Priority determinations have significant outcomes for unpaid contractors and suppliers intent on filing a mechanics lien. In the construction field, mechanics lien priority over other encumbrances levied on real estate are paramount, because it dictates whether the lien is likely to be paid. The effectiveness of the mechanics lien in protecting a claimant’s right to payment depends on the lien’s position compared to other lienholders and secured creditors in the underlying property. Much like airport boarding procedures where priority seating goes to the airline’s exclusive members and the remainder is distributed to the masses on a first come first served basis, mechanics liens priority determines who gets served first. Thus, a race to be first is the logical outcome. This brief article will provide necessary guidance to contractors and suppliers who are unsure of the legal impact of their lien and likelihood of getting paid when other encumbrances exist on the underlying property. Know where your lien stands in line.
A particular interest in real estate may be judged superior or inferior to other interests depending on the application of state laws regarding priorities. California follows the “first in time, first in right” system of lien priorities as modified by the recording statutes. In the absence of an agreement to the contrary, as a general rule, different interests in the same property have priority among themselves according to the time of their creation. However, California’s recording rules modify this rule slightly to dictate priorities among several interests in a parcel of real property primarily by the recording date of the documents evidencing the respective interests.*1 Recordation allow for constructive notice of the encumbrances to purchasers and other third parties.
A recorded instrument (i.e., a deed of trust or lien) has priority over prior unrecorded and unknown interest and subsequently recorded interests. So, an instrument’s recordation date typically determines its efficacy as a security instrument. For instance, a deed in trust recorded prior to a judgment lien has a superior property interest. As a result, a foreclosure by sale under the power given to the trustee by the deed of trust wipes out all liens and encumbrances that are subsequent to the deed of trust that is being foreclosed, including the judgment lien. This leaves the judgment lien essentially worthless. The priority principal of recorded interests also establishes the relative strength of mechanics liens.
Vast construction projects require substantial funding and a multitude of trades. This reality has some potential outcomes. First, the landowner likely sought and received a construction loan to finance the work of improvement. Most construction projects are not financed with the owner’s cash. There is usually a loan in place to pay for the construction. Generally, the security for the loan must be the first lien on the property. To solidify “first lien” priority, the lending institution must get its deed of trust on record. Second, it is rare to find a single contractor or material supplier left unpaid on a large job. More likely, many firms are in the same situation of having growing accounts receivable that are being neglected or unpaid either by the GC or project manager. In this instance, the property being improved will likely become burdened with several recorded mechanics liens by unhappy claimants. When this happens, the relative priority and, thus, effectiveness, of all the encumbrances is a critical issue because it determines who will secure any payment on the underlying debt.
Mechanics liens have a special place in the recording statutes. They are in a class of off-record interests that are senior to claims of bona fide purchasers. This means that mechanics liens have priority over subsequent liens and interests in the improved property from the date work on the project commences, even though a claim of lien is not recorded until the project is completed. When a claim of lien is recorded, the priority of the lien “relates back” to when work commenced, and the lien retains priority over any intervening interests that were subsequently created or recorded.*2 However, mortgages, deeds of trust and other liens that were of record prior to the commencement of any work retain priority over the mechanics liens. Moreover, the priority of each and all of the mechanics liens is the same. They all relate back to the time of commencement of the work of improvement as a whole, regardless of whether or not there was a direct contract and irrespective of the time when the particular claimant furnished his own labor and materials or when he recorded his claim of lien.*3
Thus, the priority of mechanics lien turns on when work “commenced”. The commencement of a work of improvement is considered to be physical work on a ground easily discernible by anyone, commonly known as the “visible to the eye” test. The following are considered to be clear indications of the commencement of the work: demolition of old buildings or removal of trees and weeds, preparatory to the new construction; test holes, loads of dirt or building materials; preliminary landscaping; installation of a power pole; staking out the actual location of the building; digging foundation holes, etc.*4 The California Supreme Court has also ruled that the delivery of materials to the work site is sufficient to constitute the “commencement” of the work of improvement.*5
The rules on mechanics lien priority can cause problems for lenders. The lender seeks to preserve the priority of the deed of trust or other instrument securing its construction loan. To do this, the lender or its title insurer may inspect the land to make certain no improvement have begun which might give mechanics lien claimants priority. If the lending institution gets its deed of trust on record prior to the “commencement of the work,” the deed of trust of the lender securing the construction loan will have priority over any and all mechanics liens. The lender has thus effectively protected itself against the possibility of losing priority to future mechanics liens which would relate back to the legal commencement of the work.
California law greatly assists mechanics in preserving the priority and effectiveness of their liens. The legal principal that each lien relates back to the first commencement of work, protects all contractors and suppliers regardless of when they applied or delivered their individual trade or materials to the work of improvement. The law also protects an “inchoate” lien that was not recorded until later in time. The equal priority of all liens prevents a race to record and typically permits for the distribution of some proceeds at a foreclosure sale among all claimants. However, diligent claimants should still attempt to determine whether other encumbrances exist on the property before assuming their mechanics lien is effective. This can usually be done my obtaining a title report, which should detail all recorded interests. The report will allow the claimant to identify whether other interests, like a deed of trust, were recorded before work commenced and, thus, have priority over the lien.
An attorney specialized in construction law and real estate can greatly assist contractors and material suppliers in assessing the relative priority and strength of their mechanics lien. The legal insight will greatly assist claimants in determining whether the lien can expect any proceeds from a possible enforcement action or foreclosure against the owner.
If you would like to have a discussion or consultation on the comments made in this article, please reach out to efarrell@cwlawyers.com to set up a time to discuss.
*1 Miller & Starr, Cal. Real Est., 4th ed., Section 10:1.
*2 Miller & Starr, Cal. Real Est., 4th ed., Section 10:130. See also Civil Code §8450(a).
*3 Connolly Development, Inc. v. Superior Court (1976) 17 Cal.3d 803, 808.
*4 Matthew Bender & Co., Inc., 1 Ca Mechanics’ Lien Law & Prac. § 4.156 (2020) [internal citations omitted].
*5 Walker v. Lytton Sav. & Loan Asso. (1970) 2 Cal.3d 152, 157.
