Background Information
1. Employers Are Required to Maintain Workers’ Compensation Insurance
California law requires that employers, including those in the construction industry, carry workers’ compensation insurance, even if they have only one employee subject to California workers’ compensation laws1. For contractors, Business & Professions Code (“B&P Code”) §7125(a) provides, in part, that “Except as provided in subdivision (b), the board shall require as a condition precedent to the issuance, reinstatement, reactivation, renewal, or continued maintenance of a [contractor’s] license, that the applicant or licensee have on file at all times a current and valid Certificate of Workers’ Compensation Insurance or Certification of Self-Insurance in the applicant’s or licensee’s business name.”
The workers compensation insurance exists for employees who get hurt or sick because of work. Workers’ compensation insurance provides basic benefits, including medical care, temporary disability benefits, permanent disability benefits, supplemental job displacement benefits and a return-to-work supplement, and death benefits. The importance of this insurance cannot be overstated. If a worker is injured working on your property and the contractor doesn’t have insurance, you could be financially liable to pay for injuries and rehabilitation.
2. Severe Consequences for Contractors Failing to Maintain Workers’ Compensation Insurance
If a contractor is required to maintain workers’ compensation, but fails to do so, its license will be automatically suspended2. A license suspension has drastic, even draconian, consequences for a contractor. First, the contractor may not continue to perform any work while the license is suspended, which may lead to delay damages for the projects it is working on. Second, a contractor who performs any work for which a license is required while its license is suspended may not sue to recover any compensation for any work under the entire contract (i.e., regardless of whether the work was performed while the license was in effect or suspended) and the owner can sue to recover all payments made to the contractor for the project – not just payments for work while the contractor was suspended, but all payments made under the contract.
3. Exemptions for Workers’ Compensation Insurance
Licensed contractors who don’t have employees must file a workers’ compensation exemption with the Contractors State License Board (“CSLB”), which is noted on the license record. The CLSB Exemption from Workers Compensation form4 includes the following:
• To be exempt from workers’ compensation, an applicant or licensee must submit this form to CSLB, certifying under penalty of perjury that he or she does not employ anyone in a manner that is subject to the workers’ compensation laws of California. (See Business and Professions Code Section 7125.)
• DO NOT SUBMIT THIS FORM IF:
- You have an inactive license.
- The license qualifier is a Responsible Managing Employee (RME).
- You hold a C-39 Roofing classification – all contractors with a C-39 Roofing classification are required by Section 7125 to have a Certificate of Workers’ Compensation Insurance or a Certificate of Self-Insurance on file with the Board. Contractors with a C-39 Roofing classification are not eligible for exemption from workers’ compensation.
- You have employees.
• I certify under penalty of perjury under the laws of the State of California that the information provided on this exemption statement is true and accurate. I understand that, upon employing anyone in a manner that is subject to the workers’ compensation laws of the State of California, the claim of exemption executed under this form will no longer be valid. I also understand that, as soon as I employ anyone
subject to the California’s workers’ compensation laws, I must obtain a Certificate of Workers’ Compensation Insurance, submit that certificate to CSLB within 90 days of its effective date, and continuously maintain the coverage provided by the certificate in accordance with the law. I further understand that failure to comply with this requirement is grounds for disciplinary action.
Thus, a contractor with an active license cannot claim an exemption from workers’ compensation if (a) the license qualifier is an RME, the licensee holds a C-39 Roofing classification, or, (c) the licensee has employees. Filing a false claim of exemption has severe consequences, including disciplinary action against the licensee, a misdemeanor against the RMO or RME, issuance of a stop work order, and automatic suspension of the contractor’s license8. And, according to the Department of Insurance, “willful failure to secure workers’ compensation for your employees is a violation of Labor Code Section 3700.5, a misdemeanor punishable by up to one year in county jail and a $10,000 fine for the first offense.”
