The Griess Law Firm, LLC

In the recent case of Ferguson Enterprises, Inc. v. Keybuild Solutions, Inc., Case No. 10CA2234, December 22, 2011, the Colorado Court of Appeals addressed a situation regarding the priority of mechanic’s liens.

Backround Summary

To understand the situation, one must understand that mechanic’s liens for certain improvements to a property such as new construction have priority over other earlier liens or mortgages on the land.  CRS 38-22-103(2).  However, a lien for a construction loan which is taken out to do the improvements at issue, which is recorded before the improvements begin, and which is actually used to pay for improvements, is an exception, i.e., it has priority over the mechanic’s liens related to work done after the construction loan lien is recorded. 

While the exception exists, a mechanic’s lien for work on improvements also relates back to the first work on the property so it has the same priority as the first work on the project at issue even if there are liens recorded in the intervening time, such as the construction loan lien.  CRS 38-22-106(1).  Specifically, as the Court in Ferguson notes, an architect’s work on a project has been held to be first work on a project to which a mechanic’s lien by other later subcontractors related back.  What this means is that so long as the developer got someone to do initial plans, survey work, soils testing, or the like, for improvements on the land (which one would expect a lender to require before lending money), any liens by the subcontractors after the recording of the construction lender’s lien would relate back to that first work and have priority over the construction lien deed of trust.  Furthermore, because this first work on the property is presumably also work on improvements to the property, any lien on such work would have priority over prior recorded liens or mortgages on the land.  Practically, the subcontractor’s mechanic’s lien gets priority over everyone else but the other subcontractors.

Mechanic’s Liens Meet Foreclosures

On this mechanic’s lien framework, we now impose the foreclosure framework.  A foreclosure works to extinguish all junior liens to the lien being foreclosed.  If a lien is senior to the lien being foreclosed, for example, because it is recorded first, a statute says it has priority, or the lien relates back to a prior date, then title from the foreclosure is taken subject to the senior liens.  In general, foreclosures are designed to provide clean title and are based on the idea that everyone with a junior lien has notice of the senior liens so they can act accordingly. 

When the mechanic’s lien statutes and the foreclosure statutes are put together, there is a clash between the policy favoring notice for foreclosures, and the policy favoring the security for subcontractors using mechanic’s liens. 

So What Happened in Ferguson?

So now we address the situation in Ferguson:  The first owner of a property hired an architect to get plans together for improvements but then defaulted on its loan and was foreclosed on.  The bank that foreclosed became the second owner and transferred the property to a new developer (the third owner) who began work after getting a construction loan for the property from a second bank.  However, subcontractors on the project filed liens and the third owner defaulted, resulting in the second bank foreclosing and becoming the fourth owner of the property.

The second bank then filed a motion to dismiss the subcontractors’ foreclosure on their mechanic’s liens which had been filed before the second bank’s foreclosure.  The second bank’s basis was that its lien had priority over the mechanic’s liens.  At the trial court level, the court granted the subcontractors’ cross-motion for summary judgment holding that the mechanic’s liens were senior to the second bank’s construction loan deed of trust.  The appeal followed.

Initially, the Court of Appeals appears to follow existing law and found that the mechanic’s liens were junior to the construction loan and would be extinguished by the foreclosure of the construction loan deed of trust based on the date of the liens’ recordings, and the exception giving construction loan liens priority if certain conditions are met.  However, whether the mechanic’s liens were junior and extinguished also depended on whether they related back to prior work on the project, specifically in this case, the architect’s work which pre-dated the construction loan deed of trust.

It should be noted that the Court of Appeals is dealing with this only on the record before it which does not include all of the facts at issue.  For example, if there was work before the second bank recorded its lien for the construction loan, the mechanic’s liens would relate back to that work and be senior.  But the court approaches the situation by only examining the work by the architect because that is the work to which the subcontractors sought to relate back.

It is Unclear What the Court is Doing

At this point, the case gets very confusing and it is essential to point out that it is entirely unclear what the court is saying, or how we can get clear guidance from the case.  This is because there are several contradicting issues and concerns. 

One of these is the court appears to assert that to relate back to the architect, the architect not only had to do work before the first foreclosure, it had to actually file a lien in order for the later mechanic’s liens to relate back.  This does not appear to be what the relating back statute says, but it seems the court is concerned about how future buyers after a foreclosure get notice there is a “latent” senior lien right in the foreclosure process. 

And while the court requires this lien filing in the situation of the first foreclosure, it does not appear to require it in the second foreclosure where the mechanic’s liens at issue were filed before the bank foreclosure took place so that all parties in the bank foreclosure the second time around clearly had notice of the mechanic’s liens.

It does not seem likely that the court is saying that simply paying the party who does the first work, getting their release, or waiting until they run out of time to file a lien, means later subcontractors do not get the benefit of relating back to that first work.  This would be like adding a requirement to the relating back statute that you can only relate back to the first work on the project that has not been paid.  Instead, it may be that the court is narrowly trying to make a foreclosure procedure more effective against mechanic’s lien interests that arise after the foreclosure but purport to have rights not easily known at the time of foreclosure. 

In the Meantime

For the time being, it seems that mechanic’s liens may not be as senior as previously thought.  It also seems that at least a foreclosure could have a negative impact on the ability of a mechanic’s lien to relate back to prior work unless there is some kind of a prior lien on the prior work.  And even if there is a prior lien, questions remain.  What if the prior lien was released in a settlement, or was satisfied?  Does the future mechanic’s lien get only the same status as the prior lien or does any mechanic’s lien operate as a kind of notice that there are future mechanic’s lien interests which might relate back?  Furthermore, there are questions about what situations could arise that are like a foreclosure which, under the same reasoning, might result in cutting off the ability of a mechanic’s lien to relate back.  For example, could a developer do a project in phases,  and at specific points in time, file a quiet title action to the property in order to prevent future subcontractors with potential mechanic’s liens from being able to get priority over a construction loan deed of trust recorded before the quiet title action? 

For now, the water is a a bit muddier than before.

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