Michigan Court of Appeals: Construction Lien Can’t Exceed Contract Value

Scott R. Murphy | Barnes & Thornburg | September 27, 2019

The Michigan Court of Appeals held that an arbitrator’s decision to award a contractor consequential damages on a construction lien claim warranted reversal even under the extremely narrow standard of review for arbitration awards. In reaching its decision, the court made the definitive ruling that a contractor may not assert a construction lien for consequential damages beyond the monetary value of the parties’ contract.

In TSP Services, Inc. v. National-Standard, LLC, the contractor’s scope of work included asbestos abatement, demolition of steel structures and disposal of scrap steel as well as other site restoration work for an abandoned industrial facility. The parties’ contract required payment in installments with an aggregate contract price of $414,950, due upon completion of the asbestos abatement. Notably, the contract did not mention the sale of scrap steel or TSP’s potential profits therefrom as compensation under the contract. This fact was significant in the eyes of the appeals court because the arbitration proceeding focused on the profits from the sale of scrap steel as a major component of the contractor’s scope of work.

Because the project experienced significant delays in permitting, the contractor was unable to begin the steel reclamation work. During the delay, the market price for steel declined dramatically and as a result, the value of the contract was diminished significantly. In response to the declining steel prices, the contractor requested an equitable adjustment to the parties’ contract. At the time the contractor requested the equitable adjustment, only 9 percent of the available steel had been removed from the project site. When the parties could not reach an agreement to adjust the contract price, the owner terminated the contractor for cause.

However, the arbitrator ultimately concluded that the owner improperly terminated the parties’ contract and committed the first material breach of the parties’ contract. The arbitrator awarded the contractor a construction lien for $782,496.05 and broke that amount out as follows:

  • $141,083 on the unpaid invoices under the contract
  • $46,557.39 for interest and unpaid invoices
  • $391,809 for lost profits on steel inventory
  • $33,793 for interest on those profits
  • $169,226 in attorneys’ fees

The arbitrator determined that the contractor’s construction lien was valid, and was enforceable against the entire award, including the award for consequential damages for lost profits on steel inventory. Notably, the arbitrator awarded the contractor the full value of all the steel even though the contractor never actually removed the steel from the project site.

Despite the extremely narrow standard of review for arbitration awards under Michigan law, the Michigan Court of Appeals reversed the arbitrator’s award of consequential damages in connection with the lien claim because the value of the lien was nearly double the value of the parties’ contract. In reaching this decision, the appeals court emphasized that under the Michigan Construction Lien Act, the amount of any construction lien cannot exceed the remaining unpaid balance under the contract. See MCL 570.1103(4).

Because the arbitrator approved a construction lien well in excess of the contract value, the award violated the Construction Lien Act. Specifically, the arbitrator approved a lien for $782,469, which is $641,386 greater than the unpaid balance under the contract. According to the appeals court, the arbitrator’s award constituted a clear legal error that would reduce the value of the lien by over $500,000.

In reversing the arbitration award, the appeals court relied upon the Michigan Supreme Court’s decision in Detroit Auto Inter-Insurance Exch v Gavin, which held that judicial interference with an arbitration award is appropriate where the arbitration award contains a clear error of law that if corrected would substantially change the award. The Michigan Court of Appeals granted interlocutory relief because further proceedings on the lien claim would have only further complicated the issues and lead to multifarious litigation.

In summary, the decision in TSP Services, Inc v National-Standard makes it clear that consequential damages are not available under the Michigan Construction Lien Act when they exceed the balance of the parties’ contract.

Alabama Supreme Court Clarifies Construction Lien Priority

Madeline Hughes and Stephen Pudner | Baker Donelson | September 17, 2019

The Alabama Supreme Court recently reinforced its policy of giving priority to construction lenders over materialmen in its holding in GHB Construction and Development Co., Inc. v. West Alabama Bank and Trust, 2019 WL 1416893 (Ala. 2019). GHB, a contractor, challenged the priority of its materialman’s lien against a future-advance mortgage under which no funds had been extended to the borrower at the time work commenced. The Court held that because the future-advance mortgage was recorded prior to GHB’s commencement of work, the future-advance mortgage is given priority over GHB’s lien regardless of whether proceeds had been disbursed prior to the commencement of work.

