Mechanic’s Liens Take Priority Over Equitable Subrogation, ASA Tells Arizona Supreme Court

ALEXANDRIA, Va. (May 23, 2014) — Using the doctrine of equitable subrogation to establish lender priority over mechanic’s liens would “completely defeat” the legislative intent behind mechanic’s liens statutes and “improperly shift the known and assumed risks” from construction project owners and lenders to contractors and subcontractors, the American Subcontractors Association (ASA) and ASA of Arizona told the Supreme Court of Arizona.

In the associations’ amicus brief, filed on May 22, in The Weitz Company, LLC, Plaintiff-Appellee, v. Nicholas Heth, et al., Defendants-Appellants, ASA and ASA of Arizona urged the state Supreme Court to affirm a court of appeals decision, saying, “The mechanic’s lien statutes are one part of the intricate statutory framework adopted by the Legislature to protect subcontractors and ensure that laborers and materialmen are paid for their work. All 50 states have some form of mechanic’s lien statutes. The language and details of the statutes vary widely, as does the jurisprudence. However, the basic premise of all is that those whose labor or materials go into improving real estate should be permitted, in fairness, to satisfy their unpaid bills out of that real estate.”

Sacks Tierney P.A., of Scottsdale, Ariz., prepared the ASA brief in this case.

“Those involved in construction depend on their mechanic’s lien rights as security for payment for the work they perform,” said Matthew B. Meaker, attorney at Sacks Tierney. “Affirming the Court of Appeals decision regarding equitable subrogation results in a bright line rule that all stakeholders can rely upon.”

General contractors, subcontractors and material suppliers share certain common risks on a construction contract. Among others, they must estimate their costs of labor and materials in advance and bid construction projects accurately enough to cover those costs and make a reasonable profit. If they bid too high, they will not get the job. If they bid too low, they will lose money. In either situation, they cannot remain in business and keep their workers employed. Subcontractors are creditors, but not traditional ones. They provide labor and/or materials on a construction project on the “credit” of the promise of future payment. Subcontractors, who often must pay their laborers weekly, their suppliers monthly and their home and field office overhead (rent, electricity, gas, etc.) monthly, routinely wait 30 days or longer to be paid for their labor and materials, while the owners/developers pay no interest for that credit. Because subcontractors extend these large blocks of credit and have a large number of workers dependent on them for payment, they are vulnerable.

In the underlying case, the construction project owner, Summit at Copper Square, LLC, obtained construction loans to build a high-rise condominium on an empty lot in Phoenix. The owner hired the Weitz Company as the general contractor. Weitz and its subcontractors spent 30 months and $59 million building the 23-story tower containing 165 units of mixed-use commercial and residential condominiums.

Either before construction was finished, or shortly after, the developer sold 91 of the condominiums, and the proceeds were used to pay down the construction loan, solely for the benefit of the developer and lender. Most of the condominium purchases were financed by purchase money loans, but 15 buyers paid cash. The borrower and construction lender received nearly $40 million from these 91 sales, without paying Weitz the full amount owed on the construction contract despite their earlier agreement to pay Weitz the balance due as the condominiums were sold. Weitz was not paid the final $3.8 million owed on the project. The parties stipulated that Weitz’s mechanic’s lien was $2.125 million.

Equitable subrogation is a doctrine, based on principles of fairness, where the one who pays the obligation of another is treated as the beneficial owner of the original obligation. In this case, the lenders argued that by financing the purchase of certain individual units, they were paying off the outstanding obligations of the construction loan and thus had the right to the priority of the bank, which had—by recording its deed of trust in a timely manner—priority over the mechanic’s lien claimants.

ASA and ASA of Arizona wrote in their brief that the appeals court correctly held that the state’s mechanic’s lien statutes’ “plain and express language precludes application of the equitable subrogation doctrine.”

“Equitable subrogation is designed to prevent injustice, and will not be applied when there is no injustice to prevent,” ASA and ASA of Arizona wrote. “Here, the decision of the Court of Appeals served justice and should be affirmed. In contrast, Appellants’ demands would effectively rewrite the statutory mechanic’s lien provisions and in the process create a great injustice not only to Weitz and its unpaid subcontractors, but to all subsequent subcontractors on future projects who would lose the certainty of the plain statutory language and have their statutory remedies imperiled and rendered ineffective under the guise of an ‘equitable’ doctrine. The Court should not allow property improved by subcontractors to be sold without involving those trades in the process and protecting their right to payment.”

ASA and ASA of Arizona added that a decision to apply equitable subrogation in this situation would be even more inappropriate because, “in addition to ignoring the plain statutory language and intent, it would also conflict with an entire line of Arizona precedent dating back at least 80 years. As early as 1932, this Court stated that a purchaser of a mortgage takes subject to the claims of laborers and materialmen. A sale or transfer would be subject to the mechanic’s liens.”

ASA’s Subcontractors Legal Defense Fund financed the brief. Contributions may be made to the SLDF via the ASA Web site.

Founded in 1966, ASA amplifies the voice of and leads trade contractors to improve the business environment for the construction industry and to serve as a steward for the community. The ideals and beliefs of ASA are ethical and equitable business practices, quality construction, a safe and healthy work environment, and integrity and membership diversity.