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Nowhere To Run To, Baby: Arbitration Is Nowhere To Hide For Unlicensed Contractors

By Kathlynn Smith

The subject of licensing has been on the minds of California’s courts recently. Hot on the heels of the appellate court’s decision in Twenty-Nine Palms Enterprises Corporation v. Bardos (See “Contractor Licensing Law: The High Price of Being an Unlicensed Contractor,” by Aaron Flores, Esq.), the California Court of Appeal just handed down another solid victory to parties contracting with unlicensed contractors in Ahdout v. Hekmatjah, 213 Cal. App. 4th 21 (2013). The Court of Appeal in Ahdout eliminated any doubt that arbitration awards either granting compensation to or denying disgorgement from unlicensed contractors is subject to independent review and reversal by trial courts. The Court held that although arbitration awards are almost uniformly upheld – even where the award is based on an error of fact or law – trial courts have the final word on whether the California Licensing Laws apply.

Following a 27-day private arbitration, the arbitrators issued an award denying a developer’s attempt to “disgorge” the costs of construction paid to an unlicensed contractor. The arbitrators found that although the contractor was identified as such in the operating agreement, it acted more as a manager or consultant to the LLC and did not engage in any work typically done by general contractors. Instead, subcontractors performed the work through direct agreements with the LLC and “virtually all of [the subcontractors] were licensed.”

The developer petitioned the superior court to vacate the arbitration award on the grounds that the arbitrators exceeded their authority by allowing the contractor to keep compensation received for construction despite being unlicensed.

The trial court denied the petition to vacate the arbitration award and granted the petition to confirm it concluding that it did not have the power to review the arbitrators’ decision for errors of fact or law.

The Court of Appeal disagreed. Instead, the Court determined that where, as here, an arbitration award involves claims in which there is a clear expression of illegality or public policy by the Legislature, the trial court must undertake an independent review of the award and reverse any award that contradicts the stated Legislative purpose. The Court found that section 7031 is a clear legislative expression of public policy to protect the public from incompetence and dishonesty in the construction industry. California’s licensing requirements provide a minimal assurance that the contractor has the necessary skills, character, and knowledge to perform the work. To this end, section 7031 is intended to discourage any contactor who fails to comply with these basic licensing requirements from offering or providing services by withholding from it judicial aid of any sort. Since the trial court erroneously determined the arbitration award was not reviewable, the Court of Appeal referred the matter back to the trial court to independently review the evidence to determine whether disgorgement of compensation for the contractor’s work was required by section 7031.

Time and time again, the California courts stand by the Legislature’s choice to impose harsh penalties on unlicensed contractors and uniformly uphold decisions that deny these contractors access to courts or compensation for work. The Appellate Court’s finding that the Licensing Laws fall within a public policy exception to the finality of arbitration awards reinforces this pattern. As a result, unlicensed contractors should not take comfort in the mercy of arbitrators because trial courts have been instructed to show no mercy.

Kathlynn Smith is an Associate Attorney with Hunt Ortmann, a leader in California construction law. If you have any questions about this bulletin or contractor license law, please contact her at smith@huntortmann.com.

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