Trial Court Must Independently Review Arbitration Ruling Whether Contractor was Licensed. (Ahdout v. Hekmatjah (2013) 213 Cal.App.4th 21)

Overview

Binding arbitration of construction disputes has been a fixture of California practice for half a century. But recently, a California court decided that when an arbitration proceeding involves an “explicit legislative expression of public policy” the award is not binding. Rather, the owner/consumer has the right to insist that a trial court independently review the evidence and decide the issue.

One the one hand, this new decision protects the owner/consumer and ultimately the public from arbitrators who, in rendering their decision, refuse to follow the law or properly apply the facts of the case. On the other hand, arbitration, as we have known it – a quick and inexpensive method of resolving construction disputes, may be less so since owners/consumers now have the incentive to assert statutory issues at arbitration thereby giving them two opportunities for a favorable ruling – first at arbitration and then again at trial. In addition, contractors now face the prospect of litigating the same issues twice.

Facts

Mouris Ahdout (Ahdout) and Majid Hekmatjah, aka Michael Braum (Braum) formed a limited liability company (LLC) for the purpose of developing a condominium project with Braum designated as manager of the company. Disputes developed between Ahdout and Braum and pursuant to the agreement between the parties they submitted their disputes to binding arbitration before the Rabbinical Council of California.

Ahdout argued at arbitration that that Braum, as manager of the LLC retained Braum Investment and Development, Inc. (BIDI) as general contractor to construct the project, that BIDI was not a licensed contractor in California and that therefore pursuant to the Contractors’ State License Law (CSLL; Business and Professions Code section §7000 et seq.), and specifically 7031 (b), BIDI was obligated to disgorge all compensation for its services on the project.

The arbitrators found in favor of Braum, ruling that while the LLC agreement dictated that BIDI was to be general contractor for the project, in fact BIDI functioned as a consultant to the LLC, and neither Braum nor BIDI engaged in any work on the project typically performed by general contractors. Braum and BIDI petitioned in superior court to confirm the award. Ahdout petitioned to vacate the arbitration award on the ground that the arbitrators exceeded their authority by allowing Braum and BIDI to keep compensation they received for contracting work on the project, despite being unlicensed. Ahdout in its papers submitted substantial evidence suggesting that BIDI in fact functioned as a contractor on the project. The trial court held that, under the California Supreme Court decision of Moncharsh v. Heily & Blase (1992) 3 Cal.4th 1, 32, there is a strong public policy in favor of arbitration and according finality to arbitration awards and therefore it did not have the power to review the arbitrators’ decision for errors of fact or law. The trial court noted that the only possible exception permitting judicial review of the arbitration award hinged on the agreement being an illegal construction contract. However, this issue was submitted to the arbitrators and they concluded the agreement was an operating agreement for the company, not a construction contract. The trial court concluded that under Moncharsh it could not second guess that decision it therefore denied the motion to vacate the award and granted the petition to confirm. Ahdout appealed the resulting judgment.

Court of Appeal Holding

Ahdout argued on appeal that the arbitrators exceeded their powers under Code of Civil Procedure section 1286.2 in two ways, and therefore the arbitration award was judicially reviewable.

First, Ahdout contended that the Ahbout/Braum agreement was illegal and that one of the ways an arbitrator exceeds its powers is by enforcing an illegal contract. (Moncharsh, supra, 3 Cal.4th at p. 31.) However, the Court of Appeal noted that California cases have permitted judicial review of an arbitrator’s ruling where a party claimed the entire contract was illegal. The Ahbout/Braum agreement had a broad scope, including provisions that set forth the structure of the LLC, etc. The unlicensed status of BIDI was pertinent only with respect to the provision obligating the LLC to enter into a separate agreement with BIDI to act as the general contractor in the construction of the project. It therefore did not infect the entire contract and was not grounds to vacate the arbitration award.

Ahdout next argued that, under the Moncharsh decision, courts must vacate an arbitrator’s award when it violates a party’s statutory rights or otherwise violates a well-defined public policy.” This exception is applicable only when there has been “‘a clear expression of illegality or public policy’” that undermines the presumption in favor of private arbitration. Cotchett, Pitre & McCarthy v.Universal Paragon Corp. (2010) 187 Cal.App.4th 1405, 1416. The Court of Appeal agreed with Ahdout, and held that that Business & Professions Code §7031 constitutes an “explicit legislative expression of public policy,” that if not enforced by an arbitrator, constitutes grounds for judicial review.

The purpose of the Contractors’ State License Law is to protect the public from incompetence and dishonesty in those who provide building and construction services. Section 7031 advances this purpose by withholding judicial aid from those who seek compensation for unlicensed contract work, and subdivision (b) of section 7031 furthers this aim by requiring disgorgement of compensation already paid to unlicensed contractors by persons utilizing their services.

The Court of Appeal reversed the trial court’s confirmation of the arbitrators’ award with directions to the trial court to disregard the finding by the arbitrators and conduct a de novo review of the evidence to determine whether disgorgement of compensation for BIDI’s construction work was required by Business and Professions Code §7031.

Implications of Court Decision

The Moncharsh holding—that courts do not have the power to review an arbitrator’s decision for errors of fact or law—has been a fixture of California trial practice for 20 years. Parties and their counsel have submitted to binding arbitration with the knowledge that, while the arbitrator has virtually unlimited authority in fashioning an award, the tradeoff is that the parties theoretically obtain a relatively quick, easy, inexpensive and “hopefully” fair resolution to their dispute. No jury and no expensive appeal. Traditionally arbitration provisions have commonly been incorporated in employment agreements, construction contracts and personal service agreements such as attorney and real estate broker fee agreements to resolve disputes between the parties.

