In mid-2011, the Utah Court of Appeals decided a case affecting a mechanic lien’s priority over mortgages and construction loans in Olsen v. Chase (PDF Full Text). The case has important implications to mechanic lien claimants in that state, and questions the effectiveness of lien subordination agreements.

Mechanic Lien Priority Rules In Utah Generally

Before I get into lien subordination agreements and the implications of this case, let me quickly address the rules generally governing mechanics lien priority in Utah.

Lien Priority” refers to the question of which claims against a property have priority over others.  If a single property has 2 mortgages and 5 liens, and is later sold at sheriff auction, which claims get paid first?  While this is not always important because most lien claims are paid off before a sheriff’s sale is required, when a worst case scenario comes along, the question becomes very, very important.

Every state is different in prioritizing lien claims.  As we wrote a few years ago, mechanic lien claims in Virginia are extraordinarily strong, getting top billing in priority (Are Virginia Mechanic Liens The Strongest Of Them All?). Many other states, however, provide very little priority to lien claims.

In Utah, a construction lien has priority over any lien, mortgage or other encumbrance that attaches to the property at anytime after work first began on the entire project.  This rule was recently amended to provide lien claimants greater priority, as it previously gave priority only to claimants from the time they first furnished materials or labor. Now, however, it’s priority begins at the very start of a construction project.

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How Lien Subordination Clauses Work

Lien subordination clauses are frequently used by lenders to make certain that their privilege against a property is superior to all other privileges and encumbrances. There is a great definiation of subordination agreements on Wikipedia:

A subordination agreement is a legal document used to make the claim of one party junior to (or inferior to) a claim in favor of another. It is generally used to grant first lien status to a lienholder who would otherwise be secondary to another party, with the approval of the party that would otherwise have first lien.

In the mechanic’s lien context, this typically arises when a bank is providing the property owner with a construction loan, mortgage or refinance on a property that has construction work on-going or recently finished. The lender doesn’t want to make the loan unless it has collateral (the property), and to have clean collateral it needs to be sure it’s claim is superior to all mechanic lien claims.

The bank, therefore, asks contractors and suppliers with lien claims or potential lien claims to sign a “subordination agreement,” which affirms that any lien claims filed by them will be subordinate to the lender’s privilege.

Subornation Agreements Invalid in Utah As They Relate to Mechanic Liens After Olsen v. Chase

Olsen v. Chase confronts a situation when subordination agreements clash with the mechanic lien priority rules in Utah.

The facts are simple: A contractor delivered their preliminary notice on November 1, 2006, and the construction lender issued a loan on November 9, 2006.  According to Utah priority rules, therefore, the contractor’s lien claim was superior to the lender’s claim.

However, the contractor signed a subordination agreement on November 9th, agreeing to subordinate its claims to the bank.  It later argued that the subordination was ineffective.  The Utah Court of Appeals agreed, held the mechanics lien subordination agreement ineffective, and ordered that the mechanic lien claim be given priority over the subordination agreement.

How did this happen?

Well, I refer you to a discussion we’ve had on this blog in the past about lien waivers: Can Contract Provisions Alter Your Lien Rights.   In that article, I mention that in some states, contractors and suppliers cannot possibly waive their lien rights.  This is the case in Utah.

At the time in question, §38-1-29 of the Utah Mechanics Lien Act provided that “The applicably of the provisions of this chapter, including the waiver of rights or privileges granted under this chapter, may not be varied by agreement.”  The Utah Court of Appeals held that this prevents a contractor from subordinating its lien priority rights:

We do not read this provision narrowly to prohibit agreements that seek to alter the parties’ rights or privileges only by employing some variation of the word “applicability” or, for that matter, any other particular word or combination of words. Rather, we “broadly construe the statute to effect its remedial purpose[]”…which is to prohibit agreements whose purpose or effect is to render any provision of the chapter inapplicable, whatever words the agreement may happen to employ to achieve that result…Accordingly, to the extent the Completion Guaranty purports to alter the relative priority of the parties’ liens on the subject property, it is unenforceable.

This ruling is a huge victory for mechanic lien claimants, and really underscores the positive priority treatment given to claimants in Utah.  Plus, with the recent updates to Utah’s lien laws given mechanic lien claimants even greater lien priority, this case becomes more meaningful, and Utah rises up with Virginia as having some of the strongest mechanic lien rights in the nation.