Unlicensed Contractors - Can BK save them?

In a previous entry back several weeks ago, I explained how unlicensed contractors in California are not allowed to keep any money paid to them for construction projects whether or not the job was completed in a reasonable workmanlike manner. California Bus. & Prof. Code Section 7031(b).  This is based on strong public policy that prohibits unlicensed contractors from working in California on projects over $500.00 to protect owners of property from shoddy work.

To obtain his or her money, the owner must generally sue the unlicensed contractor in California state court.  The causes of action that are often alleged include: Violation of Bus & Prof Code Section 7031(b), breach of contract, and fraud.  However, the first two are much easier to assess damages: any money paid must be returned.  Fraud, however, requires that the misrepresentation (assuming there was one) caused the owner damages.  If the work was done in a reasonable workmanlike manner, then the owner received something of value in consideration of the payment, notwithstanding the statute violation.  So, the court will not award more than what was paid (ie, the court will order that the owner's money be returned).

The issue that has arisen is whether an unlicensed contractor defendant, sued and found liable for the violation of Section 7031(b), may avoid payment to the owner by filing for bankruptcy protection.  Generally, a judgment is simply an unsecured debt for which bankruptcy (except in certain exceptions) discharges.  In the recent case of In Re Sabban (9th Cir. 2010) 600 F.3d 1219, the 9th Circuit Court of Appeals affirmed the lower bankruptcy court's ruling that, unless the debtor is found liable for actionable fraud - owner/plaintiff is awarded damages in excess of the restitution under Section 7031 - the debt (restitution under Section 7031(b)) will be discharged by the bankruptcy.

This case is important because it basically flies in the face of California's policy to protect the owner, and allows an "out" for the unlicensed contractor who violates a state law, but is absolved of such conduct.  Potentially, Section 7031, et seq. also provides for public monetary penalties.  It is unclear if the decision is meant to negate the defendant debtor's liability for the penalties as well.  Anticipate more on this to come.