Court Rules Construction Loan Proceeds for Contractors

Loan SignBy Ron Pierce, RB Pierce, a Professional Law Corp.

“I do not like money; money is the reason we fight.”—Karl Man

“Money won is twice as sweet as money earned.”—Paul Newman

Despising money is easy for someone who holds someone else’s money. Some­times, one must fight to gain what one has earned.

Historically, on California private works projects, lenders hold the money for construction work. Yet lenders have used such money to make disbursements to themselves, paying interest, loan fees, and their other non-construction expens­es over contractors’ stop payment notice claims. In doing so, lenders have deprived contractors of payment.

Big Decision by Court of Appeal

In January 2014, contractors won a significant decision in the California Court of Appeal by collecting their earn­ings and beating such lending practices. In this recent case, Brewer Corporation v. Point Center Financial, Inc., Point Center Financial arranged a $13.6 million loan to complete construction on a condominium project in San Diego. Third party investors provided most of the funds. Point Center entered into private loan servicing agree­ments with the investors. Under those agreements, Point Center Financial paid investors on their fractional loan interests, charged and paid itself a 1.5 percent “ser­vicing fee,” and pre-paid itself interest and fees totaling over $ 1.5 million.

All in all, Point Center Financial raised and disbursed over $12 million. However, it never funded the remaining balance of the loan. Various contractors provided labor, services, equipment, and materials to the construction project. One contrac­tor even served a bonded stop payment notice. Nevertheless, the lender failed to withhold funds.

Later, more contractors filed stop pay­ment notices. However, when monies were due and owed to the stop payment notice contractors, the lender claimed that it was out of money. Truly, it had fully disbursed all of its loan funds to it­self and to its investors. Thus, the lender 14 May/June 2014 had no more construction funds in its possession when it received the latter stop payment notices.

Contractors Push Back

The contractors fought back, filed a lawsuit, and won. The trial court ruled that the contractors’ stop payment notice rights trumped the lender’s contractual rights to pay itself and its investors. Twice as sweet, the court entered judgment for the contractors and against the lender for over $1.5 million. The Court of Appeal af­firmed the contractors’ victory.

This case decided three important legal issues. First, the appellate court followed a 1989 California appellate decision declar­ing that construction loan lenders may not pay themselves, and related loan entities, from construction loan proceeds at the ex­pense of stop payment notice contractors. Rather, contractors’ stop payment notice claims have priority over lenders’ “assign­ments” of construction loan funds.

Appeals Court Rejects Excuses

The Court of Appeal rejected many ex­cuses from the lender to justify its sweep­ing all funds from its construction loan to help, pay, and benefit only itself. The lend­er argued that it paid itself before the con­tractors filed their stop payment notices. Thus, pursuant to its agreement with the borrower, the lender had already removed the construction loans when contractors filed stop payment notices. The lender contended that it was entitled to all con­struction loan funds, or, alternatively, pro­rata distribution with the stop payment notice claimants.

However, the Court ruled that prior­ity in time is not priority in right in this context. Contractors’ construction claims have priority over lenders’ allocations and assignments of their construction loan funds, notwithstanding whether the allo­cations and assignments were made before or after the stop payment notice is served. Thus, by their loan agreements, lenders cannot create loopholes to trump the pro­tections that the California Constitution and Civil Code give to those who enhance the value of real property by supplying labor and materials.

The lender argued that it earned the in­terest, fees, and other costs that it paid to it­self, and it added that it suffered a loss on the con­struction loan because the bor­rower did not repay the loan.

However, the Court rejected these lender ar­guments, rul­ing that lenders’ Ron Pierce loan earnings

and losses were inconsequential to stop payment notice claimants’ superior rights.

Preliminary Notices Required

Second, the Court of Appeal confirmed that direct contractors must serve lend­ers with preliminary notices as a condi­tion to maintaining stop notice payment claims, unless factually excused. Third, the California Civil Code requires stop payment notice claimants to give notice of the commencement of their lawsuits to enforce their stop payment notices to the same persons who received notice of the stop payment notice. However, the appel­late court ruled that the failure to give such notice is not jurisdictional. Such notice giving does not require mandatory com­pliance. Rather, such notice is merely “di­rectory,” Therefore, a contractor’s failure to give such notice, absent prejudice to a defendant, does not bar a contractors’ stop payment notice enforcement lawsuit.

Following the Money

This article started and ended by fol­lowing the money. From California law, the principle to remember is that con­struction lenders cannot pay themselves from construction loan proceeds in pref­erence to stop payment notice contrac­tors. Based on the opening quotations, the principle to remember is that Paul New­man made much more sense than Karl Marx – and contractors’ winning their fight for construction money earned is doubly sweet. •

Ronald B. Pierce is General Counsel to Griffith Company, and President of RB PIERCE, A Professional Law Corporation, 949.244.9367, rbpierceaplc@gmail.com.

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