On August 28, 2013, the Minnesota Supreme Court issued its decision in Big Lake Lumber Inc. v. Security Property Investments, Inc., rejecting an attempt by the Court of Appeals to clarify the test for when work done by a contractor after a mortgage is recorded relates back to pre-mortgage work.  Under Minnesota’s mechanic’s lien statutes, where post-mortgage work does relate back to the “visible beginning of the improvement,” a lien for the post-mortgage work has priority over the mortgage.  See Minn. Stat. § 514.05.

I. Factual Background.

In 2005, a company owned by Mark Hilde purchased an unimproved and heavily wooded lot in Zimmerman, Minnesota.  At the time of his company’s purchase, Hilde planned to build a house to live in for several years and then sell.  After his purchase, Hilde hired Wruck Excavating to clear a path on the property and design a septic system and contracted with Big Lake Lumber Inc. to draft preliminary building plans.  After this work was completed, Hilde changed course and decided instead to build a “spec home.”

On October 26, 2006, Hilde sold the property.  The purchasing party took out a mortgage against the property to secure a construction loan and the mortgage was recorded the following day.  After the mortgage was recorded, Wruck installed the septic system it had designed in 2005, and J. DesMarais Construction began working as general contractor to build the spec home.  In March 2007, Big Lake recorded a mechanic’s lien for materials and labor it had furnished beginning in November 2006 (just after the mortgage was recorded) and four months later, DesMarais recorded it own mechanic’s lien for labor first furnished beginning in January 2007.  When the purchaser defaulted on the mortgage a year later, the bank foreclosed and Big Lake commenced its mechanic’s lien foreclosure action.  In the resulting lien priority dispute, the district court determined that Big Lake’s and DesMarais’s post-mortgage work related back to Wruck’s initial 2005 excavation and therefore had priority over the bank’s mortgage.  The court of appeals reversed, applying the “integrated analysis” that the supreme court would later reject.

II. The Rejected Integrated Analysis.

To establish that post-mortgage work relates to the “actual and visible beginning of a project of improvement,” the holder of the mechanic’s lien must show that “the work underlying the lien ‘bears directly’ on the project of improvement and not merely on ‘the overall project involved.”  Big Lake Lumber Inc. v. Security Property Investments, Inc., 820 N.W.2d 253, 259 (Minn. Ct. App. 2012).  The court of appeals determined that two tests had been established to ascertain whether the later work bore directly on the prior work:  (1) “whether two projects of improvement to property are separate and therefore not continuous”; and (2) whether a project of improvement has been abandoned.  The continuity test consists of four factors, including “the parties’ intent, what the contracts covered, the time lapse between projects, and financing.”  Id. at 260.  The abandonment analysis calls for related consideration of “the parties’ objective manifestations of their intent and the actual and visible condition of the property in which the improvement is located as revealed by an inspection of the premises.”  Id.  After detailing these two tests, the court of appeals stated, “In reliance on supreme court caselaw, we now integrate these analyses into a single framework for application in all disputes over the priority of mechanic’s liens and mortgages under section 514.05.”  Id. at 261.

Applying its new integrated analysis, the court of appeals held that as a matter of law, the post-mortgage work was not a part of the same continuous project of improvement, rejecting the district court’s finding that the work done was all related to the “single improvement of constructing a home on the Property.”  The court of appeals noted that several factors weighed against finding one continuous improvement, including the change in the intended purpose for which the home would be used (from personal residence to spec home), the new financing obtained for the spec home, and the passage of fourteen months, necessitating additional excavation work when construction resumed.

III. The Supreme Court Reversal.

The supreme court expressly rejected the “integrated analysis” that the court of appeals purported to lay out “for application in all disputes over the priority of mechanic’s liens and mortgages under section 514.05.”  In doing so, the supreme court did not propose an alternate test, instead stressing that a mechanic’s lien priority inquiry is fact-specific and must be answered by reference to the statutory language, and not rote application of the continuity and abandonment tests.  In particular, the court directed lower courts to consider “whether the pre-mortgage work on which the lien claimant relies ‘bears directly on’ the project of improvement and not merely on the ‘overall project involved,’” and whether the pre-mortgage work is “a part and parcel of the work” of improvement.  While the court acknowledged that the four-factor continuity test and two-factor abandonment test will often be relevant, it stressed the importance of grounding analysis in the statutory language, rather than in “a multi-factor test that imposes additional requirements beyond the statutory language.”

Having established the law governing priority of mechanic’s liens, the supreme court held that the district court’s decision was reasonably supported by the evidence.  The 2005 Wruck excavation constituted the “actual and visible beginning” of a project to build a home, which was later continued by Big Lake and DesMarais.  The liens were accordingly prior to the bank’s mortgage.

In practical application, the Big Lake holding reinforces the importance that financing institutions obtain a visual inspection of property prior to entering into mortgage agreements.  Such an inspection will go far toward documenting whether an “actual and visible beginning of a project of improvement” is present and protecting mortgagees from becoming embroiled in later mechanic’s lien priority disputes.  If such disputes do arise, the mortgagee will be armed with the type of evidence necessary to prevail in the fact-intensive analysis of a mechanic’s lien priority dispute.