• Arizona Supreme Court to Contractor: Sorry, but Equitable Subrogation Trumps Mechanics’ Lien Rights
  • October 13, 2014 | Author: Richard G. Erickson
  • Law Firm: Snell & Wilmer L.L.P. - Phoenix Office
  • The smoke has finally cleared in a hard and long-fought battle between lenders and owners on one side and the general contractor (Weitz Company, L.L.C., from here on referred to as Weitz) on the other side claiming priority on a Phoenix condominium project. The project, well-known as Summit at Copper Square in central Phoenix (Summit), developed financial problems. As the project neared completion, the developer failed to pay Weitz approximately $4 million. Weitz’s mechanics’ lien case began in 2008, and the construction, lending and real estate industries have been keeping a close eye on the outcome. In the end, the Arizona Supreme Court weighed in with its “first opportunity to address the interplay between equitable subrogation and the priority granted to mechanics’ liens by [Arizona Revised Statutes] § 33-992(A).”

    The Arizona Supreme Court issued its decision in The Weitz Company L.L.C. v. Heth et. al, No. CV-13-0378-PR (Aug. 26, 2014) (Weitz) on August 27. The Weitz decision vacated all lower court rulings and concluded that Arizona’s lien statute, § 33-992(A), does not preclude “assignment by equitable subrogation of a lien that attached before construction began on the project at issue.”

    The facts of the Summit project followed the below chronology of events:

    April 2005

    Bank records its first deed of trust securing the developer’s construction loan of $44 million before construction starts.

    November 2005

    Shovel hits the ground and construction officially begins to trigger the contractor’s right to mechanics’ liens.

    December 2005

    Bank increases loan by approximately $8 million and records a modification to its original deed of trust. 

    February 2007

    Bank records second deed of trust to secure approximately $10 million in additional loaned funds.

    September 2007

    Developer begins selling condominium units to buyers who either financed or paid cash. Some of the purchase money for these units was applied to the construction loan, resulting in the Bank releasing these units from both of its deeds of trust. Deeds of trust securing the owners’ purchase money loans were then recorded against the units.

    May 2008

    Contractor records its mechanics’ lien for billings unpaid by the developer.  

    November 2008

    Contractor files a foreclosure lawsuit against developer, the unit owner and their lenders, claiming its mechanics’ lien rights in November 2005 have priority.

    At the trial court, the Owners and Lenders moved for partial summary judgment and urged that because they had paid the portions of the construction loan allocated to their units, they were equitably subrogated to the Bank’s April 2005 deed of trust and therefore had priority over Weitz’s mechanics’ lien. Weitz filed a cross-motion for partial summary judgment, and argued that A.R.S. § 33-992(A) precluded equitable subrogation, or alternatively, that the Owners and Lenders were not eligible to invoke the doctrine because they did not fully discharge the Developer’s obligations to the Bank. The Supreme Court’s recent decision established the following principles regarding equitable subrogation and Arizona mechanics’ lien law:

    • “When equitable subrogation occurs, the superior lien and attendant obligation are not discharged but are instead assigned by operation of law to the one who paid the obligation.”

    • “Because an equitably subrogated lien ‘attaches’ when the superior lien was recorded, § 33-992(A) does not require that an intervening mechanics’ lien be given priority.”

    • “[N]othing in § 33-992(A) suggests that the legislature intended to preclude equitable subrogation in the mechanics’ lien context. ... When a lien that is superior to a mechanics’ lien is assigned to another through equitable subrogation, the mechanics’ lien remains in the same position it occupied before subrogation.”

    • “[P]ermitting equitable subrogation of a lien that is superior to a mechanics’ lien is consistent with the legislature’s treatment of junior lienholders’ interests in foreclosure actions.”

    • “[A] prospective subrogee is required to discharge only the portion of an obligation that is secured by the property at issue.”

    The Supreme Court held “that when a single mortgage is recorded against multiple parcels, a third party is not precluded from attaining equitable subrogation rights when it pays the pro rata amount of the superior obligation and obtains a full release of the parcel at issue from the mortgage lien.”

    The important takeaway for contractors is to recognize that the principle of equitable subrogation may trump their mechanics’ lien rights. Contractors should evaluate the owner/developer’s financial wherewithal (via the property or otherwise) to pay and the amount of prior encumbrances on the property. Insisting on payment bonds or other financing alternatives may be a better alternative for contractors in many situations in light of the Weitz case.