Lien on Me (When Your Priority’s Gone)Imagine this scenario. You are the developer for a new mixed-used facility. Months went into clearing all of the zoning and financing hurdles, but now everything is in place. All that remains is for the lender to finish the loan paperwork and record a security deed. However, upon visiting the site, you notice that materials and equipment are already there. Some clearing has been completed and grading work begun. There appears to have been a miscommunication with the contractor, which directed its subcontractors to commence with project preparation. What is the effect, if any, on the priority of lien rights?

When construction work begins before a mortgage or deed securing the construction loan is finalized and recorded, the situation is sometimes referred to as “broken priority.” Broken priority can occur in jurisdictions that have adopted a “relation back” approach to materialman/mechanic’s liens. As an example, in California, “A lien under this chapter . . . has priority over a lien, mortgage, deed of trust, or other encumbrance on the work of improvement or the real property on which the work of improvement is situated, that (1) attaches after commencement of the work of improvement or (2) was unrecorded at the commencement of the work of improvement and of which the claimant had no notice” (Cal. Civ. Code § 8450). Under the “relation back” approach, a contractor or materialman may not have actually recorded a lien, but its lien rights could trump a security deed that the lender recorded after construction work began. Thus, even though there is no recorded lien or encumbrance that pre-dates the lender’s mortgage or deed, a contractor or materialman could record its lien months later and have superior lien rights to the lender.

Depending on what side of the table you are on, broken priority can be a significant issue. For owners or developers, broken priority can make it difficult to actually close the construction loan. The bank may not lend the funds, and the title company may not insure the loan because there is no longer certainty that the construction loan will be the senior lien on the property. A materialman or mechanic’s lien could cut in front of the lender in the priority line. Until lien waivers are obtained from each contractor that has performed work and each supplier that has provided materials, project financing may be cancelled or delayed.

For contractors, subcontractors, or material suppliers, the “relation back” doctrine can actually boost lien priority. A contractor considering recording a lien should check the land records to see when the security deed for the construction loan was actually recorded. If work began before that date, the contractor’s lien may trump the lender’s lien and allow the contractor to be paid first from the proceeds of a foreclosure.

Other jurisdictions, such as Missouri, employ a “first spade” rule. This rule is unique in that “a deed of trust recorded after the commencement of work on a project is inferior to any mechanic’s liens arising on the land from that work.” Thus, even contractors or material suppliers that got involved later in the project can take advantage of the “first spade” rule if any work commenced before the recordation of the deed or mortgage securing the construction loan. Under this rule, all mechanic’s lien claimants are on equal footing.

Due to the potential consequences of broken priority, construction lenders and title underwriters should (1) try to confirm that no work has commenced before lending funds or issuing a policy, or (2) obtain lien subordination agreements from any contractor or materialman that has already begun work or provided supplies, or (3) do both. Conversely, contractors, subcontractors, or material suppliers, should never assume that a security deed for a construction loan is automatically superior, except where they have signed a subordination agreement. In short, construction loan closing and the beginning of construction work are critical dates for determining lien priority that all parties should carefully monitor.

When Substantial Compliance ‘Trumps’ Strict Construction of Florida Lien LawsIn Florida, to perfect its right to lien a property, a subcontractor is required to submit a Notice to Owner (NTO) within 45 days of commencing its work. Among other requirements, the NTO must list the contractor’s name and be served upon the owner and any party designated for service by the owner within the time period described above. Generally, Florida courts have taken a lenient approach to compliance with the substantive requirements of the NTO under applicable law. However, errors or omissions in the NTO can be grounds for voiding a subcontractor’s lien.

In Trump Endeavor 12 LLC v. Fernich, Inc. (d/b/a The Paint Spot), a Florida District Court of Appeal recently addressed how using the incorrect name of the general contractor in an NTO affected a painting subcontractor’s lien rights on a resort renovation project. After a fact-intensive analysis, the court determined that the subcontractor had substantially complied with the requirements of Florida’s lien laws, and, that absent any adverse impact to the owner, substantial compliance was sufficient to preserve the subcontractor’s lien rights.

The court’s decision keyed in on the following facts: (1) The defect in the NTO resulted from the owner’s providing the subcontractor with a notice of commencement that listed the wrong general contractor; (2) the correct general contractor, designated by the owner for receipt of the NTO, received actual and timely notice that the subcontractor was supplying materials to the project; (3) the general contractor treated the subcontractor as a potential lienor during the performance of the work by having the subcontractor attend meetings and sign partial lien waivers in requesting payments; and, (4) the owner could not demonstrate any adverse impact caused by the error on the NTO. The court reached its conclusion despite the fact that the subcontractor had received notice of the defect in its NTO prior to commencing its work but failed to correct the deficiency.

The court awarded fees and costs to the subcontractor, and it’s likely that the award caused the final judgment to balloon substantially from the subcontractor’s original lien amount of $32,535.87. Further, the owner also faced the sunk costs of its own attorneys’ fees through the trial and appeal. Rather than relying on an uncertain and factually dependent interpretation of Florida lien law, the owner would have been better served by settling the lien amount directly with the subcontractor to avoid the substantial added costs of litigation—costs that may have ultimately dwarfed the original lien.

The Trump case demonstrates that Florida courts may go to great lengths to preserve a subcontractor’s lien rights. However, the court also noted that the timing requirements in Florida’s lien laws require strict compliance, so the lack of actual notice within the 45-day prescribed period on all required parties may void a subcontractor’s lien rights. Understanding the Florida courts’ approach to these lien law issues is important because reliance on an incorrect interpretation of compliance requirements may result in an unfavorable ruling and the assessment of attorneys’ fees and costs (Note: non-compliant lien claimants may also be exposed to slander of title damages).

This case also illustrates the importance of getting the lien requirements straight before one begins work in a given jurisdiction. Many jurisdictions provide for notice prior or shortly after beginning work. And, the case is a reminder that, if you are informed that your lien notice is somehow defective, consult a lawyer about whether and how to correct it.