Construction Law Today

D'Oench, Duhme Doctrine Applies to Failed Bank Subsidiaries

Joshua Glazov — Mon, 16 Apr 2012 22:06:04 -0500

A federal court in Milwaukee recently decided that the subsidiary of a failed bank, not the receiver for the failed bank itself, may also use the D'Oench, Duhme doctrine and 12 USC § 1823(e) to stop claims by a borrower and developer fostered by a construction loan that went very badly. The decision: SJ Properties Suites v. Specialty Finance Group, LLC (PDF).

Backstory: SJ Properties Suites v. Specialty Finance Group, LLC

Silverton Bank in Atlanta, Georgia had a wholly owned subsidiary called Specialty Finance Group, LLC (the "Lender"). The Lender focused on acquisition, development, and construction lending to hotel and other hospitality developers. One borrower was SJ Properties Suites for a project in Milwaukee, Wisconsin.

According to SJ Properties, their investors, and other related companies (collectively together, the "Developers"):

The project encountered trouble and loan-to-value ration got out of balance, rendering the Lender reluctant to fund upcoming disbursements—"draws"—under the construction loan

The Lender insisted that the Developers fund additional equity money into development and construction of the project and told the Developers that if they (the Developers) didn't do so, the Lender would foreclose and "wipe-out" the they had already devoted to the project

But despite the Developer's funding additional equity money, not missing any scheduled payments, and the Lender's assurance of loan funding, the Lender didn't fund and even stopped accepting loan payments

Then things got bad: Silverton Bank—parent of the Lender—failed and the FDIC became Silverton's receiver. This meant no more loan disbursements from the Lender. And without those disbursements, the project stalled, unpaid subcontractors started recording mechanics liens, and the position of the Developers' equity grew more precarious.

Developer Claims

So, the Developers sued the Lender. Principal to our discussion, their claims included:

Unjust enrichment

Promissory estoppel

Violation of Chapter 224, Subchapter III of the Wisconsin Statutes, requiring a license to act as a mortgage banker in Wisconsin

The Developer focused their unjust enrichment and promissory estoppel claims on the Lender's unfulfilled assurances that if the Developers fund more equity money, the Lender would overlook alleged loan defaults and fund future loan disbursements.

Lender Opposition

The Lender opposed these claims. Principal among their reasons: oral assurances of loan disbursements in exchange for more equity don't comply with the 4 Requirements and are unenforceable under the D'Oench, Duhme doctrine and § 1823(e).

Developer Rejoinder

The Developers countered:

Because the Lender is the subsidiary of a failed bank, not a failed bank itself, the Lender can't use the D'Oench, Duhme doctrine or § 1823(e)

And even if a failed bank subsidiary can sometimes use D'Oench or § 1823(e), the FDIC must intervene in the case. And the FDIC must also involve itself with "respect to an asset"—presumably the note and mortgage composing the construction loan—in which the FDIC has an interest

Judge Randa's Decision

Hearing the case, Judge Rudolph T. Randa dismissed the Developers' unjust enrichment and promissory estoppel claims. He held that a failed bank subsidiary—in this case the Lender—may use the D'Oench, Duhme doctrine and § 1823(e). And they may use each regardless of whether the FDIC intervenes in the case or otherwise participates "with respect to and asset" the FDIC has an interest in.

Responding to the Developers' opposition, Judge Randa also analyzed whether holders of failed bank assets may use the D'Oench, Duhme doctrine and § 1823(e) after the FDIC no longer has an interest in those assets (e.g., after transfer under a Purchase and Assumption Agreement or assignment to a private purchase in a financial asset sale). Consistent with coverage of this issue in past posts here, Judge Randa held that successor asset holders may also use D'Oench and § 1823(e).

