Achieving “Substantial Compliance” in Arizona

In a March 2006 ruling, the Arizona Court of Appeals offered a useful refresher course in, and a tighter interpretation of, the factors that courts and administrative authorities must consider in determining whether a contractor has “substantially complied” with statutory licensing requirements before bidding or contracting.

The case at hand, Arizona Commercial Diving Services, Inc. v. Applied Diving Services, Inc. , involved the awarding of a municipal contract to a contractor that had applied for – but not yet received – the proper license.

Arizona Commercial Diving Services (ACDS) was formed in March 2003. On May 15 of that year, ACDS submitted an application to the Registrar of Contractors (ROC) for a class K-05 license. The license was issued on June 20. On May 23 – after ACDS had applied for its license but before the license was issued – ACDS bid on a City of Phoenix project. ACDS was the low bidder and on June 20 was notified that its bid had been recommended for approval. One of the unsuccessful bidders filed a complaint with the ROC, alleging that ACDS had violated A.R.S. § 32-1151, which states, in part: “It is unlawful for any person … [or] corporation … to engage in the business of, submit a bid or respond to a request for qualification or a request for proposals for construction services as, act or offer to act in the capacity of or purport to have the capacity of a contractor without having a contractor's license in good standing in the name of the person … [or] corporation … unless the person …[or] corporation … is exempt.”

ACDS admitted that it did not hold a contractor’s license when it submitted its bid but argued that it had substantially complied with the ROC’s licensing provisions and, therefore, had not violated the statute. The ROC conducted an administrative hearing, and the administrative law judge ruled that ACDS had indeed violated the statute and recommended suspension of the ACDS’s license. ACDS filed for judicial review in Superior Court and sought a stay of its license suspension, which was granted pending the review. When the Superior Court ruled against ACDS, the contractor appealed.

Of interest to contractors is whether ACDS had “substantially complied” with the statute at the time it bid on the project. In its ruling, the Court of Appeals reviewed the five factors that are to be considered in determining whether substantial compliance has been achieved:

• Whether a failure by the ROC contributed to the contractor’s noncompliance.

• Whether the contractor was financially responsible while its license was suspended or not yet issued.

• Whether the contractor knowingly ignored the registration requirements.

• Whether the contractor immediately remedied the statutory violation.

• Whether the failure to comply with the statute prejudiced the party the statute seeks to protect.
  

The third factor was ACDS’s undoing. Like the administrative law judge and Superior Court, the Court of Appeals found that ACDS was indeed aware of the need for a Class K-05 license, as evidenced by the fact that ACDS had applied for one, and had knowingly ignored that requirement by submitting its bid before receiving the license.

ACDS argued that applying for the license should prove that the contractor did not ignore the license requirement, but that argument failed at every level. ACDS further argued that substantial compliance should not be defeated by just one factor but should be considered by balancing all five factors. But the Court of Appeals countered that the Arizona Supreme Court’s 1995 ruling in Aesthetic Property Maintenance clearly stated that a knowing violation of the licensing requirements is “fatal” to a claim of substantial compliance.

In its ruling in this case, the Arizona Court of Appeals expands the holding of its 2002 Crowe v. Hickman’s Egg Ranch decision ( see article ) regarding the necessity for having an appropriate license before negotiating a contract. The Crowe ruling focused on the requirement that a contractor have the proper license before entering into a contract; the more recent case underscores the importance of a contractor having the proper license before bidding on a contract.