Construction Law Today : Construction Lawyer & Attorney : Joshua Glazov : Design Build Contracts, Construction Bankruptcy

Enhancement Priority

Under Section 16 of the Illinois Mechanics Lien Act, a contractor's properly perfected mechanics lien gets priority to part of the foreclosure sale money.  Which part? The part attributable to project value added by work on the project.  And it's not just contractors; the same usually applies to the mechanics liens of architects, designers, and others who provide lienable goods or services too.

What's that mean in practice?  After the foreclosure sale, the judge divides the money into two proportionate parts: (a) the value of the project before the work and (b) the value the work added to the project (i.e., how much the work "enhanced" the project's value).  In the Cypress Creek case:

• The Lender's mortgage got priority to the money allocated to pre-work value
   
• The Perfected Contractors got priority to the money allocated to value added by work on the project  

Dividing foreclosure sale money is kind of like dividing scarce lemonade into two pitchers.  Those owed money line up in two queues before each pitcher with their cups out.  The higher (or more senior) your priority, the closer you stand to the front of one, or maybe even both, of the queues.  In this case:

• The Lender stands at the front of Queue #1 gathered before the pre-work value pitcher
   
• The Perfected Contractors stand side-by-side at the front Queue #2 gathered before the added value by the work pitcher

Naturally, there's controversy over how much lemonade goes in each pitcher, especially when there's not enough lemonade to go around in one, or both, of the queues.  

How Do They Divide the Money?

How does the judge decide how much money, or lemonade, goes into each pitcher? They hear expert testimony - usually from appraisers - about the pre-work value of the project and the work added value.  Based on what the experts say, the judge allocates the value and divides the available money in proportion to those values.  

Example

Assume a project sells at a foreclosure sale for $90M.  The expert appraisers value the project at $120M and allocate that value this way:

• Before work: $80M (66.6% of total value)
   
• Work added value: $40M (33.3% of total value)    

 The judge divides up the $90M of foreclosure sale money in the same proportions:

• 66.6% ($60M) to the mortgage lender
   
• 33.3% ($30M) to the contractors with perfected mechanics liens whose work added value to the project

No Enhanced Value Means No Priority

Another big source of controversy: what happens if work on the project doesn't enhance its value?  Presumably the contractors and others who provided that work don't get enhancement priority because, although they incurred costs, they didn't add value. 

Justice Daniel Schmidt wrote a special concurrence mentioning this issue.  Paraphrasing what he said:

The most feasible alternative in dealing with this property is to demolish all the buildings and site improvements because a new developer would find it easier and more feasible to start from scratch. One could argue then that the Perfected Contractors' work added no value to the real estate, rather a liability

This could have become an issue between the Lender and Perfected Contractors.  But for some reason still to be explained, it didn't.  

Coming Up Next

In Mechanics Lien Priority: Contractor vs. Lender - Part 5 we'll talk about the biggest controversy aroused by the Cypress Creek decision.  The Lender paid loan proceeds to many contractors who worked on the project and, presumably, added value.  So, in addition to standing first in the pre-work value Queue #1, should the Lender (because they paid contractors who presumably added value) get to take those contractors' places at the front of the added value Queue #2?