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

My colleagues Scott Smith, David Eisenberg, and I just published a short article about the Illinois Supreme Court's controversial LaSalle Bank, N.A. v. Cypress Creek 1, LP decision.  It focuses on three things:

• A summary of who was involved, what their respective stakes were, the positions they took, and how the Justices reacted to them to decide the case
   
• How this decision affects construction industry stakeholders, particularly construction lenders and anyone who may claim a mechanics lien (e.g., prime contractors, subcontractors, material and equipment suppliers, architects, engineers, and other design professionals)
   
• Initiatives in the Illinois General Assembly to amend the Mechanics Lien Act to change the results in future cases

And it's a  wrap-up on Construction Law Today coverage that started back here: Mechanics Lien Priority: Contractor vs. Lender - Part 1. Click this link to navigate on to our article. 

Also in the same Litigation & Counseling Alert, some of our other colleagues also wrote these companion articles that may interest you too:

• Insurance and Due Diligence in the Business Transaction
   
• Can a Forbearance Agreement Actually Help a Lender Collect from Its Debtor?

 

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LaSalle Bank, N.A. v. Cypress Creek 1, LP Decision from Illinois Supreme Court

In past posts we've been following this case as it wound its way through the Illinois judiciary up the the Illinois Supreme Court.  This morning, the Supreme Court issued this decision (PDF).  The Justices decided that a lender gets priority to the extent their loan proceeds paid for property improvement, regardless of whether the contractors paid with those proceeds timely, or properly, perfected mechanics liens. 

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Have you recently wondered how asset valuation or appraisal works?  Surely over the last three years you may have pondered one of these:

• How much value did a contractor's work add to a piece of property?
   
• How much is collateral worth?  Should a borrower be required to fund more money to restore a loan's minimum debt-to-equity balance?  How much money?
   
• How much is a loan, or portfolio of loans, worth?  How did they decide how likely a borrower, or a bunch of borrowers put together, is to default?

• What is "indubitably equivalent value (PDF)" for an asset under the Bankruptcy Code?

Maybe the answer lies in the movie Midway?  It was a favorite of my brother and me when we were kids - lots of ships and airplanes shooting each other up.  But watching it on TV recently I noticed a piece of dialogue that went over the heads of two grammar school boys.  It's between the fictional Captain Matt Garth (Charlton Heston) and cryptanalyst, Commander Joseph Rochefort (Hal Holbrooke). They're talking about breaking Japanese naval codes early in 1942.  Could you hear the same exchange with MBAs or analysts in the past week, or decade?

 

"Analysis" by Rochefort and his team actually succeeded in cracking critical parts of the Japanese code, playing a pivotal role in Second Word War.  Are contemporary analysts and appraisers as successful today?

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Must a claim of mechanics lien identify the date when the contractor (or other lien claimant) last provided labor, other services (including design services), material, or equipment for a piece of property(all together collectively "work")? 

 

Yes in Cook County.  But no after the Appellate Court (Second District) decision in National City Mortgage v. Bergman (PDF) in these counties: Jo Daviess, Stephenson, Winnebago, Boone, McHenry, Lake, Carroll, Ogle, Lee, DeKalb, Kane, Kendall, and DuPage.

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In Mechanics Lien Priority: Contractor vs. Lender - Part 4, we talked about how the Perfected Contractors got priority to a part of foreclosure sale money, known as the added value pitcher, ahead of other rival creditors. Now we're going to talk about the Lender's attempt to get equal priority in front of the added value pitcher of foreclosure sale money.

Lender Seeks Enhancement Priority

In LaSalle Bank, N.A. v. Cypress Creek 1, LP (PDF), the Lender wanted to join the Perfected Contractors at the front of queue that had lined up before the added value pitcher (a/k/a queue Queue #2).  Why should the Perfected Contractors share space, and money, with the Lender?  According to the Lender: 

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If you've been around construction contracts or architects agreements for a while, you've heard someone mention "subrogation."  So what exactly is subrogation and how does it work?

Subrogation is pretty simple, yet it defies clear explanation. Here's one attempt:

Subrogation is a method whereby one who had involuntarily paid a debt of another succeeds to the rights of the other with respect to the debt paid

Hugh??

OK, maybe subrogation is one of those things better explained by example.

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Back in Mechanics Lien Priority: Contractor vs. Lender - Part 3 we talked about step 1 in the workflow of deciding priority, and dividing foreclosure sale money, between (a) a Lender's mortgage and (b) the mechanics liens of two Perfected Contractors.  Initially, priority goes to whoever got there first.  In LaSalle Bank, N.A. v. Cypress Creek 1, LP (PDF), the Lender initially won priority because they recorded their mortgage before either Perfected Contractor (a) contracted with the Owner or (b) started work on the project.

Now for step 2: changing priority based on "enhancement" to the project.  Specifically, giving partial priority to the Perfected Contractors because their work added value to the project that, presumably, helped fetch a higher price at the foreclosure sale.

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Back in Mechanics Lien Priority: Contractor vs. Lender - Part 2 we talked about the backstory of the  LaSalle Bank, N.A. v. Cypress Creek 1, LP (PDF) decision: who was involved, what started the dispute, what was at stake, and how the first judge hearing the case decided.  Now it's time to talk about the appeals court judges' decision and why they decided the way they did.  This won't be easy or brief.  So we'll break it into a series of several posts.

