Enforcing a Mechanic’s Lien in California? Don’t Waive Your Right to Arbitrate the Dispute

Jeff Brown | Thompson Coburn LLP | June 12, 2018

On June 6, 2018, the California Court of Appeal held that a contractor waived its right to arbitrate disputes because it recorded a mechanic’s lien and then didn’t follow California Code of Civil Procedure Section 1281.5 in its subsequent lawsuit to foreclose on the lien. In Von Becelaere Ventures, LLC v. Zenovic, the parties entered into a construction contract for a single-family residence in Laguna Beach, California. The contract had an arbitration provision as follows:

If any dispute arises concerning this Contract or the interpretation thereof, or concerning construction of the Improvements, or the Limited Warranty, customer service, defects, damages, or obligations therewith (a “Construction Dispute”), such Construction Dispute will be settled by binding arbitration.

After a dispute arose, Zenovic, the contractor, recorded a mechanic’s lien in the amount of almost $450,000, and Von Becelaere Ventures, the owner, filed a construction defect lawsuit, alleging that Zenovic breached the construction contract by

“(a) failing to properly perform and construct the Work;

(b) failing to hire properly licensed and insured subcontractors;

(c) failing to comply with proper license and insurance requirements;

(d) failing to obtain written subcontract agreements;

(e) failing to properly supervise the Work;

(f) failing to maintain and provide upon request proper accounting records;

(g) failing to properly manage expenses and allowing gross overages;

(h) failing to comply with requirements regarding change orders, improperly billing for extra work and improperly categorizing work as extra work which should have been covered under the contract as included work; and

(i) improperly filing and asserting an untimely mechanics lien and threatening to file suit to foreclose on the improper lien.”

Shortly after being served with the Von Becelaere Ventures lawsuit, Zenovic filed his own lawsuit, asserting causes of action for breach of contract, reasonable value, account stated, open book account, abuse of process, breach of the covenant of good faith and fair dealing, and foreclosure on mechanic’s lien.

Not long after, Zenovic filed a motion seeking to compel arbitration under the arbitration provision of the construction contract. The trial court denied that motion. On appeal, the Court of Appeal affirmed the trial court’s decision that Zenovic waived his right to compel arbitration because he didn’t comply with Section 1281.5, which provides:

Any person who proceeds to record and enforce a claim of lien by commencement of an action pursuant to Chapter 4 (commencing with Section 8400) of Title 2 of Part 6 of Division 4 of the Civil Code, does not thereby waive any right of arbitration the person may have pursuant to a written agreement to arbitrate, if, in filing an action to enforce the claim of lien, the claimant does either of the following: (1) Includes an allegation in the complaint that the claimant does not intend to waive any right of arbitration, and intends to move the court, within 30 days after service of the summons and complaint, for an order to stay further proceedings in the action. (2) At the same time that the complaint is filed, the claimant files an application that the action be stayed pending the arbitration of any issue, question, or dispute that is claimed to be arbitrable under the agreement and that is relevant to the action to enforce the claim of lien.

Here, Zenovic “neither included an allegation in the complaint filed in the [mechanics lien] action stating he did not intend to waive any right of arbitration and intended to seek a stay of the [mechanics lien] action (§ 1281.5, subd. (a)(1)), nor filed an application for stay at the time he filed the complaint in the [mechanics lien] action (§ 1281.5, subd. (a)(2)).” As a result, the Court of Appeal held that he waived his right to compel arbitration of the owner’s construction defect claims. The Court held that Section 1281.5 “means what it says,” and that Zenovic’s failure to comply “waived the right to arbitrate construction disputes under the terms of the construction contract.”

The Perils of Online Mechanic’s Lien Services

John R. Lockard | Vandeventer Black LLP | November 16, 2017

There are several online services that prepare and file mechanic’s liens in jurisdictions throughout the United States. I recently had the opportunity to review a memorandum for mechanic’s lien that was prepared by one of these services and filed in a local Virginia court. In reviewing the document, I discovered several problems with the memorandum of lien, including:

– It did not conform to the format included in the Code of Virginia;

– It failed to identify the general contractor or the subcontractor for the project as required by the Code of Virginia; and

– It failed to identify the correct address or parcel of property upon which the work was performed.

