Payment Precedence Over Lender

The recent case of Brewer Corp. v. Point Center Financial, Inc. dealt with Stop Payment Notice claims and priority of the project funds. This particular project had a lender and various contractors, many of which ended up filing Stop Payment Notices throughout the course of the project. The lender did not withhold funds pursuant to all of the Stop Payment Notice claims that were received. The lender actually disbursed all funds and in return multiple legal actions were filed against the lender and owner (the owner filed bankruptcy).

Before getting into the outcome of the case, it is important to discuss the rights that are afforded to contractors and material suppliers. The right to a Mechanic's Lien has its roots in the California Constitution with special provisions made to protect the interests of workers or suppliers who help improve real property and await payment. There is a section which provides for a Mechanic's Lien -- a claim against the real property on which the claimant has bestowed labor or furnished material for the value of the labor done or material furnished. Subsequently, statutes were written to refine the notion, create a lien process, and specify the exact categories of persons entitled to the lien remedy.

Given this, Mechanic's Liens are intended to give contractors or material suppliers who contribute to a private work of improvement on real property a security interest in that real property for the value of their improvement. In other words, if a contractor performs on a work of improvement and is not paid, a Mechanic's Lien can be recorded and then a suit filed in order to collect what is owed.

A Stop Payment Notice is also a very effective tool to collect monies that are due for work that you have performed on a construction project, whether it is a private works or a public works project (unlike the Mechanic's Lien, which is for private works projects only). Stop Payment Notices are not as common as Mechanic's Liens, but oftentimes can be a much more effective method by which to collect monies since you are not required to physically foreclose upon a piece of real property. In effect, what you are foreclosing on is a fund of money. The holder of construction funds must set aside a sufficient amount of money from the construction fund to pay the amount of a properly prepared and served Stop Payment Notice as well as the cost of litigation. A Stop Payment Notice on a private works project must be bonded when served on the construction lender. Serving an un-bonded Stop Payment Notice on a construction lender for a private works project is essentially the same as serving a document that has no legal effect. The lender is not required to set aside any monies unless the Stop Payment Notice is bonded on a private works project.

In order to make a project owner aware of the obligations being created by a contractor or material supplier, a Preliminary Notice must be provided to the owner and any construction lender within 20 days of providing performance (whether it is labor or the provision of equipment or materials). That notice describes the work to be done or the materials provided, the name of the subcontractor or supplier, the name of the person contracting for the work or materials, the value of the work, and the fact that non-payment may result in a Mechanic's Lien or Stop Payment Notice action. One Preliminary Notice will preserve the Mechanic's Lien as well as a Stop Payment Notice right.

In public works projects, only those persons who are not in a direct contractual relationship with the direct contractor are required to serve a Preliminary Notice. That means that first tier subcontractors do not need to serve a Preliminary Notice on public works. However, if there is a lender on the project, they must also be served a Preliminary Notice, even by the direct contractor. This issue caused one of the parties in the Brewer case to lose their Stop Payment Notice rights - they did not serve the lender with a Preliminary Notice believing they did not need to do so since they had a direct contract with the owner. Because of this, they lost the protection that the Stop Payment Notice afforded them.

The main issue in the Brewer case was whether the lender's right to pay itself all interest, loan fees, and other preallocated expenses took precedence over the claims of those that filed and served the proper Stop Payment Notice. As you can imagine, if the lender took their money first, there would be even less for the contractors to split between them on their Stop Payment Notice claims. However, the court ruled in favor of the contractors stating that the Stop Payment Notice claims did come before the lender's fees. The court also awarded costs, prejudgment interest and attorneys fees per statute to the contractors. This is important information to have when you are involved in a Stop Payment Notice Action - the contractors payment comes before the lender's fees. Just make sure that you follow all of the laws in place so that your Stop Payment Notice or Mechanic's Lien can help you collect your money!