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Dec 30, 2010

Who Has Priority - Bank Financing versus Mechanics Lien?

Category: Business

On November 9, 2010, the Maine Supreme Judicial Court, sitting as the Law Court, issued a Decision in F.R. Carroll Inc. v. TD Bank, N.A.  The Decision addresses the priority of a contractor’s mechanics lien when there is a prior recorded bank mortgage.  This case is an important reminder to contractors on the necessary steps to take to increase the contractor’s ability to get paid for work on a Project while at the same time addresses steps a lender can take to protect its interests in a mortgaged property.  Maine Mechanics Lien law 10 M.R.S.A. § 3251 states in relevant part:

Whoever performs labor or furnishes labor or materials . . . by virtue of a contract with or by consent of the owner, has a lien thereon and on the land on which it stands and on any interest such owner has in the same, to secure payment thereof . . .”. 

For purposes of this statute, a bank with a prior recorded mortgage is considered an owner.  If a bank with a prior recorded mortgage consents to the contractor’s work, then the mechanics lien has priority over the prior recorded mortgage.  In earlier cases the Law Court has interpreted “consent” as requiring a contractor to “prove (1) knowledge on the part of the owner of the nature and extent of the work being performed on the premises, and (2) conduct on the part of the owner justifying the expectation and belief on the part of the [contractor] that the owner had consented.”  More plainly, the contractor gets priority if he can show the bank knew the work was being done, and the bank leads the contractor to believe that the bank thought it consented.  If these requirements are met, a mechanics lien can take priority over a previously recorded bank mortgage.

In F.R. Carroll, Inc., the Law Court reemphasized the fact-specific nature of the consent inquiry.  In F.R. Carroll, Inc., the critical facts the Court considered included (1) that the bank loaned money to finance construction of a commercial building; (2) that the bank was provided with a total cost estimate, including “site work” and “site improvement”; (3) the Plans for the Project, reviewed by the bank, depicted a paved parking lot, and the bank received a status memo with a final completion date “including final paving and signage”; (4) the bank disbursed the final loan proceeds after receiving photographs showing an unpaved parking lot; (5) the following month the owner contracted with the paving contractor to pave the parking lot, however, the bank was not made aware that the owner was incurring additional paving expenses; and (6) the work was completed by the end of October 2006, the contractor was not paid and recorded a mechanics lien and suit followed. 

The trial court ruled in favor of the contractor based on court papers and without a trial it determined that the paving contractor was entitled to priority because the bank had consented to its work.  The Law Court reversed the decision and sent the matter back to the trial court.  The Law Court held that because a reasonable factual inference could be drawn in favor of either party, a trial was necessary to resolve the dispute, and the issue of consent.

The facts in this case seem to suggest that the bank knew about and consented to work up to the point of the final payment disbursement.  Had the paving contract not come after disbursement of the funding limits, or had the bank been made aware of the paving contract, it is possible the court would have upheld the decision in favor of the paving subcontractor.  Instead, finding a factual dispute, the parties needed to go back to trial to get a final decision.

The Law Court’s Decision in F.R. Carroll follows a long line of cases addressing the importance for contractors and subcontractors to make sure, among other things, that they know who is paying the bills, and the need to ensure that lenders have notice of the scope of their work and the status of contract payments.  For financial institutions and lenders, the Law Court’s Decision in F.R. Carroll confirms the need to define “consent to the work” in loan documents, and the importance of knowing the status of all work and previous payments before making final loan disbursements. 

Given this decision, contractors should consider providing copies to banks on all critical correspondence and bills with the owner.  The more information the bank has, the less likely they will be able to argue they did not consent.  Contractors should get the name of the bank and bank officer early in the process and get the owner’s consent at the outset to keep the bank in the loop.

* Advice:  Get name of bank and bank officer early in the process.

* Advice:  Get Owner’s consent at outset to keep bank in the loop.