Moorefield Construction, Inc. v. Intervest-Mortgage Investment Company.
2014 WL 4823609 (Cal. Ct. App., Sept. 12, 2014)
HOLDING
The execution of a subordination agreement by a general contractor in favor of a construction lender is enforceable and subordinates the general contractor's mechanic's lien rights to the construction lender's deed of trust. In reaching this holding, the Court of Appeal held that while California Civil Code § 3262 (now Civil Code § 8122)protects subcontractors and suppliers from waiving their lien rights, no such statutory protection is afforded to general contractors.
WHY THIS CASE IS IMPORTANT
In private works construction projects, the recordation of a mechanic's lien generally relates back to the date of commencement of construction. As a result, if work commences on the project prior the recordation of the construction loan deed of trust, then the mechanic's lien would take priority over the deed of trust or "prime the loan". This provides contractors with the ability to foreclose on property and obtain payment of monies owed prior to the lender foreclosing on its deed of trust. Consequently, as a condition to lending money for the construction of a project, many construction lenders typically require that contractors execute subordination agreements which subordinate the lien rights, and priority, to the lender's deed of trust.
This decision holds that such subordination agreements are enforceable against general contractors, despite the fact that California Civil Code § 3262 (now Civil Code § 8122[1]) precludes the waiver or impairment of mechanic's lien rights except through the use of form releases contained within California Civil Code § 3262(d)(1)-(d)(4) (now Civil Code §§ 8132, 8134,8136, 8138). In light of this decision, one can expect to see owners and lenders include subordination agreements as part of all construction loan transactions on private works projects. General contractors must now be aware that such subordination agreements are in fact enforceable and can have substantial, detrimental impact on the ability to recover monies owed. As a result, this case is important to general contractors, owners, and lenders involved in private works projects funded through construction loans as it has significant implications on mechanic's liens and priority rights.
[1] Effective July 1, 2012, the California Civil Code was renumbered to sections 8000-9566. As this case was brought before that enactment, the Court referenced and applied the former section numbers.
FACTS
DBN Parkside, LLC ("DBN"), a developer, purchased property in San Jacinto, California with the intent to develop the property into a medical office complex. DBN had worked with the general contractor, Moorefield Construction, Inc. ("Moorefield") on prior construction projects and asked Moorefield to clear and grub the property. Moorefield and DBN then entered into a construction contract for the medical office complex. DBN obtained a construction loan from Intervest-Mortgage Investment Company ("Intervest") to pay off the land loan and to finance the construction costs. However, Moorefield had already commenced with the clearing and grubbing work by the time DBN obtained the loan from Intervest. As a result, part of the construction loan contract required Moorefield to subordinate its lien rights in favor of Intervests's construction loan deed of trust. Intervest would not have issued the loan to DBN without Moorefield's subordination agreement.
The project started off without a hitch and DBN paid Moorefield $7,200,000.00 through the first sixteen (16) payment applications. However, DBN eventually defaulted on its construction loan with Intervest, while still owing Moorefield $2,200,000.00 for the final two payment applications. Moorefield thereafter recorded a mechanic's lien for $2,200,000.00 and filed suit against DBN for breach of contract and foreclosure of its mechanic's lien. Moorefield later added Intervest as a defendant on its foreclosure of mechanic's lien cause of action. Intervest, in turn, filed a cross-complaint against Moorefield seeking declaratory relief in the form of a declaration that its deed of trust was superior and had priority over Moorefield's mechanic's lien.
The trial court held that the subordination agreement between Moorefield and Intervest was unenforceable as it violated Civil Code § 3262. As a result, the trial court held that Moorefield's mechanic's lien had priority over Intervest's deed of trust. The trial court ordered the foreclosure and sale of the medical office complex in order to satisfy Moorefield's lien. Intervest appealed this decision.
DISCUSSION
It is important to begin by noting that the California Constitution provides a priority right for a mechanic's lien. See, Cal. Const., Art. XIV, § 3. Further cementing this policy, the California Legislature enacted Civil Code section 3262, intended to protect subcontractors and suppliers from contracting away their ability to pursue mechanic's lien rights. Without this protection, owners and general contractors could potentially take away the greatest power available to a subcontractor--the power to record and enforce a mechanic's lien for services and/or materials rendered.
The applicable statute evaluated in this case, Civil Code section 3262, states 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. That waiver and release shall be binding and effective to release the owner, construction lender, and surety on a payment bond from claims and liens only if the waiver and release follows substantially one of the forms set forth in this section and is signed by the claimant or his or her authorized agent, and, in the case of a conditional release, there is evidence of payment to the claimant. Evidence of payment may be by the claimant’s endorsement on a single or joint payee check that has been paid by the bank upon which it was drawn or by written acknowledgment of payment given by the claimant." (Emphasis added.)
Moorefield attempted to use this statutory protection to extricate itself from the subordination agreement, arguing that it was against public policy to allow a contractor to impair its mechanic's lien rights. Moorefield argued that section 3262 creates two prohibitions: (1) an owner may not impair a general contractor's mechanic's lien rights and (2) a general contractor may not impair another's mechanic's lien rights. The Court of Appeal was unpersuaded by this argument as the statute only contains one prohibition: that neither owners nor general contractors may impair the mechanic's lien rights of "other persons". As a result, it was held that the operative language of "other persons" means those who are neither owners nor general contractors. As such, the statute does not offer protection for general contractors, it only favors subcontractors and suppliers. Based upon this strict interpretation of Civil Code section 3262, the Court of Appeal held that since Moorefield did not fall into the category of "other persons", it was free to waive or subordinate its mechanic's lien rights in favor of the lender.
In reviewing the legislative history of Civil Code section 3262, the Court of Appeal noted that the purpose of the statute is to prohibit entities with superior bargaining power from forcing entities with inferior bargaining power (e.g., subcontractors and suppliers) to agree to waive their mechanic's lien rights without first receiving payment. As Moorefield did not have unequal bargaining power, the Court of Appeal enforced the subordination agreement executed by two sophisticated parties.
In practicality, Moorefield signed the subordination agreement as a necessary evil in order to receive the benefit of the construction loan proceeds. In effect, Moorefield relied upon DBN's ability to fulfill its loan obligations to Intervest in order to secure a building contract worth $9,400,000.00. In the end, Moorefield was left without any recourse, contractually or by virtue of a mechanic's lien, to recover the outstanding balance owed of $2,200,000.00. This harsh result exemplifies the need for contractors to understand the substantial impact of executing subordination agreements.
CONCLUSION
This case is a cautionary tale for general contactors. Many construction lenders require contractors to sign subordination agreements before they will issue a loan. The Moorefield decision prescribes the means by which a lender can effectively nullify a general contractor's mechanic's lien rights. The risk of nonpayment resulting from the execution of subordination agreements requires the general contractor to be vigilant in its due diligence when entering into a contract with an owner/developer and in not allowing itself to get too far extended on monies owed on any given project.