PEO / Leased Employees
1. Understanding a PEO
In an effort to reduce workers’ compensation insurance costs, as well as other administrative costs, some contractors are now using a Professional Employer Organization (“PEO”) or leased employees. A PEO is a firm that provides a service under which an employer can outsource employee management tasks, such as employee benefits, payroll and workers’ compensation, recruiting, risk/safety management, and training and development. The PEO does this by hiring a client company’s employees, thus becoming their employer of record for tax purposes and insurance purposes. This practice is known as co-employment. In co-employment, the PEO becomes the employer of record for tax purposes, filing paperwork under its own tax identification numbers. The client company continues to direct the employees’ day-to-day activities. PEOs charge a service fee for taking over the human resources and payroll functions of the client company. One service provided by a PEO is to secure workers’ compensation insurance coverage at a lower cost than client companies can obtain on an individual basis. Essentially, a PEO obtains workers’ compensation coverage for its clients by negotiating insurance coverage that covers not just the PEO, but also the client companies. This is allowed because, legally, the PEO is the employer of the workers at the client companies. PEOs can also offer basic levels of background & drug screening.
2. Contractors Using PEOs
If a contractor uses a PEO for all of its workers, then (in theory) the contractor can claim an exemption from workers’ compensation insurance because it would have no employees. However, there are limitations. As noted above, a contractor holding a C-39 Roofing classification is required to maintain workers’ compensation insurance regardless of whether it has employees.
3. Contractors with an RME May Not Use PEOs
Additionally, as noted on the CSLB Exemption form above, a licensee whose qualifying individual is an RME may not claim an exemption. An RME under California law is an individual who is a “bona fide employee”9 of the applicant for a contractor’s license, and is actively engaged in the classification of work for which that responsible managing employee is the qualifying person on behalf of the applicant10. Thus, a contractor with an RME cannot claim exempt because an RME must be a full time employee of the contractor who works at least 32 hours or 80% of the company’s operating time, whichever is less11.
4. Contractors with an RMO Using PEOs
The CSLB does not include this same rule for contractors who are qualified with a Responsible Managing Officer (“RMO”) because the definition of an RMO does not include the “bona fide employee” provision in B&P Code §7068(c). Instead, the general terms in Labor Code §3351 would apply, which defines an “employee” as follows:
“Employee” means every person in the service of an employer under any appointment or contract of hire or apprenticeship, express or implied, oral or written, whether lawfully or unlawfully employed, and includes:
(c) All officers and members of boards of directors of quasi-public or private corporations while rendering actual service for the corporations for pay. An officer or member of a board of directors may elect to be excluded from coverage in accordance with subdivision (p) of Section 3352. [Emphasis added.]
The key, is that the officer (here, an RMO) must be paid by the corporation. If the pay is from the PEO instead of the contractor corporation, then the RMO would not be an employee of the contractor. Additionally, Labor Code §3352 provides exclusions from the general definition of “employee,” and it provides, in pertinent part:
“Employee” excludes the following:
(p) An officer or member of the board of directors, as described in subdivision (c) of Section 3351, if he or she owns at least 15 percent of the issued and outstanding stock of the corporation and executes a written
waiver of his or her rights under this chapter stating under penalty of perjury that the person is a qualifying officer or director. The waiver shall be effective upon the date of receipt and acceptance by the corporation’s insurance carrier and shall remain effective until the officer or member of the board of directors provides the insurance carrier with a written withdrawal of the waiver. [Emphasis added.]
Thus, even if the RMO is receiving compensation from the contractor, the RMO could execute a waiver of its rights to workers’ compensation insurance as long as the RMO owns at least 15% of the stock of the contractor. Thus, it is possible to have the PEO provide workers’ compensation for a contractor with an RMO, or to have the RMO waive its rights to workers’ compensation insurance, if certain requirements are met.
5. Duties of the RMO
The duties of the RMO and/or RME must meet certain criteria which are codified in B&P Code §§7068 and 7068.1. Those duties include:
• Being responsible for exercising that direct supervision and control of his or her employer’s or principal’s construction operations as is necessary to secure full compliance with the provisions of this chapter and the rules and regulations of the board relating to the construction operations.
• Ensuring that the building, safety, health and lien laws of the state are complied with, as well as the administrative principles of the contracting business as set forth by the contractor’s board for the safety and protection of the public.
As noted above, the RMO must be engaged in “direct supervision and control” of the work14. For purposes of B&P Code §7068.1, “direct supervision and control” includes any one or any combination of the following activities: (1) supervising construction, (2) managing construction activities by making technical and administrative decisions, (3) checking jobs for proper workmanship, or (4) direct supervision on construction job sites15. The RMO does not have to do all of these activities, but must perform at least one of them.
