J & N REALTY, INC.

New Requirements for Home Improvement Contracts  

If asked to name the most highly regulated profession in the State of California, few people would correctly place home improvement contractors at the top of the list.  The great degree of regulation stems from the large number of complaints to the state legislature and the state’s consumer protection agency, the Contractors State License Board (CSLB), regarding the failings of home improvement contractors.  Mounting complaints to the CSLB over the years prompted intensive legislation designed to prevent abuses by contractors.  For example, contractors who do not maintain a proper contractor’s license cannot sue for monies owed on a contract—and they can also be required to disgorge all the money previously paid to them.  A contractor can even go to jail for being unlicensed.  In addition, as added protection for consumers, contractors are required to carry bonds for themselves and their “managing employees.”  In recent years, the enforcement environment has become even more restrictive and treacherous for contractors.  This is because in 2005, the legislature passed an all-encompassing law—an expansion of previous legislation—that strictly regulates the contracts between homeowners and home improvement contractors. 

The year before, in 2004, the legislature dramatically rewrote the laws regulating home improvement contracts (HICs).  Senate Bill 30 was intended “to make home improvement contracts easier to draft and understand.”  Unfortunately, the new changes were difficult to follow and prompted the construction industry to complain bitterly to the CSLB.  In response to those complaints, the CSLB took the remarkable position that it would not enforce the new home improvement law during 2005. The legislature went back to the drawing board and in late 2005 passed Assembly Bill 316, which was enacted into law.  Unfortunately, AB 316 is strikingly similar to SB 30, despite a sincere desire by the legislature to eliminate the complexities of the former law.  The new requirements for home improvement contractors remain confusing.  Indeed, AB 316 represents little improvement over SB 30 for home improvement contractors. 

AB 316 methodically amends Business and Professions Code 

Section 7159, adding 11 pages of new requirements for HICs.  Section 7159 is long, confusing, redundant, and ultimately makes compliance difficult for even those contractors acting in good faith.  Moreover, the new requirements do not reflect the realities of home improvement work.  For example, the new requirements fail to account for the different pricing methods used in the industry, such as “cost plus” contracts.  In addition, the new provisions create traps for the practitioner and contractor.  A home improvement contract should be easy to draft and understand.  However, the new law effectively precludes a simple, one-page construction contract even for minor home improvement work. 

For starters, HICs are now regulated right down to the way they look.  The contract must be printed in at least 10-point type with each heading in at least 10-point boldface type.  The words “Home Improvement,” in at least 10-point boldface type, must appear at the top of the document.  The first page of the contract must contain the date upon which the owner signed the contract and the name and address of the contractor, along with the contractor’s license number, preceded by a statement advising the homeowner that a Notice of Cancellation can be sent to the address noted.  Almost all the requirements mentioned in the new law must be a part of the contract itself and not merely incorporated by reference to an attachment.  This is especially difficult for contractors who use preprinted forms for their work.  It is safe to say that the vast majority of preprinted forms currently in use by contractors do not comply with the new rules. 

Contract Price and Payment Provisions 

Of course, in addition to formatting requirements, HICs must comply with numerous substantive provisions.  It would seem that giving a customer a signed copy of the contract would not need explicit regulation, and yet the contractor must include the following statement in at least 12-point boldface type: “You are entitled to a completely filled in copy of this agreement signed by both you and the contractor before any work may be started.”  The homeowner’s receipt of the contract marks the commencement of the time in which the right to cancel may be exercised (either three days or seven days, depending upon the type of project), so a copy of a fully executed contract must be given to the homeowner prior to commencement of the work. 

Arguably, the most problematic change in the new rules applies to the contract price.  The new law states that, under the heading Contract Price, the amount of the total cost of the contract—including profit, labor, and materials and excluding finance charges—must be listed.  This requirement does not contemplate contracts priced on a “cost plus” or “time and materials” basis, both of which are common in the home improvement industry.  