There is no question that the lien’s failure to identify the correct property would be fatal to the lien. For the other issues, it is not clear that each problem on its own, or even in conjunction with the other issues, would invalidate the lien. However, even if those issues would not ultimately cause the lien to fail, they would almost certainly lead to litigation over whether the lien was valid, instead of focusing on the contractor’s right to payment. The contractor could spend significant legal fees litigating these types of issues with the lien, and could still end up not being paid.

Preparing a mechanic’s lien in most jurisdictions and Virginia, in particular, is much more complex than simply filling in blanks on a form. The lien must include complete and correct information for the project. For example, the property description must match the legal parcel where the work was performed. Someone also needs to make sure that all amounts included in the lien are for work performed on that particular parcel of land. If any work at all was performed outside the limits of the parcel as shown in the property records, the entire mechanic’s lien could be invalid.

Virginia law does not require that a memorandum of mechanic’s lien be prepared or filed by an attorney; but the law is complex on lien filing and enforcement, and the types of issues above illustrate the risks of liens prepared by someone unfamiliar with the requirements of Virginia law or the details of the particular construction project. In the case described above, the lien would likely not be enforceable—meaning that the contractor would be left without security for payment for its work. Contractors and suppliers should strongly consider contacting an attorney experienced in Virginia construction law to discuss the requirements for filing a mechanic’s lien. An experienced construction law attorney can assist in preparing and enforcing a mechanic’s lien and also with pursuing other options to collect the debt.

Court Rejects Contractor’s Mechanic’s Lien Because Of ‘Intent’

David A. Dick | Thompson Coburn LLP | December 2, 2016

The Illinois Court of Appeals’ recent decision in AUI Construction Group, LLC v. Vaessen highlights the need for careful planning in structuring development agreements, construction contracts, and the use of an easement as opposed to a lease. The appeal in AUI Construction Group addressed a subcontractor’s mechanic’s lien claim against a landowner, although those two litigants were at opposite ends of multiple layers of contracts. The layers of contracts are explained below.

The case arose out of a wind farm project. The land at issue, once farmland, is owned by Louis and Carol Vaessen. The Vaessens entered into an agreement with wind farm developer GSG 7, resulting in an easement in favor of the developer to install and operate wind energy systems. The agreement required the developer to pay the Vaessens $7,500 per year. The developer contracted with Clipper to supply both the wind turbine and the tower to support the turbine. Clipper built the turbine itself, but entered into a fixed price subcontract with Postensa Wind Structures US, LLC for the construction of the tower. Although the Clipper/Postensa contract was a fixed-price contract, Postensa and AUI entered into a cost-plus subcontract where AUI agreed to build the tower. The Postensa/AUI agreement estimated that AUI’s construction costs would approximate $1.66 million. However, upon completion of its work, AUI claimed that the total cost of its work pursuant to the cost-plus agreement was just over $5.9 million. After its work was complete, AUI claimed an unpaid balance of almost $3.2 million.

AUI filed for arbitration against Postensa, and the arbitrator awarded AUI just over $3.5 million. However, Potensa filed for bankruptcy before entry of the final arbitration award. AUI then filed a complaint seeking a mechanic’s lien against the landowners. AUI claimed that its work in constructing the tower that supported the wind turbine was a valuable and permanent improvement to the landowners’ property, and that the landowners had benefitted in an amount equal to the unpaid arbitration award. Although not a factor in the court’s analysis, the court noted that the developer had agreed to indemnify the landowners from mechanic’s lien claims.

Upon pretrial motions, the trial court agreed with the position taken by the landowners and general contractor Clipper that AUI’s mechanic’s lien failed as a matter of law, because the tower was not a permanent improvement to the realty, as is necessary for a mechanic’s lien to attach. The Third District of the Court of Appeals agreed, and affirmed the trial court’s ruling dismissing the mechanic’s lien claim.

The appellate court framed the “central question” as whether “AUI’s work constituted improvement to real estate, which is lienable, as opposed to improvement to a trade fixture, which is not.” The court then noted three factors are considered in answering this question: (1) the nature of the attachment to the realty; (2) the work’s adaptation to and necessity for the use of the land; and (3) whether it was intended that the item in question be considered part of the realty. Immediately after listing the three factors, the opinion noted that “intent is the preeminent factor.”

