In a decision that seemingly conflicts with the federal rule that arbitrators must decide a challenge to the validity of the underlying contract, the California Court of Appeal has affirmed a trial court's correction of a construction arbitration award.

In Betts v. Compaction Plus, Inc., Nos. E043258, E043739, 2008 WL 2811215 (Cal. Ct. App. July 22, 2008), a dispute arose over a construction contract. Betts and CPI sued each other, each claiming breach of contract. The parties later agreed to resolve their claims in arbitration in accordance with American Arbitration Association (AAA) rules.

In its opening brief at arbitration, CPI raised a defense to Betts's claim, maintaining that Betts was not a properly licensed contractor and was barred from recovery under California law. See Cal. Bus. & Prof. Code § 7031(a) (forbidding contractors from bringing an action in court for compensation of an act requiring a license without possessing that license). The arbitrator found that Betts was entitled to almost one million dollars in damages, but that he understood Betts's recovery was barred by statute because Betts was not licensed.

CPI moved to confirm the award, but the trial court corrected the award instead. It reviewed the arbitrator's conclusions regarding Betts's license de novo, found Betts possessed the proper license, and corrected the award to allow Betts the damages refused by the arbitrator. CPI opposed the trial court's order, citing AAA rules vesting jurisdiction over the license determination with the arbitrator, but the trial court instead confirmed Betts's award.

The Court found the trial court possessed the authority to review the arbitrator's decision of the licensing issue because the licensing issue implicated the enforceability of the entire contract, including the arbitration agreement. This, to the Court, was within an exception to the general rule forbidding such review, "when the entire contract is unenforceable because a party is not licensed." See, e.g., Moncharsh v. Heily & Blase, 832 P.2d 899, 918 (Cal. 1992) ("the rules which give finality to the arbitrator's determination of ordinary questions of fact or of law are inapplicable where the issue of illegality of the entire transaction is raised in a proceeding for the enforcement of the arbitrator's award").

The Court also expressed disapproval "that CPI delayed raising the licensure issue until the eve of arbitration" in its opening brief to the arbitrator. This, according to the Court, violated AAA Construction Arbitration Rule R-8, stating that a party must object to the jurisdiction of an arbitrator or the arbitrability of a claim at the first opportunity. The Court held that this failure to raise this defense at an earlier time waived and forfeited the argument.

While the Court maintained that courts had the authority to review an arbitrator's determination of the enforceability of a contract de novo, it qualified this power to instances where the contract was unenforceable. However, neither the Moncharsh decision nor the applicable California statute directly supports this expansive interpretation of the court's authority to review an arbitrator's decision.

Moncharsh, as above, restricts this power to instances of illegality, not simple unenforceability or the denial of a cause of action to one party to the contract. Cal. Bus. & Prof. Code § 7031(a) only denies an unlicensed contractor the ability to bring a cause of action or to recover damages, and does not necessarily render the existing contract illegal.

Notably, the Court did not raise the U.S. Supreme Court's holding in Buckeye Check Cashing v. Cardegna, 546 U.S. 440 (2006), presumably because the Court concluded without explanation that the case fell outside of the ambit of federal preemption under the Commerce Clause. Buckeye stands for the proposition that disputes over contract illegality are for the arbitrator rather than the court to decide.