A failure to list the total contract amount can subject the contractor to a misdemeanor.  “Cost plus” and “time and material” contracts are preferred by some contractors, so the best practice for complying with the total cost requirement and protecting contractors in these types of contracts is the inclusion of a “not to exceed” amount as part of the maximum price of the contract.  In this way, the homeowner has been effectively informed of the total cost of the contract as required under the code. 

Most arguments between owners and contractors concern what each party claims to be included in the price of the contract.  Thus, a detailed description of the work to be performed is always extremely important in construction project contracts.  This information is now a required element of an HIC and must be placed under a specific heading: Description of the Project and Description of the Significant Materials to be Used and Equipment to be Installed.  With this provision, however, the focus of disputes is likely to shift toward whether the project description is adequate or whether particular materials are “significant” and should have been described.  While these disagreements may nominally reduce the amount at issue in construction disputes, they are unlikely to reduce the number of disputes. 

In effect, the statute requires a complete description of the project and materials to be installed.  For swimming pool contracts, for instance, this description must include an aerial drawing showing the shape, size, dimensions of the construction, equipment, and specifications.  If a contractor is providing a specific brand of plumbing fixture, appliance, lighting, floor material, alarm, paint, siding or other wall surface, insulation, roofing, or HVAC unit, the contract or specifications must include a complete description of the goods or materials, including any brand name, model number, or similar designation.  This required specificity is meant to prevent the unscrupulous practice of some contractors who use lesser-quality material but charge the price of higher-quality material. 

Down payments used to be an important part of the negotiation between a contractor and owner, especially when custom items were involved.  Not anymore.  If a down payment is to be charged, the actual amount of the down payment must be listed under the heading Down Payment and followed by a statement in 12-point boldface type: “THE DOWN PAYMENT MAY NOT EXCEED $1,000 OR EXCEED 10% OF THE CONTRACT PRICE, WHICHEVER IS LESS.”  This is probably the most infuriating requirement for contractors, as it prevents them from collecting money up front for materials.  These costs can be significant for custom items.  The new law forces contractors to finance the project and possibly be left with unusable materials if the owner fails to pay for them.  Alternatively, and to avoid this result, the contractor could have the homeowner purchase the materials directly from the supplier and have the contract apply only to the installation of the materials.  This is the best way for contractors to avoid having to finance custom materials, but it deprives contractors of a source of profit.  

Contractors usually mark-up materials that are specially ordered.  Many contractors are loathe to give up this source of revenue, but in order to continue this practice, contractors will have to accept the risk of not receiving payment until after the materials are installed.  If the parties contract for progress payments, the details of these payments must be set forth under the heading Schedule of Progress Payments.  Each progress payment must be specified in dollars and with reference to what will trigger the payment, including the amount of work or services to be performed as well as any materials to be supplied.  This description must be preceded by the following statement in 12-point boldface type: “The schedule of progress payments must specifically describe each phase of work, including the type and amount of work or services scheduled to be supplied in each phase, along with the amount of each proposed progress payment.  IT IS AGAINST THE LAW FOR A CONTRACTOR TO COLLECT PAYMENT FOR WORK NOT YET COMPLETED, OR FOR MATERIALS NOT YET DELIVERED.  HOWEVER, A CONTRACTOR MAY REQUIRE A DOWN PAYMENT.” 

Thus, except for the down payment, contractors may neither request nor accept payment that exceeds the value of the work performed or the materials delivered.  This warning advises the homeowner not to overpay the contractor—a common mistake homeowners make on remodeling projects.  Homeowners can be left with an unfinished project if the contractor has been overpaid for work performed.  Some unscrupulous contractors will neglect projects in which they have a positive cash position to the detriment of projects on which there is money still to be made.  The best way for homeowners to manage a project is to keep tight control of disbursements to the contractor and never pay for work not actually completed. 