The Court explained that the equitable validity of a future-advance mortgage cannot be attacked by a non-party to the transaction. Because GHB could not challenge the validity of the mortgage, the Court relied on the language of Ala. Code § 35-11-211 (a), which instructs that a materialman’s lien will take priority over all other liens, mortgages, or encumbrances created subsequent to the commencement of work. Because GHB commenced work after the future-advance mortgage was recorded, its lien did not take priority over the future-advance mortgage.

This holding emphasizes Alabama’s policy of ensuring that construction projects continue to be funded. This case tells contractors that: 1) contractors should not assume their work will take priority over future-advance mortgages even when the work is performed before the loan proceeds are extended; and 2) a contractor’s commencement date is crucial and will control priority against other lenders, and therefore, it is imperative that contractors memorialize that date and that they know whether any mortgages have been entered into and recorded before that date. In Alabama, it does not seem to matter whether that mortgage is a future advance or traditional mortgage.

California Subcontractor Gets a Kick in the Rear (or Perhaps the Front) for Prematurely Recorded Mechanics Lien

Garret Murai | California Construction Law Blog | September 3, 2019

California provides three statutorily recognized construction payment remedies: (1) mechanics liens; (2) stop payment notices; and (3) payment bond claims. Each is intended to provide payment protections for those who furnish labor, materials and services on a construction project. However, each is also different in important ways.

One of those differences has to do with timing. Specifically, when the statutory payment remedy may be used by a claimant. Stop payment notices can be served at any timeduring a project even before a claimant has completed its work.  However, mechanics liens may only be recorded and payment bond claims may only be made after a claimant has completed or ceased performing its work.

In Precision Framing Systems, Inc. v. Luzuriaga, Case No. E069158 (August 29, 2019), the 4th District Court of Appeal examined whether a subcontractor had prematurely recorded a mechanics lien and, thereby, was prevented from filing a lawsuit to foreclose on its mechanics lien.

Precision Framing Systems, Inc. v. Luzuriaga

Precision Framing Systems, Inc. was a framing subcontractor on a veterinary hospital project in Wildomar, California. Precision’s scope of work was to supply and install trusses on the project. Precision hired Inland Empire Truss, Inc. for the fabrication of the trusses.

In late July 2013, Precision started working on the framing. Later that month, Inland delivered the trusses to the site. And by the beginning of August Precision began installing the trusses.

Shortly after the trusses were installed, the city issued a correction notice stating that “[t]russ bearing points are not per plan.” Precision notified Inland and Inland carried out some repairs.

In early December 2013, the city issued a second correction notice. A walk through of the project was conducted between Precision and the general contractor, and the general contractor found that Precision’s work was complete and fully in compliance with the plans and specifications. The city later approved the framing work.

However, Precision never received full payment for tis work. The project owner, Deborah Luzuriaga told the president of Precision that “she was not interested in paying Precision and told [him] to sue her.” He did.

On January 2, 2014, Precision recorded a mechanics lien in the amount of $53,268.16.  That same month, the Luzuriagas changed the locks on the building, locking all contractors out. Precision later met with project architect and building inspector and, at this meeting, learned for the first time of additional correction notices.

Ms. Luzuriaga took the position that Precision’s mechanics lien was premature because it had not yet completed its scope of work and, in particular, had not corrected its work as required by the outstanding correction notices. A site inspection was conducted and, in mid-February 2014, Inland performed additional repairs. The repairs took two to three hours.

Precision later filed suit to foreclose on its mechanics lien. During pendency of the case, the Luzuriagas moved for summary judgment on the ground that Precision’s mechanics lien was prematurely recorded because it was recorded before it had ceased its work in February 2014. The trial court agreed and Precision appealed.

The Court of Appeal Decision

The Court of Appeals began by citing the mechanics lien statute, specifically, Civil Code section 8414 which provides:

A [mechanics lien] claimant other than a direct contractor may not enforce a lien unless the claimant records a claim of lien within the following times:

(a)       After the claimant ceases to provide work.

