Arizona Court of Appeals Holds Arbitration Clause Did Not Apply to Third Party in Construction Case

RLI Insurance Co. v. National Construction & Development Inc.
Arizona Court of Appeals Division II
November 5, 2024
JSH Attorney: Justin Ackerman & Ashley Caballero-Daltrey

In a written opinion last week, the Arizona Court of Appeals held that an arbitration clause did not apply to a third-party surety in a construction case.

In the case, National Construction & Development, Inc. (NCD) entered into a construction contract with a property owner, Robert Pulver, in October 2021.  Under the contract, NCD was to remodel a building and parking lot for Pulver in Fort Mohave, Arizona.  The contract included an arbitration clause in which NCD and Pulver agreed that: “Any dispute or claim related to or arising from this Contract, its performance, breach, interpretation, validity, or enforceability, shall be exclusively (except as provided below) resolved by final binding arbitration before the American Arbitration Association (AAA), utilizing AAA Commercial Arbitration Rules.”

In February 2022, NCD mailed a preliminary twenty-day lien notice to Pulver, in accord with A.R.S. § 33-992.01.  Thereafter, NCD completed the project and mailed Pulver an invoice seeking final payment.  Pulver did not pay the invoice.  NCD then recorded its “Notice and Claim of Mechanics’, Materialman’s, or Professional Services Lien Pursuant to A.R.S. § 33-993” with the Mohave County Recorder.  NCD, pursuant to its construction contract, filed a claim for arbitration against Pulver with the AAA.

After the arbitration proceeding between NCD and Pulver began, Pulver secured a statutory discharge of lien bond from RLI Insurance Company (RLI) with Pulver as its principal, pursuant to A.R.S. § 33-1004.  The lien discharge bond was recorded in Mohave County.  Although RLI was not a signatory to the construction contract, NCD thereafter amended its AAA arbitration pleading to add RLI as a party defendant.

In response to being added as an arbitration defendant, RLI filed a complaint with the superior court seeking: (1) declaratory relief that NCD had failed to perfect its lien against the property; and (2) a summary determination under A.R.S. § 12-3007(B) that it is not bound to Pulver’s and NCD’s arbitration agreement.

NCD moved to dismiss the complaint by arguing that RLI became bound to the mandatory arbitration provision by stepping in as surety under the lien discharge bond and “binding itself to pay the outstanding obligations alleged to be owed” by its principal, Pulver.  NCD also argued that, even though RLI was not a signatory to the arbitration agreement, “the statutes governing sureties generally provide for including sureties as parties” in disputes with their principals, and, otherwise, common law exceptions applied that bound RLI to arbitration.  The superior court dismissed RLI’s complaint because it determined that RLI was bound by the mandatory arbitration clause in the construction contract between NCD and Pulver.  It therefore concluded that it lacked jurisdiction over the dispute on the mechanic’s lien.  RLI appealed.

The court of appeals first held that stepping in as a surety in this context does not bind RLI to the arbitration requirement of the underlying contract. It explained that the law governing a materialman’s lien establishes that these lien rights are distinct from any contractual obligation that may or may not exist and that the statutes governing a surety’s responsibilities under a lien-discharge bond do not erase these distinctions.  Thus, the statutes, on their plain terms terms, do not bind RLI to obligations arising under a construction contract between the bond’s principal and a lien claimant.

The court then concluded that RLI was not bound to NCD’s arbitration clause by common law exceptions. NCD argued that “direct benefits estoppel” applied to bind RLI to arbitration.  But as the court explained, RLI’s obligations arose from statute and not from a construction contract.  Accordingly, the direct benefits estoppel exception was inapplicable. NCD also claimed that RLI was a third-party beneficiary, but it failed to point to any benefit that RLI received, or any intent that the arbitration provision or contract was meant to benefit any third party.

Because RLI was not bound to arbitration, the court of appeals vacated the superior court’s judgment in favor of NCD and remanded for further proceedings.