The mechanics lien document is the most effective collections remedy there is for those in the construction industry, and we’ve explored why in countless previous articles, including the popular 17 Ways a Mechanics Lien Works To Get You Paid. Only one of the many reasons why a mechanics lien works is that it can be foreclosed upon, and it only in that rare and single circumstance that the subject of “lien priority” will mean anything to you.
Nevertheless, if you find yourself foreclosing a mechanics lien and battling other lien and privilege holders for priority, the subject of lien priority will suddenly mean everything to you. Some states will throw mechanics lien claimants to the very front of the payment line, and other states will not. Some states have a “first to file” rule, which will govern a lien’s priority against other privileges based on the timing of “filing.”
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Arizona is a state that gives mechanics lien claims a priority over all other claims. Other privilege holders recently challenged the scope of this priority preference by trying to leapfrog a lien’s priority through the doctrine of equitable subrogation.
The Arizona appeals court rejected this at the end of November 2013, underscoring the power of a mechanics lien claim in Arizona.
Arizona Court Reminds The World That Mechanics Lien Claims Take Priority Over All
The Arizona Court of Appeals introductory paragraph does a terrific job of summarizing its recent holding in Weitz Company LLC v. Heth. Judge Brown opened the opinion with the following:
The question we address is whether Arizona’s statutory provision governing the priority of mechanics’ liens (Arizona Revised Statutes (“A.R.S.”) section 33-992(A)) permits a court to shift lien priorities by applying the doctrine of equitable subrogation. Because § 33-992(A) expressly provides that mechanics’ liens have priority over all subsequent encumbrances (subject to a narrow exception not applicable here), we hold that allowing a subsequent lienholder to equitably subrogate its loan to a position ahead of a mechanic’s lien would contravene the plain statutory requirement. We therefore affirm the superior court’s grant of summary judgment.
The court’s opinion, when framed like this, seems simple and straightforward: the legislature said that mechanics liens have priority over everything else, and therefore, nothing [including equitable subrogation] can displace that.
Nevertheless, it is an important decision because lenders and other privilege holders are constantly brainstorming ways to circumvent the priority of a lien claim. This particular effort had never been considered, and in this decision, the Arizona court not only rejects this effort, but puts the burden pretty high to win in any future efforts. It does this by starting off its opinion’s discussion with an analysis of how powerful mechanics lien priority is in the state:
[L]ien’s priority is governed by [ARS] § 33-992(A), which provides in part:
“The liens provided for in this article . . . are preferred to all liens, mortgages or other encumbrances upon the property attaching subsequent to the time the labor was commenced or the materials were commenced to be furnished except any mortgage or deed of trust that is given as security for a loan made by a construction lender . . . if the mortgage or deed of trust is recorded within ten days after labor was commenced or the materials were commenced to be furnished.”
Legislative recognition that mechanics’ liens have priority over subsequent liens has been in existence since 1865, almost half a century before statehood…
As recognized by our supreme court, the purpose of the mechanics’ lien statutes is to protect the rights of those who furnish labor and materials to improve another person’s property…Because these statutes are remedial, we construe them liberally to achieve their primary purpose.
The court’s discussion of the “Historical Preference of Mechanics’ Lien” is quite short in relation to the whole opinion, but it’s packed with a punch. In the short discussion, the appeals court reminded the litigants that:
- The law requires that mechanic liens be prioritized over all other liens and encumbrances;
- That this has been like this since 1865, nearly 50 years before Arizona was even a state
- That the lien statutes purpose is to protect those furnishing labor and materials to construction projects
- That courts must liberally construe the lien statutes to achieve this primary purpose
While Equitable Subrogation May Apply, It Is Superseded by Mechanics Lien Statutes in Arizona
The idea of equitable subrogation is simple, and you can figure out everything you need to know by breaking the word into its two parts. The first – equitable – is a legal term for fairness. The second – subrogation – is the legal concept whereby the rights of one party are assumed or acquired by another party.
Equitable subrogation, therefore, is the passing along of rights from one party to another because of some fairness reason. In the case of mortgages, the law of most states considers it “equitable” to give a new party the priority rights of an original lien holder (i.e. the original mortgagee) if the new party is paying off the original lien holders obligation using proceeds from the original loan or mortgage.
Thinking about these sorts of legal concepts can twist your brain. Look at the situation in Weitz Company for an example.
- Property Developer borrowed $40m to build condos from Bank A
- Property Developer sold a bunch of individual condo units to buyers
- The Buyers borrowed money from Bank B to pay off obligations from Bank A
- Bank B claimed to have equitable subrogation of Bank A’s position
The Arizona court did not dispute that, in the above example, Bank B could claim Bank A’s position through equitable subrogation…except that the doctrine did not apply to displace the mechanics lien claims, for the reasons as explored in the previous section.
Arizona Case In Line With Recent Nevada Case, But Perhaps Not In Line With California Case Law
Does this lien priority v. equitable subrogation argument sound familiar? The very same thing recently played out in Nevada in a very large and publicized case that pitted hundreds of subcontractors and suppliers against a lender in a fight over $100+m: The Las Vegas Fontainebleau Project. In fact, the Arizona court referenced the Nevada decision in the Weitz Company case:
Consistent with the reasoning in Fontainebleau, we conclude that equitable subrogation cannot operate to supersede the statutory requirement that mechanics’ liens have priority over all subsequent encumbrances, except for construction loans filed within the narrow time constraints of the statute.
Is it interesting or coincidental that this equitable subrogation argument would come up within a single year in two neighboring states? Let me give you the answer: The answer is no.
Every once in a while lenders and their attorneys will talk about different exposure areas for their mortgage priority. Something (probably an attorney opinion on the subject) precipitated lenders to give this argument a shot in the courts as a way to offset the priority afforded to mechanics lien claims. They lost in both states. They might, however, have some ground (or, at least some ambiguity) in California.
Sedgwick Law published a great (2010) article on how equitable subrogation has been treated in California courts over the past twenty years, Lien on Me: The Doctrine of Equitable Subrogation. That article’s last paragraph summarizes the state of California’s law on this topic:
The doctrine of equitable subrogation is a malleable one that has been inconsistently applied. Until California’s appellate courts have clarified the doctrine, it will remain a wild card in litigation over lien priorities.
While Sedgwick Law calls this a wild card, I’d be surprised if California doesn’t follow the trend now set in Nevada and Arizona. The NV and AZ decisions make sense, they follow the purpose behind these lien laws, and they are fair. Of course, however, we’ll see soon…