Creativity can Forfeit a Construction Lien

David Anderson – August 6, 2012

As a construction project winds down, money to pay for it can start to dry up. But contractors with construction liens have super-priority. That is, contractors can get their payments before other creditors get theirs. When money is short, that can be the difference between getting paid or not. But management of a construction lien requires strict compliance with lien law.

The Oregon Court of Appeals recently issued a decision that serves as a warning to contractors looking to enhance their construction lien in creative ways. In Evergreen Pacific Inc. v. Cedar Brook Way LLC, the contractor and the owner had a dispute about the contractor’s work.

The dispute itself was nothing special. The owner claimed that the contractor did not perform the work as required and did not pay the contractor. The contractor filed a construction lien claim against the property.

Then complications arose. The owner had obtained a loan from a bank and, to secure payment on that loan, granted the bank a trust deed to the property: The owner used the property as collateral for the loan. That meant that if the value of the property was less than the sum of the construction lien and the amount owed the bank under the loan, either the contractor or the bank would not be paid in full. In modern terms, if the property was underwater, not all creditors would be paid if the owner ran into financial challenges.

Not surprisingly, the bank was not happy with the situation. It counted on the property as collateral to ensure that the loan would be repaid. The owner’s refusal to pay the construction bill, even if justified, reasonably caused the bank to wonder if it would be repaid on the loan. Although some types of trust deeds or mortgages can take priority over construction liens, the bank’s trust deed in this case did not. The bank demanded that the owner take care of the construction lien.

Heeding the bank’s bidding, the owner sued the contractor to invalidate the construction lien. In an attempt to resolve the dispute in a mutually beneficial manner, the contractor and the owner reached an agreement: The owner would pay the contractor for the work it had performed, some new work and additional repair work (the owner would make an immediate partial payment and pay the balance in lump sums after the contractor finished new work or repairs).

Rather than rely exclusively on its right to file an additional construction lien if the owner again failed to pay the contractor for its work, the contractor agreed that the owner would grant the contractor a trust deed to secure payment. From the contractor’s view, this provided a belt and suspenders to ensure payment.

By tacking a trust deed on top of the right to a construction lien, the contractor sought extra payment protection. In case there was any question about its right to a construction lien, the contractor ensured that the agreement expressly stated the contractor did not release or waive the contractor’s right to record a construction lien if the owner failed to make required payments. At least that was the plan.

Even the best made plans can go awry. The contractor performed the new work it agreed to perform. But following completion of the new work, the owner refused to make payment and even refused to let the contractor access the property to finish the repairs. Meanwhile, the owner also failed to make payments on the bank’s loan. This led to a showdown between the contractor and the bank as both sought to sell the owner’s property and be paid from the sale proceeds. As expected, more litigation followed.

Between the bank and the contractor, there was no dispute that the contractor’s construction lien took priority over the bank’s trust deed. The bank argued nonetheless that the contractor’s lien was invalid because the contractor forfeited its construction lien rights by taking a deed of trust on the owner’s property.

A well-respected trial judge ruled for the contractor, explaining that the construction lien was valid and noting that the bank had no right to complain because it knew about the settlement agreement between the contractor and owner in which the contractor expressly did not waive its construction lien rights.

The bank appealed, and the Oregon Court of Appeals ruled that the trial court was mistaken. It explained that by taking a deed of trust, the contractor forfeited its right to a construction lien. As support for its decision, the court relied on cases from 1861, 1879 and 1932.

Even though those cases were very old, the court reasoned that nothing had changed. It stated, “The parties have not identified any statutory changes that undermine the general principles announced in (1879), or call the continuing viability of (those earlier decisions) into question, and we are not aware of any.”

In other words, ancient law can be enforceable when nothing has changed to affect that law.

So, what is the lesson? When it comes to construction liens, wearing a belt and suspenders is not stylish. Ancient cases can complicate the world of lien law.

Yet properly administered construction liens provide powerful payment protection for contractors. Contractors should take advantage of these liens to ensure payment on projects to the greatest extent permitted by law and business sense.

But contractors should be cautious about managing this complicated area of the law on their own. Sometimes disputes merit complex or creative solutions. In executing a unique agreement, a lawyer’s caution is needed to ensure that Civil War-era laws do not undermine what would otherwise be a benign solution.

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