Mechanics liens are powerful tools to secure payment, but when there’s not enough money to go around, it may ultimately be a lien’s priority that determines whether or not the lien claimant will be paid. Priority battles can be a messy, and in some cases can be a winner take all fight. Priority doesn’t really matter until there’s not enough money for everybody to get paid, but, when that happens, a security interest’s place in the priority line becomes one of the most important factors. In a priority battle, the winners get paid, and the losers likely end up with nothing. The creditors will fight it out to see who gets first shot at the debtor’s assets to pay off the money owed them. Since there are generally multiple creditors, each of which may be secured or unsecured, and/or have different types of security with different priority rules, these battles can get a bit complicated. Since mechanics liens are created by state statute, state law determines the priority of the lien as well. In the Nevada decision discussed in this article, the court put the mechanics lien in the backseat to a deed of trust.
In July 2006, Scott Financial Corporation (SFC) gave three loans to Gemstone Apache, LLC (Apache) in order to purchase property (Manhattan West) in Las Vegas. The amount of the loans totaled about $38 million (the Mezzanine Deeds of Trust). The land was going to be developed for mixed use. In April 2007, APCO Construction (APCO) commenced work on the project. Later that year, in May and October, SFC and Apache amended the Mezzanine Deeds of Trust to obtain additional funds.
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In 2008, Gemstone Development West, LLC (GDW) bought the Manhattan West from Apache, along with its loan obligation. To further construction, GDW borrowed another $110 million from SFC (the Construction Deed of Trust). This deed of trust was recorded on February 7, 2008. Eventually, relationships deteriorated and a legal battle ensued with APCO filing a mechanics lien claim. At this point, the priority battle seemed simple: 1) the Mezzanine Deeds of Trust, 2) APCO’s Mechanics Lien, and 3) the Construction Deed of Trust. Here’s the twist. GDW agreed to subordinate the Mezzanine Deeds of Trust to the Construction Deed of Trust. This is our point of contention.
The Arguments and the Court’s Reasoning
The subordination agreement caused a lot of confusion pertaining to priority. APCO saw this agreement as a complete subordination of SFC’s Mezzanine Deeds of Trust, giving the mechanics lien first priority. APCO also argued that NRS 108.225 completely prevented the Construction Deed of Trust from taking priority over its mechanics lien claim. The statutory provision reads
1. The liens provided for in NRS 108.221 to 108.246, inclusive, are preferred to:
(a) Any lien, mortgage or other encumbrance which may have attached to the property after the commencement of construction of a work of improvement.
(b) Any lien, mortgage or other encumbrance of which the lien claimant had no notice and which was unrecorded against the property at the commencement of construction of a work of improvement.
2. Every mortgage or encumbrance imposed upon, or conveyance made of, property affected by the liens provided for in NRS 108.221 to 108.246, inclusive, after the commencement of construction of a work of improvement are subordinate and subject to the liens provided for in NRS 108.221 to 108.246, inclusive, regardless of the date of recording the notices of liens.
SFC argued that the agreement was a partial subordination. Simply put, the agreement was meant to restructure the order in which its debts were paid. This agreement would have no effect on the mechanics lien priority. SFC would still have first shot at GDW in the priority order for its initial $38 million.
After a bit of back-and-forth, the district court eventually decided in favor of SFC. A writ of mandamus was then filed to compel the district court to recognize APCO’s mechanics lien as having first priority. This writ brought the matter before the Supreme Court of Nevada to determine whether or not a mechanics lien takes priority of a contractual subordinated debt because the subordination agreement was a complete subordination or NRS 108.225 precluded the partial subordination. In In re Manhattan West Mechanics Lien Litigation, the court states
In a complete subordination, the agreement subordinating the senior lien to a junior lien effectively subordinates the senior lien to intervening liens.
Partial subordination would leave the intervening lien unaffected. This just essentially rearranges the debts without affecting the priorities of others.
There is a bit of contention among court decisions in whether a general subordination agreement constitutes partial or complete subordination. Nevada Supreme Court finally reasoned that a general agreement is only a partial subordination. The agreement only suggests lowering one priority, not raising another. Also, nothing mentioned in NSR 108.225 precludes partial subordination.
The Battle Continues
Just because Nevada adopted the approach that a general subordination agreement only qualifies as partial subordination does not mean that competing approaches allowing complete subordination with corresponding priority changes are eradicated. Priority battles are never straightforward and never should be viewed as such. It is an uncertain area of lien law when entering a legal setting because of the complication of certain matters. Many jurisdictions follow a first-in-time, first-in-right rule, but because of certain “special” rules such as the “relation back doctrine” the actual first-in-time can be difficult to determine. Even with all of this confusion and uncertainty, mechanics liens generally enjoy a relatively strong priority position, and remain a good way to ensure payment.