Introduction

The Court of Appeal in the Fourth District of California recently held that a general contractor’s mechanic’s lien rights were subordinated to a lender’s deed of trust such that a mechanic’s lien was extinguished when a lender foreclosed on its deed of trust. As a result, a general contractor lost its right to approximately $2.2 million in unpaid wages for work done on the project.

This decision is significant in a number of respects, but most notably because it cuts against California public policy, which strongly supports the preservation of laws which give laborers and materialmen security for their claims. In reaching its decision, the court concluded that neither the plain language of the California Constitution nor the California Civil Code prevented a general contractor from subordinating its mechanic’s lien rights.

Background

DBN Parkside, LLC, purchased certain real property with a loan from BankFirst to construct a medical office complex. Thereafter, Moorefield Construction, Inc., entered into a contract with DBN for the construction of the project. After DBN and Moorefield entered into the contract, DBN entered into an agreement with Intervest-Mortgage Investment Company and Sterling Savings Bank (collectively, “lenders”) whereby the lenders agreed to provide a construction loan to DBN secured by a deed of trust on the property.

As part of the lending agreement, Moorefield was required to sign and consent to a subordination clause whereby Moorefield agreed that “any and all payments made or payable to it” were subordinate to the loan and that “any and all liens for labor done and materials and services furnished pursuant to the Contract or otherwise” were subordinate to the deed of trust.

Throughout the course of the project, Moorefield submitted 16 payment applications that were all approved and funded by DBN. Subsequently, Moorefield submitted two final payment applications totaling approximately $2.2 million, but DBN defaulted on its construction loan agreement with the lenders. As a result, Moorefield recorded a mechanic’s lien against the property for the two unpaid payment applications and filed a lawsuit to foreclose on the liens.

The trial court found that Moorefield’s mechanic’s lien was valid and had priority over the lenders’ deed of trust because in the trial court’s view, the subordination clause in the contract violated California public policy. Specifically, the trial court held that the subordination clause would deprive Moorefield of its mechanic’s lien priority right that is a guarantee to a contractor under the California Constitution. The lenders appealed.

Decision

On appeal, the court of appeal reversed the trial court’s decision and held that the subordination clause was enforceable. In making its decision, the court relied on the plain language of Section 3262(d) of the California Civil Code, which states:

Neither the owner nor original contractor by any term of a contract, or otherwise, shall waive, affect, or impair the claims and liens of other persons whether with or without notice except by their written consent, and any term of the contract to that effect shall be null and void.

In holding that Moorefield could subordinate its mechanic’s lien rights, the court reasoned that the plain language of Section 3262(d) prevents an owner or general contractor from waiving or impairing the claims and liens of other persons, not from waiving or impairing its own rights. In other words, Section 3262(d) does not prevent a general contractor from waiving its own mechanic’s lien rights. Instead, Section 3262(d) only prevents a general contractor from waiving the rights of its subcontractor without the subcontractor’s consent.

In reaching its decision, the court also considered Moorefield’s argument that enforcing the subordination clause would be contrary to California public policy. Specifically, Moorefield argued that the court’s interpretation of Section 3262 contradicts the purpose of the statutory scheme governing mechanic’s liens. The court, however, rejected Moorefield’s argument and stated that the general rule that mechanic’s lien statutes should be interpreted in favor of the lien claimant cannot override the plain language of Section 3262.

Because the court concluded that the subordination clause was valid and not contrary to California public policy, the court held that Moorefield’s mechanic’s lien was subordinated to the lenders’ deed of trust. Accordingly, the court of appeal reversed the trial court’s judgment with instructions to enter judgment in favor of the lenders. When the lenders foreclosed on its deed of trust, Moorefield’s mechanic’s lien was extinguished.

Takeaways

This decision clearly holds that a subordination agreement, when a lender’s deed of trust is in first position, takes priority over a general contractor’s mechanic’s lien. As a result, general contractors in California, and possibly elsewhere, must be cautious when reviewing their contracts for clauses subordinating or releasing their lien rights.

Although the court’s decision in Moorefield is binding, labor associations, such as the American Subcontractors Association, have asked the California Supreme Court to grant a petition for review, or at a minimum to depublish the Moorefield decision. For the time being, if a contractor has any confusion regarding any subordination provisions, it should consult with legal counsel to understand the implications and alternatives in connection with signing such agreements.

Moorefield Construction, Inc. v. Intervest-Mortgage Investment Co., 230 Cal. App. 4th 146 (2014)