• Partial Subordination Agreement not Involving or Affecting Mechanics Lien Claimant Priority is Enforceable in Nevada
  • October 21, 2015 | Author: Leon F. Mead
  • Law Firm: Snell & Wilmer L.L.P. - Las Vegas Office
  • When visible construction begins, Nevada law says mechanic’s liens attach to the construction site. A construction lender wants to ensure that its deed of trust securing the construction loan has first priority to the property title, if the loan is not paid and the lender needs to initiate foreclosure proceedings. But if the project owner does not already have construction financing when construction begins, the mechanics liens will have “priority” over any deed of trust recorded after to secure that financing. NEV. REV. STAT. § 108.225. Nevada law makes such a “break” in the lender’s title priority difficult to change, making some lenders reluctant to finance construction projects after construction begins.

    One method historically used to fix a lender’s broken priority over the mechanics liens is to obtain a contractual “subordination” agreement from the potential mechanics lien claimants. However, because mechanics liens are governed by statute, the applicable statutes must allow enforcement of contractual subordination agreements. Many states, such as Nevada, have statutes espousing public policies preventing mechanics liens from being waived or “impaired” by contractual agreements at all, Nev. Rev. Stat. § 108.2453, or only allow enforcement in limited circumstances, Nev. Rev. Stat. §RS 108.2457. When contractual subordination is not available, some lenders have tried to argue for equitable subrogation of the mechanics lien claims, essentially asserting it would be “unfair” to the lender to put its loan security behind mechanics liens when its loan funds are being used to pay for lien claimants’ construction work.

    In 2012, the Nevada Supreme Court (“NSC”) dispensed with the use of equitable subrogation to provide a lender priority over mechanics liens. In Re Fontainebleau Las Vegas Holdings LLC, 128 Nev. Adv. Op. 53, 289 P.3d 1199 (2012). Fontainebleau, likewise, dispensed with the idea that a lien claimant could contractually waive its rights to record a mechanics lien before it even started work. However, the NSC also hinted that a contractual subordination agreement may be enforceable after construction had commenced by noting that “neither NRS 108.2453 nor NRS 108.2457 completely prohibit waiver of or impairment to the right to a mechanic’s lien after it arises.” Fontainebleau, supra, 289 P.3d at 1214. Rather, “non-prospective subordination agreements may be enforced as long as they meet the statutory requirements of NRS 108.2457.” Id. What exactly was needed in a contractual subordination agreement to meet the statutory requirements of NRS 108.2457 was left for another day.

    While Fontainebleau was under consideration, another dispute involving mechanics lien priority and contractual subordination was being litigated. The owners of a construction project known as “Manhattan West” had secured an initial $38 million in construction financing secured by a recorded deed of trust before construction commenced, giving that original financing priority over the mechanics liens when visible construction commenced thereafter. Later, the project was sold to a new owner who assumed the original construction loan obligations, and also obtained an additional $110 million in construction financing from the same construction lender. The additional construction financing was secured by a deed of trust that was recorded after the construction had commenced, and was thus subject to both the original deed of trust securing $38 million as well as the mechanics liens. As part of that new financing package, the construction lender executed a contractual subordination agreement with itself, agreeing that the first $38 million of its new loans would take the priority position of the first deed of trust. The effect of this subordination agreement was to give the new loan priority as to the first $38 million of funds ahead of the mechanics liens, but the original note of $38 million, as well as the balance of the new loan, would be behind the mechanics liens. The mechanics lien claimants were not parties to that subordination agreement.

    When the construction project failed during the Great Recession, the mechanics lien claimants argued that because the deed of trust securing the new loan was recorded after visible construction had begun, NRS 108.225 gave the liens priority over the deed of trust, notwithstanding the subordination agreement. The lender argued that the subordination agreement merely effected a “partial subordination;” that is, it merely “flipped” the priority of two of its loans, in the exact same amount, leaving the intervening mechanics liens unaffected. The mechanics lien claimants conversely argued that the subordination agreement was a “complete subordination” because the deed of trust securing it was recorded after the commencement of visible construction. Thus, under a plain reading of NRS 108.225, the mechanics liens must have priority over the entire deed of trust. The district court granted the lender summary judgment on lien priority, finding that because the mechanics lien claimants were not affected by the subordination agreement, it was a partial subordination and would be enforceable.

