California Curtails "Draconian" Penalties Against Unlicensed Contractors on Commercial and Public Works Projects
In Short
The Situation: Under current California law, a contractor who is not "duly licensed" at any point during performance of a contract (i) may not bring an action to recover on the contract and (ii) may be subject to disgorgement of all amounts paid. No other state has a disgorgement penalty this harsh, which California courts have called "draconian."
The Development: California Senate Bill 342 ("SB 342"), signed on September 30, 2026, replaces this all-or-nothing approach with consequences tied to the period of non-licensure. On covered public works, and on covered commercial, institutional, and certain common interest and multifamily projects, contractors licensed at contract execution may recover for work performed while licensed and must disgorge only compensation for work performed while unlicensed.
Looking Ahead: The law takes effect on January 1, 2027. Parties should reassess strategies that rely on full disgorgement, review licensing representations in their contracts, and confirm whether their projects are covered.
Background
Section 7031 of the California Business and Professions Code provides two consequences for unlicensed contractors: Subdivision (a), the "shield," bars unlicensed contractors from pursuing legal relief for nonpayment; and subdivision (b), the "sword," lets owners recover payments made to the contractor, a penalty referred to as disgorgement. The shield portion of California's law is similar to laws in a number of states. However, California is the only state in the country with a disgorgement statute that has such extremely harsh consequences. For example, if a contractor completes a major public works project, such as a new courthouse, and was paid $200 million, but had a contractor's license that was suspended for a short period of time, even a few days, the owner can seek recoupment of all money paid to the contractor, thereby essentially obtaining a "free" courthouse. The only defense is the statutory defense of substantial compliance set forth in Section 7031(e).
California Senate Bill 342
On September 30, 2026, Governor Gavin Newsom signed SB 342 (Umberg) into law (Stats. 2026, Ch. 967), significantly softening the state's "draconian" penalties against unlicensed contractors. For certain commercial and public works projects, if a contractor becomes unlicensed during performance of the contract, they are now eligible to recover payment for work performed while they were duly licensed and subject to disgorgement only for periods during which they were unlicensed. Residential projects involving fewer than four units remain subject to the existing penalties and are not impacted by SB 342. The new law takes effect on January 1, 2027.
Covered Projects
The new law applies to contracts for any of the following:
- A public work of improvement;
- A commercial construction project;
- An institutional construction project;
- A common interest development (as defined in Civil Code Section 4100), if no tenant or resident is a party to the contract; or
- A multifamily residential project of four or more units, if no tenant or resident is a party to the contract.
Key Amendments
The shield: Contractors can recover for the time they were licensed (Section 7031(a)). On a covered project, a contractor may sue for payment if they were duly licensed (i) when the contract was executed and (ii) during the portion of performance for which they seek payment, "without regard to the underlying merits of the cause of action."
The sword: Disgorgement is limited to the unlicensed period (Section 7031(b)). For covered projects, the full-disgorgement penalty "does not apply." Instead, a party that paid an unlicensed contractor may recover only "the portion of compensation paid … for work performed during the time in which the contractor was unlicensed," rather than all compensation paid. The cap depends on when the work was performed, not when payment was made.
Clients should consult counsel to assess how SB 342 affects their specific contracts, projects, and disputes.
Four Key Takeaways
- Owners and general contractors: Claims and offset strategies that rely on full disgorgement may need to be reassessed. This is true whether the situation involves an owner seeking to enforce Section 7031(a)–(b) against a general contractor or a general contractor seeking to enforce that statute against a subcontractor.
- Contractors and subcontractors: Contractors and subcontractors must still be licensed when the contract is executed and during the work for which they seek payment. The amount of recovery or disgorgement resulting from a mid-project lapse depends on the timing and duration of the lapse.
- Contract drafting and procurement: Review licensing representations in contracts. Confirm whether the project falls within a covered category to which the limited penalty applies.
- Pending and anticipated disputes: Evaluate how SB 342 may affect existing Section 7031 claims and defenses. Disputes may arise over how to allocate progress payments and invoices between licensed and unlicensed periods. Finally, disputes may arise as to how the new law impacts the filing and enforcement of mechanics liens.
