• California Court of Appeal Finds “Public Policy” Exception to Review of Arbitrators’ Award Regarding Contractor’s Lack of Licensure
  • February 25, 2013 | Author: Keith Smith
  • Law Firm: Wood, Smith, Henning & Berman LLP - Riverside Office
  • In the Ahdout case, the Second District, Division Four, of the California Court of Appeal held that the plaintiff’s claims under California Business & Professions Code § 7031 against a general contractor for lack of licensure fell within the “public policy” exception to the general prohibition of judicial review of arbitration awards, because “section 7031 constitutes a clear-cut and explicit legislative expression of public policy mandating the disgorgement of compensation received by an unlicensed contractor.” As a result, the Court of Appeal reversed the trial court’s order confirming the arbitration award (which included a denial of disgorgement under section 7031(b)), and ordered the case remanded to the trial court for a de novo review of the licensure issue.

    Facts and Procedural History

    This case stems from the creation of a limited liability company for the purpose of developing a condominium project. Plaintiff Mouris Ahdout (Ahdout) and Defendant Hekmatjah Family Limited Trust (Hekmatjah) owned adjoining parcels of real property. In 2002, Ahdout and Hekmatjah formed a limited liability company to acquire the two parcels and build a 14-unit condominium project. Ahdout and Hekmatjah were the sole members of the company. The operating agreement for the company contained a binding arbitration provision.

    Defendant Majid Hekmatjah aka Michael Braum (Braum), who was the general partner of Hekmatjah, was appointed the manager of the company. In order to construct the condominiums and as provided in the operating agreement, Braum entered into a construction contract with Braum Investment & Development, Inc. (BIDI). Construction on the condominium project suffered numerous setbacks, including the death of the architect, plan revisions mandated by the City ofLos Angelesand construction delays. Plaintiff Ahdout was unhappy with the construction delays and cost overruns, as well as the alleged mismanagement and misuse of company funds by manager Braum. Also, Ahdout alleged that while he had expected high-end, luxury condominiums to be built, the end result was economy grade units.

    Consequently, Ahdout sought to have the dispute arbitrated pursuant to the binding arbitration agreements. By way of the arbitration demand, Plaintiff Ahdout sought disgorgement of the funds received by Braum and BIDI pursuant to section 7031(b). During the arbitration, Ahdout asserted that Braum and BIDI acted as a general contractor in constructing the condominiums; however, neither Braum nor BIDI possessed a Class B general contractor’s license until after the condominiums were completed. Further, Ahdout asserted that Braum had contracted with 24 subcontractors and 11 architects/engineers/inspectors. The arbitrators denied Ahdout’s claims for disgorgement under section 7031(b) and the defendants sought to confirm the award.

    During the trial court proceeding challenging the confirmation of the arbitration award, Ahdout submitted evidence that BIDI had only a C-15 flooring and floor covering license (license no. 669297) during the construction period and not a Class B license. Ahdout also submitted a bank loan application for the project where Braum declared under penalty of perjury that “Braum Construction,” license number 669297, was the contractor for the project, as well as aCountyofLos Angeles Requestfor New Construction Information in which Braum again declared under penalty of perjury that Braum Construction was the contractor. Ahdout further submitted into evidence multiple preliminary 20-day notices, all of which listed BIDI as the contractor, as well as multiple invoices for the project submitted to BIDI and several checks paid by BIDI to subcontractors for work on the project.

    In response, Braum asserted that all of the construction costs were paid by the company and, therefore, Ahdout had no standing to bring a section 7031(b) claim since Ahdout did not contract for any services. In addition, Braum asserted that Ahdout was well aware BIDI was not a licensed general contractor and that BIDI did not perform the work of a general contractor; rather, the work was performed by licensed subcontractors.

    Ultimately, the trial court denied Ahdout’s motion to vacate the arbitration award and granted Braum’s and BIDI’s motion to confirm it, concluding that it did not have the power to review the arbitrators’ decision for errors of fact or law. The trial court held that the only exception permitting judicial review was for an illegal construction contract, but it concluded that the agreement was an operating agreement and not a construction contract. The appeal followed.

