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Feb182010

Bank Funding Construction Loses Out Where It Failed to Let Liens Be Perfected

It happens from time to time that an act of keen business judgment in keeping a project running could come back to bite you. The realities of deadlines, the need to supply funds to keep work progressing, and the differing contractual relationships that place payments into a river flowing downstream have certainly become heller-esque over the past year. So it was only a matter of time before the legal morass wrought by an industry down on its luck managed to swim upstream as well.

To stay abreast in the stream, every lender with a mortgage on a partially completed job will want to be familiar with the Illinois Third District Appellate Court’s recent decision in LaSalle Bank N.A. v. Cypress Creek, et al. (Doc. No. 3-08-0114); preferably before they try to step in and complete a project that an owner has abandoned.

LaSalle Bank had a mortgage on 13.79 acres in Illinois securing an $8 Million loan for the development of apartments for seniors. The mortgage was recorded in 2003. The owner contracted with both Edon Construction and Eagle Concrete for work on the project. Both the Edon and Eagle contracts were entered after the mortgage was recorded. Eagle and Edon subsequently recorded mechanics liens for amounts they had not been paid.

The parties foreclosed. The judgment reflected that $3 Million was due the bank. Eagle’s lien was for roughly $60,000 and Edon’s was for $280,000. The property was sold at a sheriff’s sale in May of 2006 to LaSalle for $1,300,000. Prior to the foreclosure, LaSalle had funded construction draws to complete the work, these totaled $1,587,765. Only $30,000 of the amount funded by LaSalle was for a perfected mechanics lien that had been recorded by another party which had a contract that pre-dated the mortgage. The other $1,557,765 that LaSalle paid out to contractors completing the project was never the subject of a lien claim.

The trial court confirmed the $1.3 Million sale and allocated the proceeds of the sale in what it thought was compliance with §16 of the Mechanics Lien Act. Affording apportionment based on the value of the undeveloped land to the mortgage recorded before the Edon and Eagle contracts and to Edon and Eagle and LaSalle as a subrogated lien claimant, it had paid for the construction after all, in the amount of the improvements to the value created by the construction.

Unhappy with the workout because it gave a lion’s share of the apportioned value of the improvements to LaSalle Bank for their $1.5 Million in payments for construction (the computation is on page 5 of the slip opinion) Edon and Eagle appealed the Court’s decision to include the bank as a subrogated lien claimant for the $1.5 Million. The appellate court agreed and in doing so, has taken an interesting position regarding monies paid by owners and mortgagees from the loan proceeds. The court has interpreted the 1958, Detroit Steel (151 N.E.2d 136), opinion conferring the subrogation right to a mortgagee, as stating that the mortgagee can only be subrogated to those claims that arise from perfected liens:

“[I]n order to be subrogated to other lien claimants, the liens must be perfected liens… In the instant case, LaSalle is attempting to be subrogated for “materialmen” who have been paid as the work progressed and do not have perfected liens. Detroit Steel does not mandate that result.”

The Appellate Court reflected on the facts and found that LaSalle was therefore only subrogated to the $30,000 claim for the one lien it had paid off from the funds and could not be subrogated to the remaining amounts it paid – the $1,557,765. But it accordance with this reasoning. Had the bank waited to pay out the amounts owed for construction until lien claims from the “materialsmen” were perfected, it would be subrogated to its share of proportional payment from the amount of the sale attributable to the improvements created by the construction to the full tune of the amounts it paid.

The Court held that the total improvements, which included the amounts spent by the bank, should be allocated between Eagle and Edon because their liens were perfected. Eagle and Edon were not only given their own lien claims, the apportionment for their lien claims will now be premised on an amount that includes the monies spent by LaSalle.

Leaving aside the issue of whether the proper calculations regarding the improvements vs. the land value were performed to reach the correct allocation of the remaining monies (the opinion doesn’t completely address the full origin of the different figures supporting the allocation), the portent is clear:

A lender/mortgagee financing construction and funding draws from its loan can no longer believe that it will simply be subrogated to those amounts at the time of apportionment. It has to act to protect those rights and one method of action, if the opinion is followed, is actually to wait to pay contractors or subs until they encumber the property with properly filed liens.

What once seemed like a straightforward process in paying for labor and materials to get the project finished has now become a game in making sure the “t”s are crossed and the “i”s dotted, withholding payment until others properly assert their legal rights to a mechanics lien. Rather than turn to a construction manager to get an upside-down project completed, it appears that you’ll need to first check with your attorney to make sure you’re preserving your rights and not just offering up money to finalize a project that could eventually be counted against you.

As a side note that banks, and their attorneys, will want to remember: The Court in this case also determined that the reasonable attorneys’ fees expended by the bank in pursuing the foreclosure should have been distributed from the proceeds and had full priority over any lien amounts.

Don Lee | Comments Off | |

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Attorneys' Fees,

Bank,

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Owner,

construction

February 18, 2010

Reader Comments (5)

Hi,
In this matter of lien I guess the attorneys are going to get special commands from the court. Let’s see what is next.

Thanks,
Peter

June 4, 2010 |

Ny lien

I definitely love your own posting style, very interesting. don’t give up and also keep posting as it just simply that is worth to read it,excited to looked over far more of your articles, have a good one

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