October 30, 2014 Subordination Agreements with General Contractors are Enforceable

Lenders know that recording their construction deeds of trust after the commencement of construction is risky because of the possibility of losing priority to mechanic’s liens. A recent case sheds light on a strategy lenders may use to minimize that risk and protect the priority of their deeds of trust.

Moorefield Construction, Inc. v. Intervest-Mortgage Investment Company et al., involved the construction of a medical office complex.  The contractor had already constructed a fence and started preparing the land for construction when the owner obtained its construction loan and the construction lender recorded its deed of trust.  In connection with the loan, the owner assigned its rights and remedies under the construction contract to the lender.  The contractor’s consent to the assignment included language subordinating both (i) payment obligations under the construction contract to the payment obligations under the loan, and (ii) any mechanic’s liens to the lender’s deed of trust.

When the owner later failed to make payments for the construction work, the contractor recorded a mechanic’s lien for $2.2 million and then filed suit for foreclosure.  The lender responded by asserting that its deed of trust was superior in priority to the mechanic’s lien based upon the subordination language in the assignment.  The trial court determined that the subordination clause was an unenforceable waiver of mechanic’s lien rights, but the appellate court reversed the trial court’s judgment.  The appellate court held that the statutory prohibition against the waiver of mechanic’s lien rights does not apply to waivers executed by contractors who contract directly with the owner (also known as the “original” or “general” contractors), but only to subcontractors and materials suppliers.

While lenders are typically very careful to ensure the priority of their construction deeds of trust, the Moorefield Construction case demonstrates that a contractor’s consent to the assignment of a construction contract may be an effective tool to aid in the protection of that priority.  To effectively use a subordination agreement, it is important to ensure that the agreement conforms to California mechanic’s lien statutes and their waiver requirements. 

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