    Holding

    The Court of Appeal reversed the trial court’s ruling denying the petition to vacate the award, finding: (1) The scope of judicial review of arbitration awards is extremely narrow because of the strong public policy in favor of arbitration and according finality to arbitration awards and is generally limited to circumstances where an arbitrator exceeds his or her powers; (2) Although an arbitrator exceeds his or her powers by enforcing an illegal contract, the operating agreement at issue was not a construction contract and, therefore, the agreement is not an illegal contract; and (3) An arbitrator exceeds his or her powers by issuing an award that violates a party’s statutory rights or “an explicit legislative expression of public policy.” Section 7031(b) is an explicit legislative expression of public policy regarding unlicensed contractors; therefore, the trial court should have conducted a de novo review of the licensure issue when evaluating the competing petitions to confirm and vacate the arbitration award.

    Discussion

    On appeal, Abdout asserted two main arguments to vacate the arbitration award: (1) the operating agreement constitutes an illegal construction contract because its core provisions concern the development of the project, with construction to be performed by BIDI, who is not properly licensed and (2) the public policy exception allows a trial court to review an otherwise final arbitration award.

    The Court of Appeal rejected Ahdout’s first argument that the operating agreement was an illegal construction contract. The Court of Appeal held that prior California case law vacating an arbitration award due to an illegal contract involved contrary factual scenarios where the “entire contract or transaction was illegal,” citing to the California Supreme Court decision in Moncharsh v. Heily & Blase (1992) 3 Cal.4th 1, 32. The Court of Appeal ultimately held that “the alleged illegality in the instant case does not infect the entire contract.”

    The Court of Appeal agreed with Ahdout’s second argument that there is a “public policy exception” to the finality of arbitration awards and the strong public policy in Californiaagainst unlicensed contractors warrants a de novo review of BIDI’s licensure. In so holding, the Court of Appeal made it clear that review of an arbitration award is very limited under Code of Civil Procedure § 1286.2. Relying upon section 1286.2(d), which states that the court shall vacate the award if “[t]he arbitrators exceeded their powers and the award cannot be corrected without affecting the merits of the decision upon the controversy submitted,” the Court of Appeal held that “an arbitrator exceeds his or her power within the meaning of Code of Civil Procedure section 1286.2 and the award is properly vacated when it violates an explicit legislative expression of public policy.” The Court of Appeal further indicated that the public policy exception is only applicable when there has been a clear expression of illegality or public policy that undermines the presumption in favor of private arbitration. Finding the public policy exception applicable, the Court of Appeal held as follows: “We conclude that section 7031 constitutes an ‘explicit legislative expression of public policy,’ that if not enforced by an arbitrator, constitutes grounds for review. . . Because section 7031 constitutes an explicit legislative expression of public policy regarding unlicensed contractors, the general prohibition of judicial review of arbitration awards does not apply.”

    As a result, the Court of Appeal remanded the case back to the trial court to conduct a de novo review of the evidence to determine whether section 7031(b) was applicable.

    Significance of the Case

    This case is significant to everyone in the construction industry for two important reasons. Foremost, the Ahdout decision is yet another case in the long string of cases imposing harsh penalties against unlicensed contractors. Courts are enforcing section 7031 despite the harshness of the results and without regard for equity between the parties. More and more parties are seeking to enforce the disgorgement provision of section 7031(b) and seek the return of all monies paid to the unlicensed contractor, regardless of the quality of the work. All contractors must be vigilant to ensure that they are licensed at all times and, given today’s economy, must protect themselves from lack of licensure claims, which are becoming more and more predominant.

    In addition, the Ahdout decision further establishes a very limited set of circumstances in which an arbitration award challenge is warranted, and brings into question whether arbitration is a sound alternative to court or another form of alternative dispute resolution that provides review of these decisions. Given the general rule that an arbitration award cannot be challenged, even due to the arbitrator’s error of fact or law, unless a party can demonstrate fraud, corruption or a failure to disclose a conflict, there is generally no ability to challenge the award. This decision does, however, open the door for a party to rely upon an asserted public policy in an effort to challenge an award, which should lead to creative arguments as to what constitutes an “explicit legislative expression of public policy.”