The Perfected Contractors' First Request: Full Priority

The Perfected Contractors first asked the appeals court judges to grant each of their perfected mechanics liens full priority over the Lender's mortgage.  Requested result: the Perfected Contractors get paid in full from the foreclosure sale money before the Lender gets a penny.  Naturally, the Lender opposed this.

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When the Federal Deposit Insurance Corporation (the “FDIC”) becomes the receiver for a failed bank, there’s usually a lot of lawsuits by, and against, the bank pending in state court. And there's often post-Appointment Date lawsuits filed in state court against the FDIC as receiver too.  Under Section 9(b)(2) of the Federal Deposit Insurance Act (the "FDI Act"), also known as 12 U.S.C. §1219(b)(2) (the “removal statute”), the FDIC may remove (i.e., transfer) most of those cases from state to federal court.

Most FDIC Cases are Eligible for Removal

With limited exception, under the removal statute, any case where the FDIC is a party is considered to arise under federal law.  And the FDIC may remove lawsuits arising under federal law to federal court.

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Back in Mechanics Lien Priority: Contractor vs. Lender - Part 1 we talked about the basics of priority and why it’s important.  At the end I promised to fill you in on the backstory of the Cypress Creek decision.  Here it is.

Backstory of LaSalle Bank, N.A. v. Cypress Creek 1, LP

It started when a developer (we'll refer to them as the "Owner") borrowed money from LaSalle Bank (the "Lender") to design and build a senior housing project outside of Chicago. To secure payment of principal, interest, and fees on the loan, the Owner gave to the lender, and the lender recorded, a mortgage against the project.

Later, the Owner entered into contracts with Eagle Concrete and the Edon Construction Company (together, the "Perfected Contractors").  Under these contracts, Eagle provided concrete and Edon provided carpentry.  Each then provided work on the project under their respective contracts.

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When both a mortgage lender and a mechanics lien holder foreclose against the same piece of property, who gets priority to the money paid at the foreclosure sale?  One recent Illinois judicial decision, LaSalle Bank, N.A. v. Cypress Creek 1, LP, says they both do, depending on what part of the property you're talking about:

• The lender's mortgage gets priority on the value of the property before improvement by designers and contractors
   
• The mechanics lien gets priority on value added to the property by improvements from designers and contractors
   
• Then, to the extent the lender pays off a designer or conractor who holds a properly perfected mechanics lien (each a "Payee"), the lender succeeds by subrogation to the priority of the Payee's mechanics lien.  By paying a Payee, the lender essentially buys the Payee's mechanics lien.  But that works only to the extent the lender pays off a Payee who holds a properly perfected mechanics lien.  The lender doesn't succeed, and doesn't get priority, just because they pay money to a designer or builder who provided lienable work, but didn't perfect a mechanics lien to secure payment

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Judges to owner: demanding that your contractor foreclose their mechanics lien within 30 days or lose it forever waives your right to require arbitration.

 

The Backstory of Illinois Concrete-I.C.I., Inc. v. Storefitters, Inc.

Unfortunately, the Illinois Appellate Court (Second District) decision in Illinois Concrete-I.C.I., Inc. v. Storefitters, Inc. (PDF) doesn't give us too many background details.  Here's what we can gather: an owner entered into a contract with a contractor to provide some type of construction work for the owner.  The contract had an arbitration clause, presumably one that says that if the owner and the contractor get into a dispute, they must submit the dispute to binding arbitration instead of resorting to the courts.

The owner and the contractor got into a dispute.  The owner didn't pay.  So the contractor recorded a lien against the property they'd worked on.

Under Section 34 of the Illinois Mechanics Lien Act (PDF) an owner (and others too) can serve a written demand on anyone holding a mechanics lien against their property (a "mechanics lien holder") demanding that the mechanics lien holder sue to foreclose their mechanics lien within 30 days (a "Section 34 demand").  And if the mechanics lien claimant doesn't go to the clerk of the court and file their foreclosure complaint before that 30 days expires, the mechanics lien claimant forfeits their lien.

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In this past post I mentioned a bill (HB344) in the Illinois legislature to amend the Illinois Contractor Prompt Payment Act putting caps on retainage under private construction contract and subcontracts.  The legislative session has ended and the bill did not emerge from the Illinois's Senate Executive Committee and will not be enacted this spring.  We'll see if the bill returns later this year or in the next legislative session.  Stay tuned.

Interested in construction related bills that did pass the Illinois legislature this session?  Check out the Illinois Construction Law Blog's report on HB236 amending the Illinois Mechanics Lien Act.  Both houses passed the bill and it's now with Governor Quinn waiting for him to sign it.

If Governor Quinn signs this bill, prime contractors must give homeowners written notice within 10 days after recording a mechanics lien informing the homeowner that the contractor has recorded the lien.  Here's a legislative staff summary of  HB236:

Amends the Mechanics Lien Act to provide that:

• A contractor for improvements of an owner-occupied single-family residence must give the owner written notice within 10 days after recording a lien against any property of the owner.
  
• The notice is served when it is sent or personally delivered.
  
• If timely notice is not given and, as a result, the owner has suffered damages before notice is given, the lien is extinguished to the extent of the damages.
  
• The mere recording of the lien claim is not considered damages. These changes do not apply to subcontractors and only apply to contracts entered into after the effective date.

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