Construction liens are generally filed after the contractor completes its work or the work is stopped for some reason. Although the lien claim is filed after the work comes to an end, the priority date of the lien is the first day the contractor starts work. It thus has superior rights over any encumbrances recorded after the contractor commences its work. Therefore, the construction lien lies “dormant” until a lien claim is filed. As a practical matter, it encumbers the property as soon as the contractor begins work. This tenet was recently illustrated in the following Oregon Appellate Court decision.[i]
A developer obtained a $4.49 million line of credit from a bank to develop two properties. The developer secured the debt with a deed of trust on the two parcels, which was recorded in August 2007. The developer then hired a contractor to do work on one of the properties, which was completed in February 2009. Due to a dispute over the quality of some of the contractor’s work, the developer did not pay the contractor and the contractor recorded a lien. After learning of the contractor’s lien, the bank advised the developer that it would not fund any further construction until the contractor’s lien was removed.
Soon after that, the developer and contractor entered into a settlement agreement in which the contractor agreed to release its lien claim in exchange for a partial down payment and a deed of trust on the same two parcels underlying the bank’s deed of trust to secure the remaining debt. The written settlement agreement stated that the contractor did not release or waive any of its rights to record a future lien against the property. A copy of the settlement agreement was sent to the bank.
Before paying off the contractor or the bank, the developer went broke and the contractor filed a new lien claim against the two properties. Both the contractor and the bank filed actions seeking to foreclose on their security interests in the two properties. The issue was then which party’s interest in the properties was superior – the contractor’s lien or the bank’s deed of trust? If the contractor’s lien was valid, it had priority over the bank’s deed of trust because the lien related back to the first day the contractor performed work on the properties. But, if the lien was invalid, the bank’s deed of trust had first priority. Reversing the trial court’s decision, the Oregon Court of Appeals held that the contractor’s lien was invalid because it had forfeited its right to a construction lien by accepting a deed of trust to secure the debt. The court held that when the contractor elected to accept the deed of trust as security for the settlement, it forfeited its lien rights.
The court was concerned that if the contractor’s debt was secured by the second, unrecorded lien, anyone buying property or giving credit secured by an interest in the property would run an unreasonable risk that the property is already subject to an unknown – but superior – encumbrance. These unrecorded construction liens are sometimes referred to as “secret liens” because they are not of record and become enforceable once they are filed, but relate back to the first date work was performed. Although secret liens are typically valid, the court here reasoned that the bank should be protected against the contractor’s lien when the property records reflect that the contractor has taken another form of security for the construction debt.
The contractor unsuccessfully tried to quell the court’s concern by pointing out that the bank was fully informed that the settlement agreement (between the developer and contractor) had not waived any of the contractor’s lien rights, and thus the lien was not “secret” – it was fully disclosed to the bank. The court disagreed and applied the bright-line rule that a lien is always invalid if a contractor accepts a deed of trust to secure the same debt. It reasoned that this strict rule applies even where there is no deceit because third parties are likely to assume that the mortgage is the only encumbrance securing that debt when a contractor takes a mortgage to release a lien claim.
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[i] Evergreen Pacific, Inc. v. Cedar Brook Way, LLC, 251 Or.App. 194, 284 P.3d 509 (2012).