In 2006, Point Center Financial, Inc. ("Point Center") entered into a contract with a project owner to lend $13,625,000 to fund a condominium project in Balboa Park near San Diego. Point Center pre-paid itself $1,555,771.37 to cover its interest, loan points, and other fees. In June 2007, Brewer Corporation, a subcontractor on the project, served the Point Center a bonded stop notice. Point Center failed to withhold the required funds pursuant to this stop notice. Point Center fully disbursed all amounts of the construction loan fund by October 2007. Three additional subcontractors, Brady Company, Dynalectric Company and Division 8, Inc. served stop notices on Point Center in March and April 2008. Point Center did not withhold any amounts pursuant to these stop notices as all construction loan funds had been disbursed.

The subcontractors filed actions against Point Center, the project owner and others. The owner declared bankruptcy, leaving the sole issue before the court Point Center's liability with respect to the stop notice claims. The subcontractors argued that former Civil Code section 3166 prohibits assignments of construction loan funds before or after receipt of a stop notice. The trial court agreed, finding the subcontractors' stop notice claims took precedence over Point Center's contractual right to pay itself preallocated expenses. The trial court awarded the subcontractors $1,555,771.37 and Point Center appealed.

An owner or construction lender is required to withhold sufficient funds owed to the contractor upon receipt of a stop notice. Point Center argued it could not withhold any funds pursuant to the stop notices because there were no remaining undisbursed funds. Moreover, Point Center argued the pre-payment of its expenses was not an assignment, but rather the means by which the Point Center may obtain the bargained for consideration under its contract with the property owner. The Court of Appeal disagreed, finding that a preallocation of construction loan funds and periodic disbursements were "assignments" within the meaning of former Civil Code section 3166. The purpose of the loan was to fund the construction project. Thus, a stop notice claimant has priority over any "assignment" of the construction loan funds, even if made before a stop notice is served. If the terms of a private loan agreement determined the rights of stop notice claimants, a lender and owner could effectively eliminate those rights. The Court of Appeal agreed that lenders may draft construction loan agreements to give themselves a contractual right of priority; however a court may reach back to funds a lender disbursed to itself as a source to pay stop notice claimants.

Point Center also appealed the trial court's finding related to the stop notice served by Dynalectric Company ("Dynalectric"). Point Center argued that Dynalectric failed to serve a preliminary 20-day notice upon the lender prior to serving its stop notice. A preliminary notice must be served within 20 days after a claimant begins providing services or materials. The purpose of this notice is to alert property owners and lenders of the existence of a project subcontractor or supplier that might serve a mechanic's lien or stop notice upon the project. Dynalectric claimed it did not need to serve Point Center with a preliminary notice as it had a direct contract with the owner. Dynalectric, however, was not the general or prime contractor for the project and thus was required to still give Point Center notice under former Civil Code section 3097, subdivision (b). The Court of Appeal noted that the new stop payment notice statutes now clearly require all "direct contractors," including general contractors, to serve a preliminary notice on the lender. The Court of Appeal reversed the trial court's ruling regarding the Dynalectric stop notice.

Point Center also appealed the trial court's finding related to the stop notice served by Division 8, Inc. ("Division 8"). Division 8 failed to serve Point Center with a notice of commencement of its stop notice action within five days of filing its complaint against Point Center, as required by former Civil Code section 3172. The Court of Appeal agreed Division 8 was required to provide this notice, but found that Point Center suffered no prejudice because of this failure. The notice of commencement is designed as a safeguard to alert persons withholding funds pursuant to a stop notice that the funds are claimed, via the lawsuit, to prevent premature release of the funds. Division 8's failure to serve a notice of commencement resulted in no prejudice, as Point Center had no funds to release.

Note:

This case serves as a reminder to project owners to adhere to the requirements of the stop payment notice statutes. Owners should not consider a stop payment notice invalid because a claimant fails to follow all of the statutory requirements. If a project owner fails to withhold funds required by a stop payment notice, he or she is personally liable to the claimant for the full amount of the claim.

Brewer Corp. v. Point Center Financial, Inc. (2014) 167 Cal.Rptr.3d 555.