Saturday, May 26, 2012

FYI: Cal App Ct Rules in Favor of Lender Under "Direct Contract" with Owner in Mechanics Lien Dispute

The California Court of Appeal, Fifth District, recently held that a mechanic's lien was unenforceable against a lender that foreclosed on a commercial real estate development project, where the supplier of material under "direct contract" with the owner of the development failed to provide a preliminary 20-day notice of the lien to the lender as required by California's mechanic's lien statute.
A copy of the opinion is available at: 
Several property developers undertook a real estate development project funded in part by a construction loan from the defendant lender ("Lender") to one of the developers ("Borrower") that owned certain properties involved in the project.  The loan was secured by a deed of trust.  Plaintiff-appellant, a tree nursery, entered into a contract with the owner of the project (the "Owner") to provide almost two thousand mature trees for the site.  After receiving a deposit, Plaintiff delivered about a thousand trees, which were never planted and eventually died.  In an attempt to recover almost $2 million still owed for the delivered trees, Plaintiff filed a materialman's lien against the Owner and developers.
Shortly thereafter, the Borrower defaulted on the construction loan.  Plaintiff filed suit to enforce its lien, in part seeking a declaratory judgment that its lien had priority over the Lender's deed of trust and to enjoin the Lender's foreclosure action pending resolution of the priority issue.
Lender then moved to remove Plaintiff's lien and expunge the lis pendens, asserting that Plaintiff was not able to demonstrate the probable validity of its lien, because the Plaintiff had failed to serve the Lender with a preliminary 20-day notice as required by California Civil Code Section 3097.  The trial court agreed and granted the motion. 
Sometime thereafter, the Lender, having foreclosed and acquired title to the property covered by the trustee's deed,  moved for judgment on the pleadings, arguing that the Plaintiff could not prevail on its causes of action for declaratory relief or to enjoin the foreclosure, because the lien had been removed and the Lender had already foreclosed.  Plaintiff did not oppose the motion and the trial court entered judgment for the Lender. 
Plaintiff appealed, arguing that it was exempt from giving a preliminary 20-day notice to the Lender prior to filing the lien because it had a "direct contract" with the Owner of the development. 
The Court of Appeal affirmed. 
As you may recall, California Civil Code Section 3097 provides: 
"'Preliminary 20-day notice (private work)' means a written notice from a claimant that is given prior to the recording of a mechanic's lien . . . and is required to be given under the following circumstances:
(a) Except one under direct contract with the owner . . . every person who furnishes labor, service, equipment, or material for which a lien . . . otherwise can be claimed under this title  . . . , shall, as a necessary prerequisite to the validity of any claim of lien, . . . cause to be given to the owner . . . to the original contractor, . . . and to the construction lender, if any, . . .  a written preliminary notice as prescribed by this section. . . .
(b) Except the contractor, . . . all persons who have a direct contract with the owner and who furnish labor, service, equipment, or material for which a lien . . . otherwise can be claimed under this title, . . . shall, as a necessary prerequisite to the validity of any claim of lien, cause to be given to the construction lender, if any, . . . a written preliminary notice as prescribed by this section."
The Appellate Court held that the legislature's intent to provide owners and lenders notice of potential claims arising from contracts to which they were not parties required strict compliance with the mechanic's lien statute.  Accordingly, the Court rejected the Plaintiff's arguments that it was exempt from giving the 20-day preliminary notice to the Lender, because (1) it was excepted under either subdivision (a) or (b) of Section 3097; or (2) because it was a "contractor" within the meaning of subdivision (b).
In so ruling, the Court noted that although subdivisions (a) and (b) were "inartfully drawn," the provisions could be interpreted in such a way as to avoid making either subdivision meaningless "surplusage."  Accordingly, the Court ruled that a materialman must meet the requirements under both subdivisions in order to be exempt from the preliminary notice requirement.  Specifically, the Court interpreted the phrase "under the following circumstances" to mean that all of the circumstances set forth in Section 3097 must apply, and that the two subdivisions were not alternatives, as the Plaintiff had argued. 
The Appellate Court also pointed out, that although there was some overlap in the two subdivisions with respect to a construction lender, applying both subdivisions to one materialman did not render either subdivision superfluous.
Moreover, in rejecting the Plaintiff's second argument that a person with a "direct contract" with the Owner is a "contractor" for purposes of section 3097, and therefore exempt from providing the Lender the preliminary 20-day notice, the Court determined that the Plaintiff's interpretation would render subdivision (b) meaningless.   Finding support for its interpretation in other court opinions, the Court concluded that the term "contractor" in subdivision (b) referred to the general contractor for the whole project, not to persons with a "direct contract" with the owner, such as the Plaintiff in this case.  See, e.g., Westfour Corp. v. California First Bank, 3 Cal. App.4th 1554, 1561(1992); Kodiak Industries Inc. v. Ellis, 185 Cal. App.3d 75, 82 n.3 (1986). 
Accordingly, the Appellate Court affirmed the lower court's ruling that the Plaintiff's lien was unenforceable for failure to provide the 20-day preliminary notice to the Lender.

Ralph T. Wutscher
McGinnis Tessitore Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
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