The court noted that the first two of the three factors suggested that the tower is a lienable improvement to real estate and not a trade fixture. The tower was over 500 feet tall and had an extensive underground structure. The tower itself was obviously necessary to support the wind turbine, and necessary to the operation of the wind farm. So, the first two factors seemed to strongly favor a finding of an improvement to land as opposed to a trade fixture. However, the appellate court noted that the third factor – intent – “strongly weighs” in favor of finding the parties intended the tower as a trade fixture and not an improvement to the real estate. The court noted that the agreement between the landowners and the developer provided that the developer retained ownership of and could remove the tower (and other improvements) upon three months’ notice. The court then concluded that “[a]s the intent of the parties is the most important factor . . ., the easement agreement establishes that the tower was a trade fixture.”

The court’s analysis certainly elevated “intent” – and notably, the key documents defining intent were the agreements of the owner and the developer, not the documents or expectations of the subcontractor lien claimant. The appellate court rejected a number of other arguments asserted by the subcontractor lien claimant, consistently returning to the rationale that the agreements between the landowners and the original developer expressed the intent that the turbine and tower would be a trade fixture and not a permanent improvement to the land. The appellate court rejected the attempts to invoke the remedial purpose of the mechanic’s lien statutes. The appellate court extensively cited and then declined to follow the policy arguments made by several amici, including the Associated General Contractors of America, the American Subcontractors’ Association, and other builders’ trade groups.

The court’s opinion also rejected the plaintiff’s arguments that the easement in favor of the developer should be treated as a lease. The court recognized the significance of that distinction, in that a lease may be subject to a mechanic’s lien while an easement is not.

This decision’s embrace of “intent” as evidenced in the agreements of the landowner and the developer emphasizes the need for careful choice between an easement and a lease, and planning and documentation of development agreements and construction contracts.

New Tool for Illinois Property Owners and Lenders to Remove Mechanics Liens

William J. Dorsey and Daniel J. Elrod | Katten Muchin Rosenman LLP | January 15, 2016

Introduction

The Illinois Mechanics Lien Act has long served as a powerful collection mechanism for Illinois contractors and material suppliers that provide labour or materials for the construction of improvements to real property.(1) The act permits them not only to record mechanics liens against the real property where the work is performed, but also – unlike the legislation in many other states – to claim priority over a previously recorded mortgage up to the value of the improvements to the property. Illinois law also did not permit mechanics liens to be bonded over. Thus, disputed mechanics lien claims, which can take years to resolve through the courts, cast a long shadow on title and frequently stopped efforts to refinance, sell or foreclose in their tracks.

A recent amendment to the Illinois Mechanics Lien Act that permits owners, lenders and other lien claimants to substitute a bond in lieu of the real property itself came into effect on January 1 2016. The amendment will likely represent a sea change in the way disputed mechanics lien claims are handled in Illinois. If a property owner or lender has the wherewithal to post a bond, mechanics lienors asserting disputed lien claims can no longer tie up properties for years while their claims are litigated. Property owners can sell or refinance their properties without first paying in full a mechanics lien claim that they intend to dispute.

Requirements of Section 38.1

The new amendment, Section 38.1, permits an applicant to file with the court a petition to substitute a bond for the property that is the subject of a mechanics lien claim. An applicant may file a petition any time prior to five months after the filing of a complaint or counterclaim by a mechanics lien claimant to enforce its mechanics lien claim.(2) An ‘applicant’ may be an owner of real property, another lien claimant (eg, a mortgage holder) or a third party that holds an interest in the property (eg, a condominium association or homeowners association).

An applicant should file with the clerk of the court an eligible surety bond, which must satisfy a series of straightforward requirements – the most critical of which are as follows:

  • The bond must be equal to 175% of the claimed lien amount;
  • The principal and surety must submit to the jurisdiction of the county where the property is located; and
  • The surety must have a financial strength rating of ‘A’ and meet certain other requirements.

Once the surety bond has been obtained, applicants must file a brief petition with the clerk of the circuit court in which the property is located. The applicant must deliver written notice of the petition to the lien claimant. The lien claimant is then permitted 30 days from service of the notice to file objections to the surety bond.

If no objections are filed in this 30-day window, the applicant may proceed ex parte to establish that the surety bond is eligible. If the court agrees, it will enter an order “substituting the security of the bond for the property securing the lien claim and discharging the property described in the petition as being subject to the lien claim”.(3) If objections are filed, a hearing is set to determine the eligibility of the surety bond. Unlike many other states, where an applicant can simply file the surety bond with the county to accomplish substitution of the bond for the property, Illinois has built in an objection period, which could delay obtaining clear title to the property and any related sale or refinance.