In addition, prior to making progress payments, it is extremely important for the homeowner to obtain an unconditional release on any previous payment from the contractor and each of the subcontractors that served 20-day preliminary notices to the owner regarding their lien rights.  To aid the homeowner in understanding this remedy, the contractor must place in the contract a statement to the effect that once payment has been made for any portion of the work, the contractor must, prior to any further payment being made, furnish to the owner a full and unconditional release for any claim for a mechanic’s lien for the portion of work for which payment has already been made.  Releases are the only effective way for homeowners to prevent the successful imposition of mechanic’s liens on their homes.  Failing to obtain lien releases from all contractors on the project, especially those that have served 20-day preliminary notices, could subject homeowners to paying twice for the work if the general contractor fails to pay its subcontractors. 

The contract must include an Approximate Start Date and a definition of what constitutes substantial commencement of the work.  The Approximate Completion Date must also be stated in the contract with an equal degree of specificity.  However, without some form of liquidated damages provision in the contract, the required statement of a completion date is likely meaningless.  The contractor suffers no penalty for late completion, and a homeowner usually is not damaged enough by the late completion to warrant a breach of contract suit.  If timely completion is especially important, the homeowner should include a liquidated damages provision in the contract and a bonus for early completion. 

The contract must also provide notice, in close proximity to the signatures of the contracting parties, that the owner has the right to require the contractor to secure a performance or payment bond.  However, unless the project is very expensive, the cost of the bond may not be worth the protection.  Even though an owner can require the bond, the contractor is not required to pay for the extra cost of the bond. 

Change Orders 

Probably the greatest points of contention on remodeling projects arise from change orders, which are changes or additions to the scope of work not originally contemplated by the parties or covered by the contract.  A blank change order form must be included as part of the contract or as an attachment.  Because of the problems associated with change orders, the new law requires HICs to contain several notices regarding them.  The following statement must be included under the heading Note About Extra Work and Change Orders: “Extra Work and Change Orders become part of the contract once the order is prepared in writing and signed by the parties prior to the commencement of any work covered by the new change order.  The order must describe the scope of the extra work or change, the cost to be added or subtracted from the contract, and the effect the order will have on the schedule of progress payments.”  The contract must also include a statement that the owner may not require a contractor to perform extra work without written authorization. 

Another required statement will inform the owner that the cost of extra work or change order work is not enforceable against the owner unless a change order identifies all of the following in writing: 

1) The scope of the work encompassed by the change order. 

2) The amount to be added or subtracted from the contract. 

3) The effect the change order will have on the progress payments or completion date.  The contract also must contain language informing the owner that the contractor’s failure to comply with the requirements of the paragraph on change orders does not preclude the recovery of compensation for work performed based on legal or equitable remedies designed to prevent unjust enrichment.  This is the only portion of the statute that specifically allows a contractor to recover even if he or she is not in compliance with the law. 

The requirement for change orders to be in writing and signed by all parties prior to commencement of the covered work actually is not beneficial to the homeowner.  It allows the contractor an opportunity to demand an unreasonable price for the extra work, since no work can be performed prior to an agreement by the parties.  Homeowners would be better served by a provision in the law allowing changes with an agreed-upon price to be determined at a later date and by a formula.  This could be accomplished by including in the original contract an agreement to price changes that constitute the actual cost of a change plus an agreed-upon contractor’s fee.  The provision would allow the continuation of work that will be paid for once the contractor shows evidence of the actual costs of the work.  However, without this provision and according to the law as it is currently written, a contractor can just request a lump sum and refuse to perform if the homeowner fails to agree to the price for changes in the middle of construction.  Under these circumstances, a significant portion of the project will either remain unfinished or be placed on hold pending a change order negotiation or dispute.  Homeowners will find themselves in the weaker negotiating position, because they need to get their projects completed.  Statutory Notices 

There are six statutory notices that may either be included as part of the main contract or in an attachment to the contract.  Because they are lengthy, it is better to include them as attachments. 

