Arizona Court of Appeals Division One Holds That (1) an Arbitration Clause in a Construction Contract Is Void or Voidable When the Contractor Did Not Possess a Contractor’s License, and (2) an Arbitration Is Not an “Action” for Purposes Awarding Attorneys’ Fees and Costs under A.R.S. §§ 12-341 and 12-341.01.

WB is a residential construction company, wholly owned by Wright Brothers, a commercial construction company.  WB and Wright Brothers have the same directors.  In 2006, WB entered into a construction contract with El Destino LP and Community Development, Inc. (collectively, “Appellees”) to develop real property in Santa Cruz County, Arizona.  The contract contained a provision requiring arbitration for claims related to the contract.

In 2008, WB filed an amended complaint in superior court, claiming that Appellees had breached the contract.  WB asked the court to stay proceedings so that the parties could engage in arbitration as required by the contract.  The court entered an order staying the proceedings.

During the arbitration, Appellees discovered that WB was not an Arizona licensed contractor at the time it entered into the contract.  Thus, they filed a motion in superior court to lift the stay and for summary judgment.  Appellees argued that, because WB was not licensed, both the construction contract and the arbitration clause were void and unenforceable pursuant to A.R.S. § 32-1151 and WB was barred from obtaining relief by A.R.S. § 32-1153.  The superior court lifted the stay and entered summary judgment in favor of Appellees.  The court also granted Appellees’ application for attorneys’ fees and costs, awarding them $200,000 in fees, $225,988.41 in non-taxable costs, and $6,701.72 in taxable costs.

On appeal, WB argued that the superior erred in granting summary judgment because (1) only the arbitrator had the authority to determine the validity of the contract, and (2) there were genuine issues of material fact that precluded summary judgment.  The Court of Appeals rejected both arguments.

First, the Court skirted the issue of which law applied to determine the validity of the arbitration clause – the Federal Arbitration Act, as argued by WB, or Arizona law, as specified in the contract – concluding that the same analysis would apply under either scheme.  The Court then noted that, given the public policy favoring enforcement of arbitration clauses, a stay of arbitration proceedings is proper only if there is a challenge to the arbitration clause itself, not just a challenge to the underlying contract.  In this case, Appellees had challenged the validity of the underlying contract and the validity of the arbitration clause, claiming that both were void under A.R.S. § 32-1151 because WB was not licensed.  Thus, the Court turned to the question of whether WB’s not possessing a contractor’s license rendered the arbitration clause void.

It was undisputed that WB was not a licensed contractor at the time it executed the construction contract.  Because WB was not licensed, under A.R.S. § 32-1151, it was unlawful for WB to enter into a contract to engage in the business of contracting or to act as a contractor.  Therefore, the Court concluded, any contract entered into by WB, including the arbitration agreement, was void or at least voidable, and the superior court correctly refused to enforce the arbitration clause.

The Court also rejected WB’s arguments that summary judgment was not proper because there were genuine issues of material fact concerning whether WB had substantially complied with the licensing requirements and whether Wright Brothers was a party to contract and its license satisfied the requirements.  Although substantial compliance with the licensing requirements can prevent an unlicensed contractor from being barred from relief under A.R.S. § 32-1153, there is no substantial compliance if the contactor knowingly ignores the registration requirements.  The Court concluded that WB failed to present evidence that it did not knowingly ignore the licensing requirements because “several documents and/or communications in the record conclusively show[] that WB knew that it was unlicensed in Arizona and that it knew it needed to obtain a license.”  In addition, any claim that WB did not know of the requirements was belied by the undisputed facts that Wright Brothers was licensed in Arizona and shared the same directors and management with WB.

The Court also found no genuine issue of fact concerning whether Wright Brothers was a party to the construction contract.  WB argued that Appellees treated Wright Brothers and WB as the same company and should not be allowed to treat them differently now.  The Court concluded, however, that the contract unambiguously listed only WB as a party to the contract and named WB as the sole contractor.  Therefore, WB’s proffered parol evidence that Wright Brothers was also a party could not be considered.  The Court also concluded that WB would not have been covered under Wright Brothers’ license even if Wright Brothers had been a party to the contract.

WB also challenged the superior court’s award of fees and costs, arguing that the award erroneously included fees and costs relating to the arbitration proceedings.  WB argued, and the Court of Appeals agreed, that A.R.S. § 12-341.01 allowed an award of fees only in connection with an “action” and that an arbitration proceeding was not “action” for purposes of this statute.  “Action” is defined in A.R.S. § 1-215 as “any matter or proceeding in a court, civil or criminal.”  Relying on this definition and previous case law indicating that an administrative proceeding is not an “action” for purposes of § 12-341.01, the Court concluded that an arbitration proceeding is likewise not an “action” for purposes of awarding fees.  The Court applied the same analysis to Appellees’ the award of costs under A.R.S. §§ 12-332 and 12-341.

The Court also rejected Appellees’ argument that they should be able to recover their fees and costs for the arbitration proceedings because the arbitration proceedings were “intertwined” with the court proceedings.  This argument failed, even though a prevailing party may recover arbitration fees when they are intertwined with court fees – Appellees had submitted exhibits supporting their application for fees and costs that clearly showed that Appellees and their attorneys treated the arbitration proceedings and court proceedings separately and that they were not intertwined.  The Court of Appeals therefore vacated and remanded the entire award of attorneys’ fees and costs to the superior court for reconsideration.

PRACTICE NOTE:  The Court of Appeals declined to award attorneys’ fees on appeal to Appellees under A.R.S. § 12-341.01 because “neither party has been entirely successful on appeal.”  The Court concluded, however, that WB was entitled to recover its costs on appeal under A.R.S. §12-342(A) because “it has succeeded in reducing the judgment against it.”

Judge Winthrop authored the opinion; Judges Hall and Thompson concurred.