California Court Orders Judicial Review of Arbitrator’s Decision Not to Order Disgorgement from Unlicensed Contractor

A recent California case, Ahdout v. Hekmatjah (2013) 213 Cal.App.4th 21, held that an arbitrator’s refusal to apply California’s disgorgement remedy against an unlicensed contractor was subject to judicial review even if the underlying agreement was not entirely void.

Two adjacent landowners formed a limited liability company to develop condominiums on the combined property. The LLC’s operating agreement provided that the LLC would hire a contractor owned by the managing member to construct the project. The contractor was not to receive any direct payment for its work. Instead, the agreement provided that the managing member would receive a greater credit to his capital account based on the construction price, and a correspondingly greater share of the profits.

Unhappy with delays and cost overruns, the non-managing member initiated arbitration proceedings. The non-managing member asserted that the managing member’s contractor was not properly licensed, and thus under California Business and Professions Code section 7031 the non-managing member was entitled to (a) equalization of the profit-sharing mechanism, and (b) a 50% share of the construction cost, all of which should be disgorged to the LLC.

The arbitratror denied disgorgement, on the basis that neither the managing member nor the contractor acted as a general contractor.

The non-managing member sought to vacate the arbitrator’s award, but the trial court determined it did not have the power to review the arbitrator’s decision.

On appeal, the court reviewed Loving & Evans v. Blick (1949) 33 Cal.2d 603, which held that a construction contract with an unlicensed contractor was void, and an arbitrator’s award in favor of the unlicensed contractor under that void agreement was unenforceable. The court determined that Loving was not directly applicable, because the provision in the LLC’s operating agreement mandating hire of the unlicensed contractor was only a portion of the agreement, and did not void the entire agreement. Under Moncharsh v. Heily & Blase (1992) 3 Cal.4th 1, when only part of an agreement containing an arbitration provision is illegal (and the illegal part is not the arbitration provision), disputes under the agreement remain arbitrable.

However, the court found refuge for the non-managing member in a portion of the Moncharsh decision identifying a public policy exception to its broad rule in favor of arbitration. The court found that California’s strong public policy against unlicensed contractors was sufficient to merit “judicial review of arbitration awards that allegedly fail to enforce section 7031.” Id. at 39. The court remanded the case to the trial court to conduct a de novo review of the evidence to determine whether disgorgement was required.