Construction Law

This article appeared in the September 2009 issue of "The Construction Advisor" published by Lang Baker & Klain, PLC. Free Subscription to the Construction Advisor View the Construction Advisor index

If you have been involved in a lawsuit over a contract dispute, you may be aware that, under Arizona law, the prevailing party in contract litigation may ask the court to order the other side to pay the prevailing party’s attorneys’ fees.

While that may seem simple enough, whether a legal action truly “arises out of a contract” is not always clear. In a recent Arizona Court of Appeals case, Keystone v. Kang, a licensed contractor avoided liability for an owner’s attorneys’ fees by successfully arguing that the action did not arise out of the parties’ contract for tile flooring, but instead arose out of its statutory obligation as a licensed contractor to perform its work in a workmanlike manner.

Background

A homeowner, Mr. Kang, contracted with Keystone Floor & More to install floor tile in his residence. Keystone completed the work and, under the terms of their agreement, Kang paid Keystone $30,000.

When some of the tiles cracked, Kang alleged that the cause was “terrible workmanship” by Keystone. Keystone countered that the cracks were the result of an “unsettled foundation.” Kang filed a complaint against Keystone with the Arizona Registrar of Contractors, and an ROC inspector examined the premises and issued a corrective work order.

When Keystone did not comply with the order to the ROC’s satisfaction, the ROC issued a citation to Keystone for violations of various statutes and for its failure to perform work, as required in Arizona Administrative Code R4-9-108, “in a professional and workmanlike manner.” After a hearing, the ROC ordered revocation of Keystone’s license.

Keystone filed a complaint in Superior Court against Kang and the ROC, asking for judicial review of the ROC’s decision under the Administrative Review Act (A.R.S. §§ 12-901 through 12-914). After oral argument, the Superior Court judge affirmed the ROC’s revocation of Keystone’s license.

Kang applied for an award of attorneys’ fees, stating that he met the statutory requirements contained in A.R.S. § 12-341.01(A) – i.e., this was a contested action, he was the successful party, and the action arose out of the contract.

Keystone contested the awarding of attorneys’ fees, arguing that the statute does not apply to fees related to appeals of ROC decisions to Superior Court, since ROC appeals are based in contractor licensing statutes, not in contract.

The Superior Court judge ruled for Kang and ordered Keystone to pay $8,128.50 in attorneys’ fees. Keystone appealed.

Ruling

The sole issue that the Arizona Court of Appeals considered was whether the Superior Court judge ruled properly in awarding attorneys’ fees to Kang. At the heart of the Court of Appeals’ ruling was whether the action for which the attorneys’ fees were awarded – in this case, Keystone’s appeal of its license revocation – arose out of the contract.

Citing its 1983 ruling in ASH, Inc. v. Mesa Unified School Dist. No. 4, the Court noted that fees “may be recovered when a contract is the ‘cause or origin’ of the dispute.”

However, the Court also noted that, per Hanley v. Pearson, “the fee statute does not apply … to ‘purely statutory causes of action’ … nor does it apply ‘if the contract is a factual predicate to the action but not the essential basis of it.’ That is, when the action arises out of a statutory obligation and is ‘based on a statute rather than a contract, the peripheral involvement of a contract does not support the application of the fee statute.’”

In this case, Keystone’s appeal of its license revocation was a statutory cause of action, not a contract-based cause of action.

In the end, the Court of Appeals ruled for Keystone and reversed the Superior Court’s awarding of attorneys’ fees to Kang. In its ruling, the Court wrote:

“We find the superior court’s review of the ROC’s decision does not constitute an action ‘arising out of contract’ … because the basis for the action is purely statutory. … Although the appeal to the superior court involved a contract, it was not the ‘cause or origin’ of the appeal – rather, the contract was peripheral to the primary cause of whether the ROC erred in finding Keystone had violated its statutory duties as a licensed contractor.

“At issue … was Keystone’s failure to comply with the Workmanship Rule … not Keystone’s failure to meet its contractual obligations.”

Aftermath

While Keystone prevailed on the issue of attorneys’ fees, it was in large measure a hollow victory for this contractor compared to the loss of its license.

However, the ruling in Keystone v. Kang does provide positive news to other licensed contractors, since it allows them to pursue statutory remedies to unfavorable administrative rulings, generally without fear of having to pay the other party’s attorney.