Mechanics Liens: Part 5

Some problems

1. Time.   Suppose S, a concrete sub, completes the concrete work on a residence on June 1.  Ninety days later, the entire residence is finished and the owner moves in.  10 days after that, 100 days after finishing its part of the work, the concrete contractor then records a mechanic’s lien.  Is it timely?  Yes.  The 90 days runs from completion of the entire work of improvement. Time is computed from the completion of the work of improvement as a whole.

The theory is that a potential lien claimant can always find out when the 90 day period starts to run by going to the job site and observing whether there is work going on or it has been finished.

What if the concrete sub had recorded a lien when he first finished and the 90 day period had run without foreclosing on the lien, the concrete sub can record a second lien within 90 days from completion

2. Completion.  Completion occurs when the work is finished, regardless of pick-up or warranty or call-back items

Occupation of the work by the owner equals completion.

Cessation and a recorded notice is the equivalent of completion, even though the job is not actually completed.  A notice of cessation recorded shortens the lien time to 30 days and 60 days once the 60 day period of cessation occurs.

  1. When does a sub or material supplier that deals directly with the owner have to record a lien?  If a notice of completion was recorded, the general would have 60 days to record its lien.  The material supplier or sub recorded its lien(s) within 40 days.  They were no good since 40 days was beyond the 30 day time period allowed to claimants other than direct or prime contractors.
  2. Foreclosure suit.  Suppose M records a mechanic’s lien and has a bona fide dispute with the owner regarding some items of work and the quality. M acknowledges some back charges are warranted. Since it is inexpensive to record a lien, M figures that he can keep owner’s property tied up.  The 90 days on the lien will lapse unless there is a lien foreclosure lawsuit filed by M.

5. What if O hires K to build a residence for $100,000.  K builds the residence, O pays the $100,000 and K become bankrupt.  Then the unpaid subs and material suppliers record mechanic’s liens against O’s property.  O finds that in order to preserve its property, it has to pay off $30,000 worth of mechanic’ liens claims. The result is that O has paid $130,000 for the residence instead of $100,000 it agreed to pay.  How can O be protected?

If the contractor, K, is required to furnish a labor and material (“payment”) bond under which the bonding company guarantees that the contractor will pay for all work and materials used on the job. If the mechanic’s lien claims ensue, the owner may call upon the bonding company to pay them and remove them from the owner’s title.

  1. Priorities.  What if there are more than one mechanic’s lien recorded on a piece of property?  Suppose the foundation contractor has a mechanic’s lien for $8000 and a painting contractor on the same job has a mechanic’s lien for $4000. The court forecloses both liens and the sheriff holds a sale.  However, there is only $6000 above the money owed the lenders for the lien claimants, who are junior to the deeds of trust on the property, the $6000 will be distributed pro­-rata.  The foundation contractor will receive $4000 and the painting contractor will receive $2000.

6a. Priority from commencement of improvement.  Under the law, mechanic’s liens are preferred to any encumbrance that attaches after the work of improvement commenced.  The same rule applies to deeds as well as encumbrances.

Suppose O hires K to build a house.  K pours the foundation and then O deeds the property to B.  The mechanic’s lien of K would have priority over the title of B.

Suppose O borrows money from L and gives L a trust deed on the property, which L records.  10 days later O hires K to build a house and K starts work.  The trust deed would have priority over K’s mechanic’s lien since it was recorded before work began.

Now, suppose O gives L a trust deed and then hires K to build a house.  K pours the foundations and later, L records the trust deed.  The mechanic’s lien claim of K would have priority over the trust deed.  Assuming K did not know about the trust deed when he started work.  Moreover, the liens of all subs and suppliers would have priority over the trust deed, since all mechanic’s liens share the same priority and take their priority from commencement of the construction.

  1. Priority over deeds of trust.

Most of construction is funded by construction loans

Suppose O wants to build an apartment building that will cost $1 million but has no money.  O does have a lot worth $100,000.  O takes the plans to L, a savings and loan, and asks for a loan.  They give O a secured loan of $1 million.