(b)       Before the earlier of the following times:

(1)      Ninety days after completion of the work of improvement.

(2)      Thirty days after the owner records a notice of completion or cessation.

The Court of Appeals, noting that Precision’s subcontract required that Precision supply and install “trusses . . . necessary to complete the . . . project,” held that the repairs performed in February 2014 were part of Precision’s “work” and that because Precision had recorded its mechanics lien in January 2014 it had done so prematurely.

The Court of Appeals also explained that the fact that the general contractor deemed Precision’s work to be complete is irrelevant, since the scope of Precision’s work was established by its contract not by “the factually unsupported legal opinion of two witnesses.”

Finally, explained the Court of Appeal, while “it may seem unfair to hold that [Precision] recorded its claim prematurely” when “it did not know that it had any work left to do” that the Court had “not found any case law suggesting that a claimant’s subjective knowledge or belief as to whether it has ceased to provide work is relevant” and further that “nothing in the Mechanic’s Lien law prohibited [Precision] from recording its claim again after the repairs were prepared.”

Conclusion

Timing issues related to mechanics liens typically arise as to whether a mechanics lien was timely recorded rather than whether a mechanics lien was prematurely recorded. Precision Framing is a cautionary tale for contractors, subcontractors, suppliers and equipment lessors that they can get caught not only by mechanics lien deadlines but also by the premature recording of a mechanics lien.

The case does give me some concerns though, as the earliest time a mechanics lien can be recorded and the deadline by which a mechanics lien can be recorded are both based on the date of completion or cessation of labor.  They are, in short, part of a larger whole, and can’t be viewed in isolation. Most lien claimants, in order to not get caught having recorded a mechanics lien past the statutory deadline, view completion as not including repair or punchlist work.

Reminder About the Upcoming Mechanic’s Lien Form Change

Christopher G. Hill | Construction Law Musings | June 14, 2019

As July 1, 2019 approaches with its inevitable changes to the Virginia Code, I wanted to remind you once again that the statutory form for a Virginia mechanic’s lien will change as of that date.

HB2409 passed both houses of the General Assembly and has been signed by the Governor.  This bill reconciled the language found in Virginia Code Sec. 43-4 with the various forms for general contractor, subcontractor and sub-subcontractor/supplier forms found in later sections of the code.  As you will see if you download the .pdf of the bill as signed, this involved some tweaks to 43-4 and some updates to the mechanic’s lien forms that are in the code.  The recent Desai case from the Virginia Supreme Court made it clear that such action was necessary.

Of particular note is an addition of a specific section of the form spelling out which portion if any are claimed but not due (for instance retention or money subject to pay if paid clauses) as of the date of the recording of the memorandum of lien.  Failing to spell this out on your memorandum of lien could potentially cost you a valid lien given the picky nature of these powerful but finicky beasts.  Another minor change was an amendment to 43-4 to require a statement of a date from which interest was claimed.  This last was part of the form to begin with so this won’t affect your form.

As always, be sure to work with an experienced Virginia construction attorney when calculating deadlines and populating this new form.

Preliminary Notices: Common Avoidable But Fatal Mistakes

William L. Porter | Porter Law Group

In the California building and construction industry, service of a “Preliminary Notice” is a prerequisite for Subcontractor and Supplier claims for payment through the Mechanics Lien, Stop Payment Notice and Payment Bond Claim process.  Without proper drafting and service of a Preliminary Notice, these extremely valuable claims cannot be protected. Unfortunately, despite the vital importance of the Preliminary Notice, Subcontractors and Suppliers often make common self-defeating mistakes that make their Preliminary Notice efforts completely ineffective, resulting in loss of their claims rights.  The purpose of this article is to list some of these common mistakes in the hope that the reader will avoid such mistakes, preserve the integrity of the Preliminary Notice, and protect the claims rights it makes available:

Not Sending out the Preliminary Notice Within 20 Days After Supplying Labor or Materials:

The protection of a Preliminary Notice begins 20 days before it sent out.  This means that if a Subcontractor or Supplier claimant delivered $100,000 in materials on February 1, that same claimant must serve the Preliminary Notice on or before February 21 (the sooner the better), or the claimant will not be able to pursue an enforceable Mechanics Lien, Stop Payment Notice or Payment Bond claim for that $100,000.  There are very few exceptions. Best practice: A Subcontractor or Supplier must send out the Preliminary Notice as soon as an agreement to provide work or materials to a California construction project is in place (See California Civil Code 8204).