Insurance 

Under the heading Commercial General Liability Insurance (CGL), the contractor must disclose whether or not he or she has insurance.  Business and Professions Code Section 7159(e)(1) contains the full wording of the notice.  Homeowners should make sure the contractor has adequate liability coverage on all projects and request to be added as an additional insured under the contractor’s policy. 

Workers’ compensation 

Contractors must disclose whether they have workers’ compensation insurance or whether they are exempt.  Contractors are only exempt from workers’ compensation requirements if they have no employees.  Homeowners should be wary of contractors who claim they are exempt but appear on site with employees.  These workers may be considered to be the homeowners’ employees, and the homeowners’ insurers may be forced to cover the workers for any injuries sustained on the project.  Further, the homeowner could be sued in tort for any injuries sustained by uncovered workers. 

Mechanic’s liens 

HICs are required to include a notice, under the heading MECHANIC’S LIEN WARNING, that liens for nonpayment may be placed on the homeowner’s home.  Section 7159(e)(4) contains the full text of the notice. 

CSLB notice 

HICs must contain a notice informing homeowners that they may file complaints with the CSLB and warning against using unlicensed contractors.  Section 7159(e)(5) contains the full text of this notice.  Nevertheless, the required information and warning are all but meaningless, because unlicensed contractors are unlikely to comply with this part of the statute.  By doing so they will be warning homeowners of the illegality of their conduct and essentially the unenforceability of the contract. 

Three-day right to cancel 

A contractor must provide a Three-Day Right to Cancel Notice to the homeowner unless a contract is 1) negotiated at the contractor’s place of business, 2) subject to the Seven-Day Right to Cancel Notice, or 3) the contractor is subject to licensure under the Alarm Company Act.  The notice must be in 12-point boldface type and in immediate proximity to the contract signatures.  The owner must also acknowledge receipt of the notice by signing and dating the notice form on the signature page.  Most important, this notice must be written in the same language that was principally used in the oral sales presentation for the contract.  Section 7159(6)(B) contains the full text of the notice.  The notice must be accompanied by a blank Notice of Cancellation form in duplicate, also in the same language in which the contract was negotiated.  Section 7159(6)(c)(vi) contains the full text of this form. 

Seven-day right to cancel 

The contract must provide a Seven-Day Right to Cancel Notice if the contract is for the repair or restoration of a residential premises damaged by “any sudden or catastrophic event for which a state of emergency has been declared by the President of the United States or the governor.”  The seven-day right to cancel has the form requirements as the three-day right to cancel. 

AB 316 also created a new type of contract, a Service and Repair Contract.  This is an agreement by an owner and a contractor characterized by several factors: 1) the home improvement work costs $750 or less, 2) the owner initiated the contact with the contractor and requested the work, 3) the contractor does not sell to the owner goods or service beyond those reasonably necessary to take care of the agreed-upon work, and 4) no payment is due or accepted by the contractor until the work is completed.  The requirements for service and repair contracts—as detailed as those for more extensive home improvement work—should be reviewed by counsel with clients who consistently perform minor home improvement work.  

Impact of Noncompliance 

Failing to include the required provisions and notices in HICs exposes the contractor to discipline by the CSLB.  Once a consumer’s complaint is received by the CSLB, it will generally ask to review the contract between the parties.  If the contract is not in compliance, the contractor can be subject to discipline even before the complaint is investigated further.  Moreover, a violation for failing to state the contract amount, overcharging on the down payment, or accepting payment that exceeds the value of the work performed subjects the licensee to a misdemeanor punishable by a fine of not less than $100 nor more than $5,000, or by imprisonment in county jail not exceeding one year, or both. 

