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: 

http://www.courtinfo.ca.gov/opinions/documents/F062924.PDF.

 

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
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mtwllp.com
 

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FYI: US Sup Ct Rules RESPA Requires Division of Fees b/t 2 or More Persons

The Supreme Court of the United States recently held that a borrower must demonstrate that a charge for settlement services was divided between two or more persons in order for the fee splitting prohibition of the federal Real Estate Settlement Procedures Act ("RESPA") to apply.  A copy of the opinion is attached. 

 

The plaintiffs in this action were three married couples who obtained mortgage loans from the defendant lender ("Lender").  The plaintiffs alleged they were charged fees for which no services were provided, in the form of "loan discount fees," "processing fees," and "loan origination fees."

 

Lender moved for summary judgment on the ground that the plaintiffs' claims were not cognizable under RESPA, 12 U.S.C. §2607(b) ("section 2607(b)") because the allegedly unearned fees were not split with other parties.  The District Court agreed and granted summary judgment in favor of the plaintiffs.  A divided panel of the United States Court of Appeals for the Fifth Circuit affirmed.  On appeal, the Supreme Court affirmed.

 

As you may recall, section 2607(b) provides in relevant part that "[n]o person shall give and no person shall accept any portion, split, or percentage of any charge made or received for the rendering of a real estate settlement service . . . other than for services actually performed." 

 

The Supreme Court noted that the question on appeal "boil[ed] down to whether [section 2607(b)] prohibits the collection of an unearned charge by a single settlement-service provider . . . or whether it covers only transactions in which a provider shares a part of a settlement-service charge with one or more other persons who did nothing to earn that part." 

 

The plaintiffs cited to the 2001 policy statement issued by the Department of Housing and Urban Development in arguing that section 2607(b) should apply to an unearned charge by a single-settlement-service provider.  As you may recall, the policy statement provides, among other things, that section 2607(b) is not limited to situations where at least two persons split or share an unearned fee. 

 

However, the Supreme Court held that section 2607 "unambiguously covers only a settlement-service provider's splitting of a fee with one or more other persons."  The Court reasoned that "by providing that no person 'shall give' or 'shall accept' a 'portion, split, or percentage' of a 'charge' that has been 'made or received,' 'other than for services actually performed,' §2607(b) clearly describes two distinct exchanges." 

 

The Supreme Court explained that there first must be a "charge" that is "made" or "received" from a consumer by a settlement-service provider.  Next, that provider must "give," and another person "accept," a "portion, split, or percentage" of the charge.  The Court stated that "Congress's use of different sets of verbs, with distinct tenses . . . would be pointless if . . . the two transactions could be collapsed into one," as the plaintiffs argued. 

 

The plaintiffs attempted to "avoid collapsing the sequential relationship of the two stages," by arguing that it is the consumer who "give[s]" a "portion, split, or percentage" of the charge to the provider who "accept[s]" it.  The Supreme Court disagreed with the plaintiffs' interpretation, noting that it would lead to a result where the consumers were lawbreakers under the statute for giving an unearned fee.

 

The Court further stated that "[t]he phrase 'portion, split, or percentage' reinforces the conclusion that §2607(b) does not cover a situation in which the settlement service provider retains the entirety of a fee received from a consumer."  The Court noted that while "portion" and "percentage," can be used to include the entirety of the fee, it is not the normal meaning of either word. 

 

The plaintiffs also argued that if section 2607(b) is not construed to reach undivided unearned fees, then "it would be rendered 'largely surplus age' in light of §2607(a)'s express prohibition of kickbacks."  The Court did not agree, stating that "each subsection reaches conduct the other does not." 

 

Finally, the plaintiffs argued that the purpose of RESPA would be served by applying the statute in the manner they proposed.  The Court again disagreed, stating that "[v]ague notions of statutory purpose provide no warrant for expanding §2607(b)'s prohibition beyond the field to which it is unambiguously limited: the splitting of fees paid for settlement services."  
 