Once a surety bond has been approved by the court, the lien claimant’s action to recover on the bond can be asserted against only the principal and surety. No other parties are necessary to the litigation. Importantly, the principal and surety become jointly and severally liable to the lien claimant, but are entitled to raise defences, which are limited to those that could have been brought against the lien claimant as if no surety bond were issued.

Attorneys’ fees awarded to prevailing party

Section 38.1 provides for a mandatory award of attorneys’ fees to the “prevailing party” in the bond litigation, an award that might not otherwise be available in mechanics lien litigation.(4) A lien claimant is deemed the prevailing party if the judgment amount is equal to at least 75% of the amount of the lien claim; the award is capped at the amount remaining on the bond after judgment. The principal is deemed the prevailing party if the judgment amount is equal to or less than 25% of the amount of the lien claim; the cap is 50% of the lien claim amount.

Accordingly…

To finish reading this article

General Contractors Beware of Subordination Clauses

Amy M. Anker, Esq. | Construction Chaos | December 10, 2014

In California, a general contractor can usually rest assured that in the event of nonpayment, it can rely upon the remedy of a mechanics lien, which remedy is, in fact, even a constitutional right. The priority rights accorded to mechanics liens are strong. For example, although California is a race-notice statute (meaning that priority is determined by notice and date of recordation), a mechanics’ lien, even if it is recorded after another encumbrance, and even if the mechanics lien claimant had notice of that earlier recorded encumbrance, takes priority over such earlier encumbrance for work performed prior to recordation of the earlier encumbrance. This means a general contractor can feel comfortable that notwithstanding an encumbrance recorded after its work has started, any mechanics lien it records for nonpayment of such work, even if the mechanics lien is recorded after a later encumbrance (which didn’t exist at the time work commenced), relates back to when work started and takes priority over such later encumbrance. Or so was the case before Moorefield Construction, Inc. v. Intervest-Mortgage Investment Company (September 12, 2014, No. D065464), in which the Fourth Appellate District Court held that a general contractor could waive its priority rights of a mechanics lien.

In 2006, general contractor Moorefield Construction, Inc. (“Moorefield”) entered into a construction contract to build a medical office building and commenced work at the property. About a month after work started, the owner of the property obtained a construction loan from Intervest-Mortgage Investment Company (“Intervest”), which loan was secured by a deed of trust on the property.  In connection with the loan, Intervest required Moorefield to subordinate its mechanics lien rights to Intervest’s deed of trust.

By the end of construction, the owner defaulted under the construction loan and failed to pay Moorefield outstanding payments totaling approximately $2.2 million. Moorefield timely recorded a mechanics lien and sued to foreclose on the mechanics lien in accordance with the statutory scheme specifically designed for this type of circumstance. Intervest filed a cross-complaint claiming that its deed of trust was senior to Moorefield’s mechanics lien given the subordination clause Moorefield agreed to.

The trial court found in favor of Moorefield and ordered the foreclosure and sale of the property to satisfy the mechanics lien. In doing so, the trial court held that the subordination clause was null, void and unenforceable largely for two reasons: first, the clause is void as a public policy matter because it would deprive Moorefield “of its mechanic’s lien priority right that is a guarantee to them (as a contractor) under the California Constitution,” and second, the clause is unenforceable since it did not substantially follow the statutory forms set forth in former California Civil Code § 3262(d) (now § 8122).

Intervest appealed and the Fourth Appellate District Court reversed, holding that Section 3262(d) does not protect general contractors, explaining that the plain language of Section 3262(a) allows a general contractor to waive its own rights. Section 3262(a) read as follows: “[n]either 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…” The Court stated: “The clear implication is that the contractor may waive or release his own claim, when doing so does not affect or impair the claims or liens of other laborers or subcontractors.”

The beneficiary under the deed of trust foreclosed on the loan and took title to the property. Moorefield’s mechanics lien, as a subordinate lien, was extinguished. Without a lien, Moorefield lost any chance of recouping more than $2 million for unpaid work.

In light of this case, California general contractors should be very mindful of any documents they may be asked to execute in connection with a construction loan, especially anything containing a subordination clause, and should always have such documents reviewed by an attorney knowledgeable in the area.

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