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Contractor Forfeits Right to Construction Lien by Accepting Mortgage Or Trust Deed As Security For Debt

The Oregon Court of Appeals recently issued a ruling which made it clear that a contractor’s acceptance of a mortgage or trust deed as security for the debt owed to them constituted a waiver of their construction lien rights. While the ruling at first glance sounds fairly logical and straight forward, it could have negative unintended consequences for contractors who release their construction lien rights in exchange for a mortgage or trust deed.

In the case of Evergreen Pacific, Inc. v. Cedar Brooke Way, LLC, filed July 11, 2012, Case No. A146478, the owner of several parcels of land being developed hired a contractor to pave parking lots and perform related work. To finance the development, the property owner obtained a line of credit from a bank and provided the bank with a trust deed against the subject property as security.

The owner/developer failed to pay the paving contractor following the substantial completion of the paving contractor’s work. The paving contractor subsequently filed a construction lien against the subject property. A construction lien foreclosure lawsuit resulted from the paving contractor’s construction lien filing and owner’s failure to pay the paving contractor.

The parties settled their differences before the foreclosure lawsuit went to trial. Pursuant to the settlement agreement, in exchange for the owner’s agreement to pay a specified sum to the contractor (including an immediate payment of approximately 40 percent of the settlement amount), the contractor agreed to make some repairs to its original work, perform some additional work, and release its construction lien. In addition, the owner agreed to provide the contractor with a trust deed against the subject property as security for the remaining amounts owed under the settlement agreement.

After the parties entered into the settlement agreement, the owner made the initial payment to the contractor and the contractor released its construction lien. A trust deed in favor of the paving contractor to secure the remainder of settlement payment was subsequently recorded. The contractor then proceeded to complete all the new work contemplated in the settlement agreement, as well as some of the repairs. However, the owner failed to pay the remaining amounts owed to the contractor under the settlement agreement. Such failure caused the paving contractor to file a new construction lien against the property. The contractor’s attempt to foreclose its second construction lien, as well as it’s foreclosure of the trust deed, were the basis of the court’s decision that is the focus of this article.

The owner did not appear in the second foreclosure case and the court issued a default against them. However, there was a trial, which included the bank who had provided a line of credit to the owner, concerning the validity (and priority) of the paving contractor’s lien. The bank took the position at trial that the paving contractor’s lien was not valid because (1) the paving contractor waived its right to a construction lien when it released its first construction lien, thus precluding a second construction lien against the same project; and (2) the paving contractor had forfeited its right a construction lien when it accepted a trust deed to secure the project debt. The trial court ruled that the construction lien was valid, and per Oregon’s super-priority statute for construction liens, also ruled that it was superior in priority to the bank’s line of credit trust deed against the subject property. The bank appealed the trial court ruling and renewed its position that the construction lien was invalid because the paving contractor had forfeited its right to a construction lien by accepting the trust deed from the owner as security for the project debt.

The court of appeals, while citing a case from 1877 which held that a contractor waives its rights to a construction lien when they accept a mortgage or trust deed to secure the underlying debt, ruled that the trial court erred in finding that the second construction lien was valid. Accordingly, the court of appeals reversed the foreclosure judgment in favor of the paving contractor. In making its ruling, the court of appeals held that the 1877 case upon which their decision was based established a bright-line rule, which follows: When a contractor takes a mortgage (or trust deed) to secure construction debt, the contractor forfeits the right to a construction lien.

In light of the fact that the paving contractor received a trust deed against the subject property to secure the remaining project debt in exchange for the release of its first construction lien, the ruling of the court of appeals initially appears to be without negative ramifications. However, contractors could cause themselves some problems if they release a construction lien in exchange for a trust deed against the same property. The potential problems relate to the priority of the construction lien against other encumbrances on the subject property.

Oregon has a super priority statute for construction liens which holds, with exceptions, that a construction lien, once perfected, has priority over “all prior liens, mortgages, or other encumbrances against the property”. Said statute is contrary to the general priority rule of “first in time, first in line”. Thus, an unknowing contractor could lose the priority its construction lien has over other encumbrances by releasing its construction lien and accepting a trust deed in exchange for the released construction lien. As such, it is important that contractors consult with an attorney that is familiar with the intricacies of Oregon’s construction lien laws before they accept alternative security for their construction liens.