    On appeal, the mechanics lien claimants argued that the NSC decision in Fontainebleau mandated that NRS 108.225 should be given its plain meaning, and therefore the subordinated deed of trust should be subject to the mechanics liens, but NSC disagreed. In its decision of In re: Manhattan West Mechanic’s Lien Litigation, 131 Nev.Adv.Op. 70, --- P.3d --- (2015), the NSC determined that a “complete subordination” would mean that a subordination agreement not only “subordinates a first-priority lien to a third-priority lien, but also has the effect of subordinating the first-priority lien to the second-priority lien,” thus placing the second-priority lien in first position. Manhattan West, 131 Nev.Adv.Op. 70 at fn 5. On the other hand, a “partial subordination occurs when the effect of a subordination agreement subordinates the first-priority lien to a third-priority lien without affecting the priority of the second lien.” Id. at fn. 6. Noting a split between jurisdictions, the NSC sided with the majority which held that a general subordination agreement that has “no affect” on lien holders that are not parties to the subordination agreement, should be read as effecting a “partial subordination.” Since the mechanics lien claimants were not a party to the subordination agreement, the court would not ascribe a purpose to the parties to enhance the priority of non-parties to the agreement. Id. at pg. 12.

    On this basis, the NSC could not find that NRS 108.225 precluded a partial subordination agreement “between lienholders with priority over mechanic’s liens and those with lesser priority in situations where the mechanics’ liens will be left in exactly the same position as if the subordination agreement had never occurred.” Manhattan West, supra, 131 Nev.Adv.Op. 70, at pg. 14. The NSC distinguished Fontainebleau by noting in that case the mechanics lien claimants were parties to the subordination agreement which attempted to subordinate the mechanics lien priority position despite the provisions of NRS 108.225. Manhattan West, supra, at fn. 7. This point was “crucial” to the NSC’s decision:

    Crucially, nothing about the subordination agreement alters the amount of debt that [the lien claimant] was junior to, and thus, the subordination agreement does not violate NRS 108.225.
    Manhattan West, supra, at pg. 14.

    While Manhattan West might seem like a bell-weather change in the NSC’s thinking on mechanics lien priority because it supports the idea that effect should be given to contractual agreements between parties that impact mechanics liens even in contravention of the Nevada Mechanics Lien Law’s pronouncements otherwise, Nev. Rev. Stat. § 108.2453, such an interpretation is undoubtedly a stretch too far. The key factor in the NSC’s opinion was the lack of a contractual agreement including the mechanics lien claimants, as well as a lack of impact of the agreement on the lien claimant’s priority position. The actual language of Manhattan West would seem to indicate almost an outright ban of subordination agreements when mechanics lien claimants are parties to them, and/or when the effect of the subordination is to subject the mechanics lien claim to additional debt. Such an indication can be seen in the NSC interpretation of NRS 108.2457.

    In the unpublished decision in Insulation Contracting & Supply, Inc. v. S3H, Inc., No. 62856, 2015 WL 5774180 (Nev. Sept 29, 2015),[1] the NSC made clear it considers waiver or impairment of mechanics lien claimant rights without full payment very difficult. In fact, the NSC specifically states that under NRS 108.2457(2)(b) “lien waivers cannot be enforced unless the waiving party is paid in full.” Id., at pg. 3. NRS 108.2457(2) provides:

    [a]n oral or written statement purporting to waive, release or otherwise adversely affect the rights of a lien claimant is not enforceable and does not create any estoppel or impairment of a lien unless ... (b) The lien claimant received payment for the lien and then only to the extent of the payment received.
    NEV. REV. STAT. § 108.2457(2).

    Fontainebleau advises that a contractual subordination agreement seeking to subordinate an existing mechanics lien priority right may be enforceable if it complies with the provisions of NRS 108.2457. Manhattan West states that a partial subordination agreement is enforceable specifically and crucially because it does not at all affect the priority of existing mechanics lien claimants and NRS 108.2457 requires a lien claimant be paid in full to impair a mechanics lien right. It is therefore very difficult to expect that the NSC will enforce a contractual subordination of mechanics liens which results in less than payment in full to the subordinating mechanics lien claimants.


    Notes:

    [1] While an unpublished opinion cannot currently be cited as authority under SCR 123, it should be noted that 1) the NSC is currently considering a petition to repeal the provisions of SCR 123 (See ADKT No. 506), and 2) a petition is currently pending under NRAP 36(f) for the Insulation Contracting decision to be reissued as a published decision.