Although the two-year statute of limitations on claims for violations of these sections runs from the date that the homeowner signs the contract, the limitations period is not applicable to any administrative disciplinary action.  These penalties can be enhanced when a contractor’s violation of Section 7159.5 is part of a plan or scheme to defraud owners or tenants in connection with damage caused by a natural disaster.  A court can order the contractor to make full restitution to the victim subject only to the contractor’s ability to pay.  In addition to full restitution and imprisonment, the court can impose a fine of not less than $500 or more than $25,000.33 In addition to discipline for failing to provide the information, notices, and disclosures required by Section 7159, violations of the new HIC rules can have other serious, unintended consequences.  Two cases have suggested that contracts failing to comply with Section 7159 could be considered void, thus preventing a contractor from collecting sums otherwise indisputably owed.  This suggestion is clear even though the cases found that the noncomplying contracts at issue were enforceable. 

In Asdourian v. Araj, the contractor sought compensation from two sophisticated property owners for remodeling work performed pursuant to oral contracts.  The owners contended that since the agreements between the parties were oral, they violated Section 7159 and thus were void.  Although the California Supreme Court acknowledged that “generally speaking” a contract made in violation of a regulatory statute is void, it stressed that “the rule is not an inflexible one to be applied in its full rigor under any and all circumstances,” and “exceptions have been recognized.”  In addition, the court stated that “in compelling cases, illegal contracts were being enforced in order to avoid unjust enrichment to a defendant in a disproportionately harsh penalty upon [the] plaintiff.” 

In Arya Group, Inc. v. Cher, a contractor negotiated an oral agreement with Cher to design and construct her Malibu home for the sum of $4,217,529.  The parties’ oral agreement was subsequently memorialized in a written contract that was never signed by Cher.  The narrow issue was whether the contractor was precluded under Section 7164 from pursuing a breach of contract claim as a result of its failure to secure a signed written contract as required by that section.  (Section 7164 contains almost identical provisions to Section 7159 for the construction of a single-family dwelling and is intended to afford consumers who contract for the construction of a single-family dwelling the same safeguards available under Section 7159.) 

Following the Asdourian decision, the court in Arya held that the contractor may seek to enforce his oral contract claim against Cher to the extent that Cher would be otherwise unjustly enriched as a result of her failure to pay the contractor for the reasonable value of its work on the project.  The contract was not necessarily void simply due to the failure of the contractor to abide by the requirements of Section 7164. 

In reviewing the evolution of Section 7159, the Arya court determined that the legislature did not intend that all contracts made in violation of the statute would be void.  The legislature thus opened the door to enforcement of noncomplying contracts in appropriate cases to avoid injustice.  The court applied this reasoning to the case, noting that 1) the defendant in Arya was not a member of the group primarily in need of the statute’s protection—that is, unsophisticated consumers, 2) contracts made in violation of Section 7159 are not “intrinsically illegal,” and 3) if the defendant were allowed to retain the value of the benefits bestowed by the plaintiff without compensation, she would be unjustly enriched. 

Following Asdourian and Arya, it appears that an HIC that violates the provisions of Section 7159 would not necessarily be void and unenforceable if the contract were with an owner who was sophisticated (and thus not a member of the class that the statute was intended to protect) and if unjust enrichment would result if the contract were held to be void.  This analysis, however, should not provide any comfort for the contractor that does not abide by the provisions of the new law. 

Contractors should always take special care with unsophisticated owners, especially the elderly, in providing construction services.  The best practice is for contractors to draft contracts in compliance with Section 7159 rather than rely on the hope that a court may in the future find that the failure to comply with the requirements of Section 7159 does not render the contract void.  With its passage of numerous substantive and procedural requirements, the legislature has made compliance with the law substantially more difficult for home improvement contractors while simultaneously creating opportunities for homeowners to rely upon technicalities to evade payment for services that were requested and properly performed. 

Moreover, the legislature has not made much progress in making home improvement contracts easier to understand or draft.  In fairness, the legislature was responding to myriad complaints by homeowners that they were being unfairly treated by contractors.  Unfortunately, the new law is not a fair compromise, because it places a heavy burden on contractors to notify homeowners of their rights and fails to make the provisions easy for homeowners to understand.  Nevertheless, because AB 316 is now the law of the state, contractors should update their contracts to conform to its requirements.  The consequences of failing to properly comply are too drastic to ignore.