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Contractor’s Unlicensed Status Must Be Raised At Arbitration or is Waived.

In Arizona, a reoccurring problem presents itself with the conflicts with Arizona’s strict licensing laws, and the private arbitration proceedings mandated by many construction contracts. In arbitration proceedings, arbitrators are only empowered to issue rulings “within the scope of their authority." What is within and without an arbitrator’s scope of authority is a regular source of litigation and the issue of proper contractor licensing is often presented. For the most part, private arbitrators will defer all issues regarding licensure issues to the Arizona Registrar of Contractors which is the state agency charged with investigating, charging, and disciplining unlicensed (or improperly licensed) contractors.

Similarly, it is not atypical for a contractor and owner dispute to be proceeding along parallel litigation tracks. 1] the administrative process set forth in ARS §32-1101 where issues relating to the contractors license, contract performance, and contract compliance may be addressed by an Administrative Law Judge, and 2] the private arbitration proceedings where the arbitrator is essentially determining the monetary aspects of the dispute.

As a matter of course, Arizona’s Administrative Law Judges will not render monetary awards in favor of a project Owner as part of their recommended decision and order presented to the Registrar of Contractors. Because the two separate proceedings involve the same parties and the same subject matter, collateral estoppel and res judicata problems arise whenever the Arbitrator or the Registrar issue their final ruling.

In April, 2011, the Arizona Court of Appeals, in the case of Smith v. Pinnamaneni, 2011 WL 1599682 (CA1, 2011), clarified the proper procedure for this reoccurring problem. The Court ruled that in Arizona, a contractor’s unlicensed status does not automatically made the contract void (thus making the arbitration clause void as well), but simply “voidable." Older cases in Arizona treated contracts with unlicensed contractors as illegal and void ab initio, (unenforceable). The distinction is significant. Because the contract is merely voidable the license status of the contractor must be raised as an affirmative defense – in the arbitration proceedings – or is waived.

ARS §32-1153 prohibits a contractor from “commenc[ing] or maintain[ing] any action in any court of the state for collection of compensation" for contracting work if the contractor was not licensed when the contract was signed and when the cause of action arose. Arizona’s Supreme Court has ruled that this statute applies to both civil cases and arbitration proceedings.

The Pinnamaneni Court held that contracts with unlicensed contractors are not per se unenforceable. Unlicensed contractors can seek compensation under ARS §32-1153 if they show substantial compliance with licensing requirements and the burden is on the opposing party to affirmatively raise the defense of lack of licensure during the Arbitration proceedings. Failure to do so constitutes a waiver. Lack of licensure cannot be raised as a defense for the first time during the subsequent confirmation proceedings proscribed in ARS §12-1512.

In reaching its decision, the Court relied heavily on the fairly typical contract language between the parties. The Court held that by agreeing to the contract which mandated private arbitration for “any Claim arising out of or related to the Contract" Defendants agreed to also arbitrate any defenses they had to those claims. Secondly, the Court held that because the contract was “governed by the law of the place where the Project is located (Arizona), the arbitrator was authorized—indeed, required—to apply Arizona law, including the prohibition against compensation to unlicensed contractors set forth in ARS§ 32-1153

The Pinnamaneni Court also held that allowing Defendants to raise the licensing defense at confirmation instead of in the arbitration would result in another round of litigation on an issue that was procedurally and substantively arbitrable.

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