The duties and the responsibilities of the qualifying individual also depends on the applicant or licensees for a contractor’s license because the RMO’s duties and responsibilities for supervision and control of the applicant’s construction operations are to be set forth in detail by the applicant and submitted to the CSLB. Furthermore B&P Code §7068.1(d) requires that every applicant or licensee qualifying by use of an RMO or RME to submit detailed information on the qualifying individual’s duties and responsibilities for supervision and control of the applicant’s construction operations.
Finally, the CSLB may discipline the licensed entity when the qualifier is not actively involved in the construction activities of the license they are representing16. In addition to administrative penalties, the individual falsely serving as a qualifier on the license can be charged with a misdemeanor and be sentenced to serve up to six months in jail, and required to pay a fine of not less than $3,000 and not more than $5,000, or both.
6. Limits on Being an RMO for Multiple Contractors
Under B&P Code §7068.1(a), the RMO may not act in the capacity as an RMO for an additional individual or firm unless one of the following conditions exists:
• There is a common ownership of at least 20 percent of the equity of each individual or firm for which the person acts in a qualifying capacity.
• The additional firm is a subsidiary of or a joint venture with the first. Subsidiary as used in this subdivision, means any firm at least 20 percent of the equity of which is owned by the other firm.
• With a respect to a partnership, corporation, or limited liability company, the majority of the partners, officers, or managers are the same.
Notwithstanding B&P Code §7068.1(a), a qualifying individual may act as the qualifier for no more than three firms in any one year period (refers to firms located in California)18. “Firm” as used in this section includes a corporation under B&P Code §706819.
An RMO’s ownership of the contractor company(ies) alters some of the requirements imposed:
• An RMO can merely be an officer of a single contractor with no ownership but may have to post an additional bond for his/her license.
• If the RMO has at least 10% but less than 20% ownership interest in the entity, then a license bond is not needed but the RMO is still restricted to being the qualifying individual for a single contractor.
• If the RMO has at least a 20% ownership in each entity, then the RMO may be the qualifying individual for multiple contractors (subject to the limitations above).
7. Conclusion
If a contractor qualifying with an RMO meets the foregoing requirements, and has no employees (e.g., all of the employees are provided by a PEO), then the contractor is not required to maintain workers’ compensation insurance. However, the contractor is still required to provide proof of workers’ compensation for the employees (even if they are, technically, employees of the PEO). The workers’ compensation may be provided by either the contractor or the PEO, but in either case, proof of insurance must be provided to the CSLB. And, rather than claiming exempt, the better (and, perhaps, only legal) practice is to certify to the CSLB that all of the licensee’s employees are provided by a leasing company and are covered by workers’ compensation insurance. In checking a contractor’s license, under the Worker’s Compensation section, the CSLB may show one of the following statuses:
• “This license is exempt from having workers compensation insurance; they certified that they have no employees at this time.”
• “This license is exempt from having workers’ compensation insurance; they certified that their employees are provided by a leasing company and are covered by a certificate of worker’s compensation from that firm.”
For a contractor using a PEO to provide all employees (including an RMO), the second status accurately reflects this situation and complies with the law. A contractor using a PEO to provide all employees whose status reflects the first status is not accurate, and may not be in compliance with the CSLB rules and regulations or the various statutes relating to insurance. While not legally binding, during a telephone call with the Workers’ Compensation unit of the CSLB discussing this issue, the CSLB stated a contractor who leases all of its “employees” from a PEO is required to provide proof of worker’s compensation for the employees. The worker’s compensation insurance can be provided by either the contractor or the PEO, but in either event proof of insurance must be provided to the CSLB. In either case, however, the contractor is not permitted to claim “exempt” from worker’s compensation on the basis of having no employees. Instead, the contractor should certify that all of its employees are provided by a leasing company and are covered by workers’ compensation insurance.
So, for any contractor20 who leases all of its employees from a PEO, the best course of action is to certify that their employees are provided by a leasing company and to have the PEO provide the CSLB with proof of workers’ compensation insurance.
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