The exception to the Moncharsh holding—allowing judicial review where there exists a “violation of a party’s statutory rights or otherwise violates a well-defined public policy”—-has historically been limited to cases involving 1) constitutional issues and 2) employment disputes. Pearson Dental Supplies, Inc. v. Superior Court (2010) 48 Cal.4th 665 [employee claim under Fair Employment and Housing Act]; Richey v. AutoNation, Inc. (2012) 210 Cal.App.4th 1516 [employee claim under the Moore-Brown-Roberti Family Rights Act]; Kelly Sutherlin McLeod Architecture, Inc. v. Schneickert (2011) 194 Cal.App.4th 519[ constitutional right of free speech]; Department of Personnel Administration v. California Correctional Peace Officers Assn. (2007) 152 Cal.App.4th 1193[ reformation of collective bargaining agreement]; Jordan v. Department of Motor Vehicles (2002) 100 Cal.App.4th 431[gift of public funds prohibited by California Constitution]; and City of Palo Alto v. Service Employees Internat. Union (1999) 77 Cal.App.4th 327 [employment arbitration award irreconcilable with the public policy requiring obedience to court orders.].

The Ahdout holding appears to be the first California case in a construction setting requiring judicial review of arbitration awards where there exists an “explicit legislative expression of public policy”. The case raises a host of questions for the construction industry and its lawyers about which statutes in California involving construction and construction contracts involve an “explicit legislative expression of public policy”, which do not and why.

The Ahbout decision concerned Business and Professions Code Section 7031 providing for disgorgement by an unlicensed contractor of all compensation for its services on a project. But what of the other provisions of the Business and Professions Code regulating the conduct of contractors? Do some or all of these other provisions qualify as “explicit legislative expression of public policy”. For example, what of section7125.2 which states that the failure of a licensee to obtain or maintain workers’ compensation insurance coverage, if required, shall result in the automatic suspension of the contractor’s license by operation of law. See Wright v. Issak, (2007) 149 Cal.App.4th 1116. What of section 7030 [requirements for home improvement contracts], section 7034 [prohibition against certain indemnification and lien practices], section 7109 [willful departure from standards for workmanlike construction or plans and specifications], section 7109.5 [violation of safety provisions of Labor Code] or section 7113 [failure to complete a project for the agreed price]. Under Ahbout an argument can be made that each of the above statutes constitutes an “explicit legislative expression of public policy”, and that therefore a trial court must conduct a trial de novo of the statutory issues in a case. And, unfortunately it will likely take several years for guidance from the courts to percolate through the system.

There is one further question raised by the Ahbout decision. What if the Ahbout arbitrators had originally found in favor of Ahdout and determined that BIDI had engaged in work on the project without a valid contractor’s license and must disgorge all compensation for its services on the project? Would BIDI then have the right to a trial de novo on the issue, just as Ahdout did when Ahdout lost? That would only be fair. Right?

The answer is “probably not”. The Ahbout decision is likely a one way street in favor of the owner or consumer. While the Court of Appeal does not specifically address the question, the clear implication of the language of the holding is that the right to trial de novo is one directional—that the consumer and the public are the ones who have the “statutory rights” or the right to benefit from the “well-defined public policy”. In Pearson Dental Supplies, Inc. v. Superior Court (2010) 48 Cal.4th 665 [employee claim under Fair Employment and Housing Act] the California Supreme Court held similarly, and Justice Baxter dissented stating in a footnote as follows:

“Apart from the above, I also question the majority’s decision to allow judicial review and vacatur of an arbitral award only where the arbitrator erroneously rules in favor of the employer, but not when the ruling wrongly favors the employee. Although we generally find a lack of mutuality in an arbitration agreement troublesome when it favors the employer as the party with superior bargaining power (see Armendariz , supra, 24 Cal.4th at pp. 114-121), I see no basis or rationale for imposing a one-sided rule of judicial review where, as here, neither party can be faulted for the situation. In contrast to the majority’s rule, each of the ex-press statutory grounds for vacating or correcting an award is neutral in its application to the parties. (§§ 1286.2, 1286.6.)” Pearson, at p. 100.

The Takeaway

The message of Ahbout to consumers and owners in construction claims is: You now have two bites of the apple, once at arbitration and again in front of the trial court. Raise as many statutory claims as you can in both forums. Arguably, as long as you assert a “a party’s statutory right or a well-defined public policy”, then you have the right to a complete new hearing with all new evidence before a superior court judge covering the exact same issue(s) that the arbitrator just adjudicated.

The message of Ahbout to contractors in construction claim is: the process just became potentially more expensive, laborious and risky. You can win before an arbitrator and then have to do it all over again and lose before a judge. You may wish to reconsider incorporation of an arbitration provision in your contract documents.

-Ralph R. Rhoades

For questions or more information about this topic, please contact Ralph Rhoades
by email at rrhoades@partonsell.com

Overview Binding arbitration of construction disputes has been a fixture of California practice for half a century. But recently, a California court decided that when an arbitration proceeding involves an “explicit legislative expression of public policy” the award is not binding. Rather, the owner/consumer has the right to insist that a trial court independently review […]