Not Sending the Preliminary Notice by Certified, Registered or Express Mail Service:

A Preliminary Notice cannot be effectively be sent by regular US mail, or by Fax, or by e-mail.  It is true that a Preliminary Notice can be effectively “hand delivered”, but the problem with hand delivery is that months or years later, when it comes time to “prove” that the document was actually delivered, reliable proof of hand delivery usually comes up short.  More reliable methods of delivery authorized by the law include certified mail – return receipt requested, registered mail, express mail and overnight delivery by an express service carrier like UPS or FedEx. If you cannot prove you used an authorized method of service, you might as well not send out the Preliminary Notice at all.  Best Practice: Subcontractors and Suppliers should serve the Preliminary Notice by certified mail, return receipt requested or by Registered mail or by Express Mail or through overnight delivery by an express service carrier like UPS or FedEx (See California Civil Code 8110).

Failure of “Direct” Contractor to Send a Preliminary Notice When There is a Construction Lender:

The service of a Preliminary Notice is generally an issue for Subcontractors and Suppliers. However, there does exist a circumstance when the “Direct Contractor” (the Contractor who has a contract directly with the owner of the property) too must serve a Preliminary Notice in order to make an enforceable claim for construction funds.  Under California Civil Code 8200(e)(2) a Direct Contractor must serve the “Construction Lender” with a Preliminary Notice. Failure to do so will generally forfeit the Direct Contractor’s claims against funds held by the lender, including the right to record a fully enforceable mechanics lien. If you are the Direct Contractor and there is a construction loan, always be sure to serve that lender with a Preliminary Notice (See California Civil Code 8200(e)(2)).

Failure to Safeguard Proofs of Service:

It is important to safeguard proofs of service of the Preliminary Notice.  Each proof of service document should include an identification number matching an identical number on the document to be served.  The proofs of service must be retained, whether anyone signed for them on delivery or not. It does not generally matter if the intended recipient signed to indicate receipt.  What generally matters is that each proof of service was properly addressed and delivery was properly attempted, even if service was refused. Keep your return receipts and records of service attempts, even if no one signed for the document.  You will need those proofs of service later to prove procedures were followed.

Failure to Use the Proper Current Preliminary Notice Form:

The Preliminary Notice form was changed by statute in 2012 (SB 189).  New language has been added to the form. Failure to use the proper, current form puts any claim based on the Preliminary Notice at risk.  Be sure to use the most current form available or you will risk your right to pursue a Mechanics Lien, Stop Payment Notice or Payment Bond Claim to secure your payment.

Overstating the Preliminary Notice:

Overstating the amount listed in the Preliminary Notice can impact the enforceability of any later Mechanics Lien, Stop Payment Notice or Payment Bond Claim on which the Preliminary Notice is based.  List on the Preliminary Notice the proper dollar amount of the contract, subcontract or purchase order for the project. Do not anticipate change orders, interest which might or might not be accrued, or attorney fees which might or might not be incurred.  Use only the principal amount of the contract, subcontract or purchase order or other correct amount based on a rational determination.  Failure to do so may result in loss of later collection rights, including loss of Mechanics Lien and Stop Payment Notice rights (see California Civil Code 8422 and 8504).

There are many other mistakes that can be made in processing and serving the Preliminary Notice.  These include not putting the correct information into the correct locations on the form, accidentally including an incorrect address, inadequately describing the work performed or material supplied, failure to indicate the method of service or not signing the document.  Every failure exposes the claimant to the possibility that the Preliminary Notice will be challenged in court. With a document so vital to the success of a claim for payment on a construction project, Contractors, Subcontractors and Suppliers must take the time and do the best job possible.