly enriched if they got to keep the benefit of the work done as a corporation without paying for it. The fact that the entity form changed has no bearing on the work that was done. The owner still got a benefit and they should pay for that benefit.
As a general rule of thumb though, all work that you perform as a contractor should be based on a written contract. The terms and conditions of the contract will provide the remedies that you can seek in court. Likewise, the steps that you take when you first get the job will dictate the extent of the remedies that you may have. For example, if you are a subcontractor on a private works project, you need to serve a Preliminary Lien Notice or you won’t have Mechanics Lien or Stop Notice rights. If you don’t file the Preliminary Notice for any new entity that you might form, then you likely won’t have these rights if you sue in a quantum meruit capacity either.
One thing to keep in mind, if the work you are doing is on a public project and you are a prime contractor, you cannot allege a quantum meruit cause of action against the public owner. There is no such right. If you are a subcontractor on a public works project though, you can make a quantum meruit claim against the general or prime contractor. In that case, the general or prime contractor would be the ones unjustly enriched if you were not paid.
If you get into a dispute with an owner and you end up in litigation, then quantum meruit is a worthwhile cause of action to include in your Complaint. You can’t get both breach of contract damages and quantum meruit, but if your breach of contract claim fails, you have a fall back in the equitable claim. Hopefully though, you just get paid and don’t have to involve yourself in any litigation.
Bio: John P. McGill is an attorney and represents contractors and suppliers throughout the Bay Area and Northern California in both private and public work disputes and in employment, transactional, and administrative matters. He is the author of California Contractor’s DESKTOP GENERAL COUNSEL What You Need To Know About California Construction Law. Contact: Work - 925-952 5403 or Cell- 707 337 1932. Or email at johnmcgill310@gmail.com
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