Oregon Contractor Records Mortgage for Construction Debt, Unintentionally Forfeits Construction Lien Priority

A contractor who took a deed of trust to secure an owner’s performance of a settlement agreement lost its lien rights under Oregon law, allowing the project’s construction lender to swoop into first position in a later foreclosure.

In Evergreen Pacific, Inc. v. Cedar Brook Way, LLC, 251 Or.App. 194 (2012), an owner took out a construction loan to develop several pieces of property. The bank recorded a deed of trust securing the construction loan in 2007.

Evergreen Pacific, Inc. was hired to perform paving work for parking lots, completing its work in 2009. The owner refused to pay for a portion of the work, due to claimed defects. Evergreen filed a construction lien against the property, asserting it was owed over $192K.

When the bank learned about the lien, it told the owner that it would not fund any further construction work until the owner got rid of the lien. The owner sued to invalidate the lien, claiming the work was defective and the amount was overstated.

Shortly thereafter, Evergreen and the owner entered into a settlement agreement under which Evergreen would perform certain repairs as well as new work, and the owner would pay the originally claimed $192K, plus $10K for the new work. The agreement required the owner to pay a portion upfront, followed by lump sums after completion of the repairs and the new work. To secure its obligation to make the later payments, the owner granted Evergreen a deed of trust against the property. Evergreen filed the deed of trust, as well as a release of its earlier lien.

Evergreen completed the new work and a portion of the repairs, but the owner did not pay. Evergreen filed a new construction lien and then sued for breach of contract and to foreclose its lien. Meanwhile, the owner had also defaulted on its payments to the bank, which filed its own lawsuit to foreclose its deed of trust. The court consolidated the cases, but the owner did not appear for trial and the court entered a default judgment against the owner. As a result, the issue in dispute was whether Evergreen or the bank stood first in line to receive proceeds from the foreclosure sale of the property.

A wrinkle in Oregon law gives a perfected construction lien (for new construction) priority over an earlier deed of trust or mortgage. That is, even when a construction lien is perfected after a lender’s deed of trust was recorded, the construction lien has superior rights in the event of a foreclosures.

Evergreen asked the court to use this law to give it priority over the bank. The trial court ruled in Evergreen’s favor, relying on the fact that the bank had received a copy of the settlement agreement between Evergreen and the owner, and the settlement agreement said Evergreen was not waiving a right to claim a lien against the property if the owner defaulted on the settlement.

The Court of appeals disagreed, citing an 1879 case for the “bright-line rule” that “[w]hen a contractor takes a mortgage to secure a construction debt, the contractor forfeits the right to a construction lien.” The court rejected Evergreen’s argument that the bank knew the contractor had not waived its lien rights if the owner defaulted on the settlement. The court believed that argument was outweighed by the need to protect third parties from “secret” liens, and for a predictable rule that when a third party sees a deed of trust in the property records, s/he may safely conclude that is the only encumbrance securing the underlying debt. Thus, the court declared Evergreen’s lien to be invalid, and the bank’s deed of trust took priority-i.e. the bank was the only one likely to get any money from the foreclosure sale.

Several morals surface from Evergreen’s travails in this case. One is a reminder to regularly review applicable lien laws, especially if you’re working in a new area. For example, not all Washington contractors may know that just across the Columbia River a construction lien might take priority over an earlier-filed mortgage.

Another moral is to consider who may need to sign off to make a project-related agreement work the way you think it will. Notably, if Evergreen wanted to keep its lien rights in the event the owner defaulted on the settlement, the court’s holding suggests the bank needed to be involved up front. Perhaps what Evergreen needed instead of a deed of trust was a subordination agreement, protecting the bank’s interests, but keeping Evergreen’s lien first in line if the owner failed to pay as agreed for the repairs.

Finally, the court’s holding may have even broader implications than the court intended. On that point, the court declared Evergreen’s lien to be “invalid” in light of its deed of trust. In that lawsuit, that meant the bank’s mortgage took priority. However, it is conceivable under the same rationale that if there were other construction lien claimants on the property-which would normally be paid pro rata in a foreclosure sale-Evergreen would have moved not only behind the bank, but behind all other lien claimants as well. The court’s preference for a “bright-line rule” suggests that if you’ve cleared all the hurdles to perfect a construction lien, you should not give it up (or in this case, trade it for a mortgage) lightly.

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