O owns a completed apartment building worth $1 million and borrows $1 million from L and signs a promissory note.  A deed of trust is recorded.

Construction loans are different from a straight deed of trust.  L does not hand O a check for $1 million as soon as the trust deed is recorded because the loan would not be adequately secured.  L would have a promissory note for $1 million but a trust deed against property only worth $100,000.

When L makes a construction loan, O signs a promissory note and trust deed, but also a construction loan agreement.  Under the agreement L transfers the net proceeds of the construction loan to an account held by L in the name of O.  L then pays out the money only as the building is completed. In theory the value of the construction loan or the amount disbursed never exceeds the value of the improved property.

Since uncompleted property is not readily marketable the actual value of the completed property is not marketable at the $1.5million price.

The value of the mechanic’s lien depends on whether is “ahead of” or “behind” the construction loan. Is the construction loan is ahead of the mechanic’s lien?  The mechanic’s lien applies only against O’s equity in the property.  If O has an apartment building worth $1.5 million and the property is encumbered by a $1 million trust deed, O’s equity is $500,000.

If K records and forecloses a mechanics lien against O, the end result is a court order directing the sheriff to sell the property at a public auction to the highest bidder.  Whoever gets the property is subject to the construction loan of $1 million.  If K has a mechanic’s lien of $150,000 and O has an equity of $500,000.  K can be fairly certain that the sheriff’s sale will attract outside bidding and that the sheriff will receive enough money from the sale to pay the mechanic’s liens.  However, if O’s equity is only $50,000, K’s mechanic’s lien is worthless.

Here is another hypothetical:

Suppose O wants to buy a piece of land and build apartments. O finds a parcel owned by S.  S agrees to sell the parcel for $200,000, with $50,000 down and $150,000 in the form of a promissory note secured by a subordinated 2nd trust deed. Now O takes the plans and land purchase agreement to L the lender and obtains a commitment for $1 million construction loan. There is a single escrow. At the close of the escrow, O is the owner of the property subject to the first trust deed of $1 million and a second trust deed of $150,000.  Building commences and for some reason O cannot complete the project and can’t pay the contractors.  L has disbursed $500,000 of the $1 million for construction and mechanic’s liens have been recorded by the contractor and subs of $200,000.  The market value of the property is $500,000.  What equity does the mechanic’s liens have to look to satisfy the $200,000?

L’s first trust deed is $500,000 plus interest.  S’s second td is $150,000.  The property is worth $500,000.  There is no equity and the mechanic’s lien is valueless.  However, if the mechanic’s lien had priority over the first and second trust deeds.  They would be of great value because the property is worth $450,000 and the mechanic’s liens are only worth $200,000 therefore the foreclosure value of the mechanics liens usually depends on whether there is priority over the construction deed or deeds of trust against the property.

  1. Optional advances

The money on a construction loan is usually advanced in stages and may either be optional or obligatory.  The money is advanced as the job progresses.  The “draws” as they are called is used by O to pay the contractor and in turn the general contractor.

Often the lender makes advances as the job progresses after mechanic’s liens have arisen against the property. Who has priority?  The entire loan or amount or the mechanics liens?

Suppose O borrows $200,000 from L secured by a trust deed. The trust deed gives L the right to lend an additional $100,000 to O which will automatically become secured by the existing trust deed. After the trust deed is recorded, O hires K to remodel the house.  K performs the remodeling job, is unpaid, and records a mechanic’s lien. O borrows an additional $100,000 from L one week later and gives L a promissory note which provides that the additional advance of $100,000 is secured by the original trust deed.  Who has priority; K, the contractor or L, the lender?

The answer is that L has priority to the $200,000.  However, the additional advance of $100,000 is junior to the mechanic’s lien claim. The law does not allow or permit the holder of a prior recorded trust deed what knowledge of mechanic’s lien claims to defeat them by making further advances to the owner.  Non-obligatory disbursements made after the recording of mechanic’s lien claim are junior to the mechanic’s lien.

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© 2013 Robert L. Bachman