Everyone in the construction industry looks for a more collaborative future where the payment system is less about covering your own rear and more about fairness and efficiency. A recent suit regarding an Arizona mechanics lien makes that future seem distant.
In Markham Contracting Co. v. Federal Deposit Insurance Company, First Arizona Savings and Loan (Federal Deposit Insurance Co. is their appointed receiver) and PrimeAZ used shady tactics in an attempt to free property from Markham’s mechanics lien. The rouse may have worked on the trial court, but thankfully the appellate court did not let the inequitable result stand. Markham’s lien was reinstated.
Markham Contracting Co. performed grading, paving, and water utility work on the project in question, and went unpaid. As a result, Markham filed a lien for $341,700 on the property. Markham’s lien was second in priority only to the deed of trust. As the project went on and costs increased, a second loan was taken on the property. The $4.8M loan was provided by First Arizona and PrimeAZ, and about $2.9M of the loan paid the balance of the original deed of trust. Not long after, First Arizona and PrimeAZ recorded a notice of trustee’s sale. Alerted to the impending sale, Markham contacted First Arizona and PrimeAZ to inform them that the lien would run with the property when sold at the trustee sale. First Arizona and PrimeAZ responded by notifying Markham that their deed of trust remained first in priority and claimed that the lien was not retained on the property due to failed notice requirements.
In January of 2010, Markham filed to foreclose on the lien. In February, the trustee sale First Arizona and PrimeAZ had earlier recorded took place. The two trustees purchased the property on a credit sale for $3.175M, in excess of the $2.9M of the original deed of trust. Markham received none of the sale proceeds. As a result, the subcontractor filed suit challenging the trustees’ priority and demanding a portion of the proceeds.
The trial court was not friendly to Markham. First the court ruled that Markham’s lien of $341,700 was valid. Seems like a win, right? Well the court also found that First Arizona and PrimeAZ’s deed of trust subrogated, or took the place of, the original deed. This meant that the priority of Markham’s lien fell behind the trustees. Lastly, the court found that the trustee sale of the property extinguished the subcontractor’s lien. So Markham was told that he held a perfectly valid lien which became perfectly worthless after the trustee sale.
The appellate court was friendlier.
As mentioned in the previous section of this post, First Arizona and PrimeAZ only took over the previous deed to trust to the amount that the second deed of trust replaced the first. The court found that because $2.9M was paid to cover the balance of the original deed of trust, only that $2.9M had priority above Markham’s lien.
The court stated that “…the manner in which they purported to use a credit bid to extinguish Markham’s lien was contrary to law and calculated to lead to inequity.” By using a credit bid, the trustees paid nothing but costs and expenses associated with the sale of the property. The $3.175M sum represented money that the trustees had already paid. Yet the trustees purported that the lien Markham held on the property was extinguished while virtually no money changed hands. The court found that under these circumstances the lien remained intact, and that finding Markham’s lien rights were destroyed by the credit sale would be inequitable.
If you will recall (the court certainly did), the amount of the credit sale was $3.175M, leaving money left over after the satisfaction of the first priority lien. However, Markham received none of that difference. The court found this was improper.
According to the court, Markham should have been paid from the proceeds of the sale that exceeded the first deed in trust. By the very definition of a credit sale, the amount of the sale can only reach the amount of the debt owed. The trustees had more than $2.9M invested in the project, but in order to exclude Markham from the proceeds the sale, they could not exceed the amount of the first priority deed. Any amount owed to the trustees beyond that amount was subordinate to Markham’s lien.
The court found that Markham should have been entitled to the proceeds from the “credit sale” that took place to the extent that the sale exceeded $2.9M. Because Markham received none of those funds, the court found that Markham’s lien had not been extinguished by the sale and that his credit interest in the property remained.
When it comes to liens, procedure can often overtake the whole process, clouding the goal of an equitable result. If not for the appellate court stepping in, this Arizona mechanics lien would have fallen by the wayside. The best way to protect your lien rights is to make sure you have a handle on your state’s lien laws, but even then the results can vary. As always, the safest way to ensure payment is to avoid litigation. To that end, communication on construction projects goes a long way.