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

• Loan proceeds from the Lender's construction loan paid many of the contractors, other than the Perfected Contractors, who worked on the project (each a "Lender Paid Contractor")
   
• Presumably the Lender Paid Contractors' work added value to the project, i.e., their work put more lemonade in the added value pitcher, yielding more money when the project was sold at a foreclosure sale
   
• Because many Lender Paid Contractors were paid with construction loan proceeds from the Lender, under the principle of subrogation the Lender gets to take over the Lender Paid Contractors' place in Queue #2
   
• Moreover, had the Lender not paid the Lender Paid Contractors, the Lender Paid Contractors would have claimed liens against the project.  And had they properly claimed liens against the project, they would stand at the front of Queue #2, at parity right beside the Perfected Contractors
   
• So, by paying the Lender Paid Contractors and taking over their (the Lender Paid Contractors') position, the Lender should stand beside, not behind, the Perfected Contractors at the front of Queue #2 as foreclosure sale money is poured out from the added value pitcher  

Perfected Contractors Oppose Lender Enhancement Priority

According to the Perfected Contractors, regardless of whether the Lender Paid Contractors were paid with construction loan proceeds from the Lender, the Lender shouldn't get to stand at the front of Queue #2.  Here's how the Perfected Contractors explained it:

• To get to the front of Queue #2, you must have a properly perfected mechanics lien. That's either one you perfect yourself securing payment for your own work, or one you get from someone else (for example, by assignment or subrogation)
   
• Each Perfected Contractor perfected their own mechanics lien against the project.  But the Lender Paid Contractors didn't
   
• By paying the Lender Paid Contractors, the Lender does subrogate into the position each Lender Paid Contractor once occupied
   
• But a traditional, and critical, tenet of subrogation is that when you pay someone and subrogate into their position, you inherit the position they (the person you paid) had and no better.  If the Lender Paid Contractors didn't perfect mechanics liens against the project and enjoy the senior priority position that comes with a perfected mechanics lien, then the Lender doesn't enjoy that senior priority position either

Putting the Perfected Contractors' argument another way: by paying the Lender Paid Contractors for their work, the Lender steps into their shoes. But those shoes don't get resoled and polished just because the Lender pays for them with construction loan money.

Judges' Decision: No Mechanics Lien Means No Priority Subrogation

Two of the three judges agreed with the Perfected Contractors: to enjoy the same priority and stand at the front of Queue #2, the Lender's loan proceeds must pay off contractors holding properly perfected mechanics lien claims.  The Lender steps into the Perfected Contractors' shoes, but doesn't improve them.   

Dissenting Judge

One dissenting judge agreed with the Lender.  He cited two reasons:

• Earlier judicial decisions - some going back to the 19th century - mandate allowing lenders to subrogate to the priority of contractors they pay as if those contractors (a) hadn't been paid and (b) had properly perfected mechanics liens.  In this case the Lender Paid Contractors didn't perfect mechanics liens against the project.  Why?  Because they were paid on time.  Had they not been paid, they would have recorded and perfected mechanics liens against the project.  Construction loan money from the Lender averted those liens.  So, the Lender shouldn't be penalized with junior priority just because the they paid on time, preventing at least some mechanics liens against the project

• Also, putting the Lender behind, instead of beside, the Perfected Contractors would unjustly enrich the Perfected Contractors.  They (the Perfected Contractors) would get a larger share of the foreclosure sale money then they are equitably entitled to

These are some good arguments.  But the first rests on the assumption each contractor, if not paid, will timely and properly perfect a mechanics lien against the project.  It equates lienable with perfected lien.  If you've observed a few mechanics lien disputes, you've probably recognized by now that assuming timely and proper perfection of a mechanics lien is assuming quite a lot. 

The second argument defies a longstanding subrogation jurisprudence: it grants the Lender more than the Lender Paid Contractors had.   But the Lender has urged that subrogation, founded on notions of fairness and equity, is a flexible enough concept to sustain an exception to the traditional rule that says you can't subrogate to more than what the person you pay has.  Perhaps the Lender is right?

Illinois Supreme Court Appeal

Dissatisfied with the majority of the judges' decision, the Lender asked the Illinois Supreme Court to hear the case.  The Supreme Court said yes.  Earlier this summer the Lender submitted this brief (PDF) stating the issue:

Whether, in determining priority under §16 of the Mechanics Lien Act, the Appellate Court erred in finding that the Lender was subrogated only to the extent the owner or the Lender paid mechanics liens which were perfected by recording instead of being subrogated for payments made for lienable improvements 

Responding, the Perfected Contractors submitted their own briefs.  One brief from Edon Construction Company (PDF) and one brief from Eagle Concrete (PDF).

Read on to see how the Justices decided this issue.