Ralph T. Wutscher
McGinnis Tessitore Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mtwllp.com
 

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FYI: Cal App Ct Rejects Another MERS-based Challenge to Foreclosure Sale

The California Court of Appeal, Fourth District recently rejected allegations that a foreclosure sale was conducted improperly, and in so doing held that where MERS' status as beneficiary is not reasonably subject to dispute, it is presumed that MERS has the authority to assign the security instrument and the note. 
 
A copy of the opinion is available at:

http://www.courtinfo.ca.gov/opinions/documents/E052943.PDF.

 

The borrowers defaulted on their home loan.  The security instrument for that loan ("DOT") named Mortgage Electronic Registration Systems ("MERS") as beneficiary, acting as nominee for the lender.  The DOT further provided that MERS had, among other things, the right to foreclose and sell the subject property, and otherwise to "take any action required of Lender..." 

 

The lender's assets were transferred to the Federal Deposit Insurance Corporation ("FDIC"), and were subsequently sold to a third party (the "loan owner").  MERS then executed an assignment transferring all interests in the DOT and the note to the loan owner.  The loan owner also executed a document naming a new entity trustee of the DOT (the "trustee").  The loan owner then assigned its interest in the DOT and note to Fannie Mae. 

 

The trustee then recorded a notice of trustee's sale, and the subject property was sold and reverted to Fannie Mae in a nonjudicial foreclosure sale. 

 

The borrowers filed suit, seeking to set aside the foreclosure sale.  Fannie Mae demurred to the borrowers' complaint, which the trial court ultimately granted as to each cause of action laid out in the complaint.  The borrowers appealed. 

 

The borrowers raised several issues on appeal, including among others: (1) whether the assignments of the DOT and note from MERS to the loan owner and from the loan owner to Fannie Mae were valid; and (2) whether the substitution of trustee was valid.

 

The Court ruled in favor of Fannie Mae as to both arguments.   

 

The borrowers' arguments regarding the invalidity of the assignments hinged on various allegations related to MERS.  Specifically, the borrowers alleged among other things that MERS had no agency relationship with FDIC; that the individual who executed the assignment of the DOT from MERS to the loan owner in fact worked for the loan owner, not MERS; and that that assignment was invalid because it allegedly took place after the lender had dissolved.

 

The Court rejected these arguments, relying heavily on the fact that the DOT provided that MERS had the right to exercise all interests and rights held by the lender and its successors.  Further, the Court cited case law providing that where MERS's status as beneficiary was "not reasonably subject to dispute," it is presumed that MERS had the authority to assign both the DOT and the Note.  Fontenot v. Wells Fargo Bank, N.A. (2011) 198 Cal.App.4th 256, 268-70.

 

In addition, the Court noted that to state a claim, the borrowers were required to allege not only that MERS's assignment was invalid, but also that Fannie did not receive an assignment in any other manner.  Specifically, the Court observed that the owner or Fannie Mae could have received an unrecorded assignment of the note, "who then would have had the authority to foreclose, regardless of MERS's assignment of the DOT." 

 

Therefore, the Court held that the borrowers "failed affirmatively to plead specific facts demonstrating the sale was invalid."

 

The Court used similar reasoning to reject the borrowers' substitution of trustee argument.  That argument rested on the borrowers' contention that the assignment of the DOT to the loan owner was void.  Because the Court rejected that contention, it concluded that "there was no showing that the substitution of trustee was void." 

 

Although it disposed of the above-referenced allegations on other grounds, the Court found an additional defect with the borrowers' arguments: even if the borrowers could show that the assignments in question were invalid, they did not establish that they were prejudiced by these alleged infirmities.  Because the borrowers did not contest that they defaulted on their home loan, the Court observed that "if MERS lacked authority to assign the note...the true victims were not [the borrowers] but the lender."

 

Accordingly, the Court affirmed the decision of the lower court.  

 

Ralph T. Wutscher
McGinnis Tessitore Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mtwllp.com
 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.

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