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Mechanic's Liens

Mechanic’s Lien Reigns Supreme in the Battle of a Project Default? Not for a Waiving General

Jonathan Rodriguez | Sedgwick Law
October 2014

In what can only be described as a devastating result for a general contractor, the Fourth Appellate District held that a general contractor may prospectively waive the priority of a mechanic’s lien to the owner’s construction lender. Thus, notwithstanding advancing its work prior to the execution of the construction loan and timely recording its mechanic’s lien, the waiver left the general contractor out in the cold for more than $2 million in receivables against a defunct owner.

In Moorefield Construction, Inc. v. Intervest-Mortgage Investment Company (September 12, 2014, No. D065464), general contractor Moorefield Construction, Inc. (“Moorefield) commenced work under a construction contract with the owner to build a medical office. One month later, the owner secured a construction loan from Intervest-Mortgage Investment Company (“Intervest”). In consideration for making the loan, Moorefield executed a consent agreement with Intervest to allow the owner to assign its rights under the construction contract to Intervest. Under this consent, Moorefield agreed to subordinate any liens for services it furnished to the lien of Intervest’s deed of trust. The owner thereafter defaulted on the construction loan and failed to pay Moorefield $2.2 million on its last two payment applications. Moorefield timely recorded a mechanic’s lien.

Moorefield sued Intervest to foreclose on its mechanic’s lien. Following a bench trial, the court entered judgment in favor of Moorefield ordering foreclosure and sale of the property to satisfy Moorefield’s mechanic’s lien. The court held that Moorefield’s separate agreement with Intervest to subordinate its mechanic’s lien to the construction loan deed of trust was unenforceable. The trial court concluded that such agreement would deprive Moorefield of its state constitutional right guaranteeing priority of its mechanic’s lien, and in any event, as a matter of law, the consent clause as written was nevertheless null, void and unenforceable because it did not substantially follow the statutory forms set forth under California Civil Code Section 3262(d).

Not so, said the Fourth Appellate District. On appeal, the Fourth District reversed the trial court, holding instead that the plain language of Civil Code Section 3262(d) only mandates protection of subcontractors and suppliers, not general contractors. Section 3262(d) states that “neither the owner nor original contractor by any term of a contract, or otherwise, shall waive, affect, or impair the claims and liens of other persons . . . except by their written consent” that follows the statutory forms. “The ‘other persons’ referenced in the statute are persons other than owners and original contractors.” (Moorefield, page 16.) (Emphasis in original.) The court also countered Moorefield’s position that it should view its prospective waiver differently than a retroactive waiver, finding no rationale distinction. The court, however, dedicated its most persuasive explanation to the history of the statute itself, providing an insightful tutorial on Section 3262’s statutory interpretation.

Reaching back to 1885, the court noted that an amendment to the statute at that time “resolved ‘a conflict in authority whether an owner and prime contractor could by a provision of their contract waive the rights of subcontractors and materialmen.’” The amendment settled the conflict by requiring a written consent to waive the lien. Ninety years later, having been largely unchanged, a 1972 amendment removed the written consent option. This threw construction lenders into a rebellion precluding loans altogether. As a consequence, the Legislature restored the statute in the form today, “restor[ing] the ability of ‘other persons’ to waive their mechanic’s lien rights in writing, established mandatory forms for those waivers, and confirmed those waivers are only valid if the forms were used or payment was in fact made.”

The court rejected the trial court’s remaining holding that Intervest’s breach of the consent agreement made the subordination clause unenforceable. The court held that Moorefield’s consent agreement did not obligate Intervest to pay Moorefield as a condition precedent to enforcing the subordination clause.

Because Intervest’s assignee, Sterling Savings Bank, foreclosed on the loan and took title to the property at the trustee’s sale, Moorefield’s mechanic’s lien, in turn, as a subordinate interest – was extinguished. Without a lien in place, Moorefield lost any standing to maintain its action to foreclose its lien. Adding to its defeat, Sterling’s winning bid left no surplus funds for the trustee to distribute to Moorefield. The opinion notes that Moorefield dismissed its claims against the owner at the outset of trial without further explanation, although one may assume the owner lacked assets.

So what should a general contractor do when faced with the prospect of agreeing to subordinate its mechanic’s lien rights to a lender? First, ensure that the construction contract contains clear payment obligations with tight deadlines and rights to stop work or terminate based on non-payment. Second, demand proof of an owner’s financing before commencing work and at project intervals, and have the information reviewed by an appropriate financial professional. Incorporate this proof of financing right into the contract. Third, if the owner defaults, seek to negotiate with the lender to fashion an approach that secures the best value of the project and settles outstanding claims. In this regard, and as a last resort, the general contractor may consider offering a cost-plus-reasonable-fee payment going forward to reach a particular project milestone while the owner or lender reworks the project financing or sets up the property for sale. And finally, have a game plan in place for a potential project default prior to commencing the project to quickly navigate the minefield of competing interests, secure rights and liberate payments.

The content of this article is intended to provide general information and as a guide to the subject matter only. Please contact an Advise & Consult, Inc. expert for advice on your specific circumstances.

SOURCE: www.sedgwicklaw.com

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