Real Estate Litigation

By: Lyndsey Torp

http://www.swlaw.com/attorneys/lyndsey_torp

In another decision favoring lenders (See http://www.swlaw.com/blog/real-estate-litigation/2014/08/29/arizona-supreme-court-to-contractor-sorry-but-equitable-subrogation-of-a-banks-later-deed-of-trust-trumps-earlier-mechanics-lien-rights/), the California Court of Appeal, in an opinion published in September 2014, entitled Moorefield Construction, Inc. v. Intervest Mortgage Investment Company, et al., D065464, held an original contractor can contractually waive or impair its own lien rights, even before it gets paid or performs work, as long as it does not waive or impair the lien rights of its subcontractors. In Moorefield, the court of appeal reversed a trial court’s decision awarding a general contractor $2.2 million on its mechanic’s lien.  In doing so, the court of appeal upheld a subordination agreement that the general contractor, Moorefield Construction, Inc., signed with the lender, Intervest Mortgage, “subordinating” the general contractor’s mechanic’s lien claim to the lender’s deed of trust, which was security for the construction loan.

In Moorefield, a developer, DBN Parkside, LLC (“DBN”), purchased property in San Jacinto, California, with a loan from BankFirst.  DBN planned to construct a medical office complex.  In anticipation of construction, DBN asked Moorefield to “clear and grub” the project site – till the soil to remove vegetation and roots, and smooth out the land.  Later that month, DBN entered into a construction contract with Moorefield.

DBN then obtained a construction loan from Intervest.  As a part of the loan, Intervest paid off DBN’s earlier debt to BankFirst.  In connection with the loan agreement, Intervest required DBN to assign its rights and remedies under the construction contract (but not its obligations) to Intervest.  Moorefield was required to consent to the assignment, which provided in part:

“…any and all payments made or payable to it pursuant to the Contract shall remain subordinate to the Loan at all times during the term of the foregoing assignment, and that any and all liens for labor done and materials and services furnished pursuant to the Contract or otherwise shall be subordinate to the Deed of Trust.”

DBN eventually defaulted under the construction loan agreement, and Moorefield did not receive payment for its work, totaling approximately $2.2 million.  Three weeks after completing its punch list work, Moorefield filed a mechanic’s lien against the property, and then filed its lawsuit, eventually adding Intervest as a defendant to its foreclosure of mechanic’s lien claim.  Intervest filed a cross-complaint for declaratory relief, that its deed of trust was superior to Moorefield’s mechanic’s lien, and for equitable subrogation, quiet title, and judicial foreclosure.  Meanwhile, Intervest assigned its interest in the deed of trust to Sterling Savings Bank, who then foreclosed and obtained the property by credit bid.

The trial court entered judgment in favor of Moorefield, finding that Moorefield’s mechanic’s lien was valid, timely recorded, and had priority over Intervest’s deed of trust.  The trial court further found that the subordination clause in Moorefield’s consent to DBN’s assignment to Intervest was unenforceable and the doctrine of equitable subrogation did not apply.  Specifically, the trial court found that the subordination clause violated public policy because it deprived Moorefield of its mechanic’s lien priority right guaranteed to it as a contractor under the California Constitution.  In addition, former California Civil Code section 3262(d) also provided that such waiver is void unless it substantially followed the language in former section 3262(d)(1) through (4).

The court of appeal disagreed and reversed.

The court of appeal analyzed California’s mechanic’s lien statutes, and noted that it placed limits on the abilities of certain persons to waive or otherwise impair mechanic’s lien rights.  Former Civil Code section 3262, subdivision (a), provided in relevant part as follows:

“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 whether with or without notice except by their written consent, and any term of the contract to that effect shall be null and void. Any written consent given by any claimant pursuant to this subdivision shall be null, void, and unenforceable unless and until the claimant executes and delivers a waiver and release.”

The parties disputed whether section 3262 (now sections 8120 through 8138) applied to an original or general contractor.  The court of appeal agreed with Intervest and held that while section 3262 prevented an owner or original contractor from waiving or impairing the claims of other liens of other persons, it did not prevent an owner or original contractor from waiving or impairing its own mechanic’s lien rights.  In addition, section 3268 provided further support, as it allowed a party to waive or release the benefits of the mechanic’s lien laws, unless otherwise prohibited by statute or public policy.  Relying on Santa Clara Land Title Co. v. Nowack & Associates, Inc. (1991) 226 Cal.App.3d 1558, the court of appeal concluded that “section 3262 simply does not apply to waivers and releases by original contractors,” and under section 3268, “an original contractor is empowered to waive or release its mechanic’s lien as it so chooses — including prospectively.”

Because the subordination clause was valid, when Intervest foreclosed on the deed of trust, Moorefield’s mechanic’s lien was extinguished.  Moorefield could no longer maintain its action for foreclosure of the property.  Intervest’s deed of trust exceeded its successful bid for the property at the trustee’s sale, so there were no surplus funds for the trustee to distribute to subordinate lienholders, including Moorefield.  Accordingly, the court of appeal reversed the trial court’s judgment with instructions to enter judgment in favor of Intervest.

This decision establishes that via a valid subordination agreement, a lender’s deed of trust is in first position, trumping the general contractor’s mechanic’s lien.  Construction lenders that obtain similar waivers from a direct contractor in these circumstances will likely be in first position in the event of a default.  Direct contractors should carefully review their contracts or their consents to assignments for such waivers, as it is likely that such a waiver will be enforced under Moorefield — and they may be left out in the cold when there are no surplus funds to distribute to subordinate lienholders.