Judge Randa also addressed how the D'Oench, Duhme doctrine and § 1823(e) affect tort claims against a failed bank's receivership estate and the successors who take assets from the estate. D'Oench and § 1823(e) apply regardless of whether the alleged tortious conduct relates to a specific failed bank asset—usually a loan—or against the failed bank at large. D'Oench and § 1823(e) will apply as long as the allegedly tortious conduct is "related to regular banking activity." They'll apply against claims based on bank representative misrepresentations about issuing a loan commitment. But they usually won't apply to a bank representative's false assurances of deferred payment to the painter who painted the lobby two weeks before the bank failed.

Other Issues

Judge Randa didn't dismiss the Developers' mortgage banker licensing claim under Chapter 224 of the Wisconsin Statutes. He observed that the Lender hadn't shown that the D'Oench, Duhme doctrine or § 1823(e) grant immunity against claims for violating that particular statute.

But, in an interesting side note, Judge Randa observed that one of Silverton's motives for converting from a Georgia state, to a national, banking charter before Silverton failed was to qualify subsidiaries—like Specialty Finance—for exemptions from registration and licensing laws in states beyond Georgia.

Conclusions and Observations

A casual agreement with a bank subsidiary can be as risky as a casual agreement with the bank itself. You're not just staking a wager that your counter-party will hold-up their end of the bargain. You're also wagering that if they don't and you sue them for it, they'll continue to be in business long enough for you to collect all that you're entitled to

If your agreement satisfies each of the 4 Requirements, you'll have less to worry about, maybe. Even if you satisfy the 4 Requirements, if your counterparts goes into a failed bank receivership (or a bank subsidiary bankruptcy), you may be left merely with an unsecured claim against the receivership or bankruptcy estate. The value of that claim will depend on the estate's payouts to unsecured creditors. And if the payout is as modest as it often is—particularly from failed bank receivership estates—maybe the trouble of complying with the 4 Requirements just isn't worth the effort?

US Green Building Council LEED Certification and Accreditation Lawsuit Dismissed

Joshua Glazov — Fri, 19 Aug 2011 06:52:55 -0500

An architect, an engineer, and a consultant sued the US Green Building Council in federal court in Manhattan. They claim that LEED building certification and professional accreditation is deceptive and violates racketeering, trademark, and consumer protection laws.

A few days ago, the judge hearing the case, Hon. Leonard B. Sand, dismissed the lawsuit in this order (PDF).

Mortgage vs. Mechanics Lien: Following- Up on LaSalle Bank, N.A. v. Cypress Creek 1, LP

Joshua Glazov — Mon, 25 Jul 2011 15:01:39 -0500

My colleagues Scott Smith, David Eisenberg, and I just published a short article about the Illinois Supreme Court's controversial LaSalle Bank, N.A. v. Cypress Creek 1, LP decision. It focuses on three things:

A summary of who was involved, what their respective stakes were, the positions they took, and how the Justices reacted to them to decide the case
How this decision affects construction industry stakeholders, particularly construction lenders and anyone who may claim a mechanics lien (e.g., prime contractors, subcontractors, material and equipment suppliers, architects, engineers, and other design professionals)
Initiatives in the Illinois General Assembly to amend the Mechanics Lien Act to change the results in future cases

And it's a wrap-up on Construction Law Today coverage that started back here: Mechanics Lien Priority: Contractor vs. Lender - Part 1. Click this link to navigate on to our article.

Also in the same Litigation & Counseling Alert, some of our other colleagues also wrote these companion articles that may interest you too:

Insurance and Due Diligence in the Business Transaction
Can a Forbearance Agreement Actually Help a Lender Collect from Its Debtor?

How Does D'Oench, Duhme Affect Joint Venture and Partnership Agreements: ORL, LLC v. Hancock Bank

Joshua Glazov — Fri, 10 Jun 2011 07:09:01 -0500

A federal court in Orlando, Florida recently decided that the D'Oench, Duhme doctrine stops claims for breach of a joint venture agreement. So does D'Oench's statutory supplement, Section 13(e) of the Federal Deposit Insurance Act (also referred to as 12 USC §1823(e)). The decision: ORL, LLC v. Hancock Bank (PDF).

Backstory: ORL, LLC v. Hancock Bank

A pair of real estate development companies borrowed money from a pair of banks (Peoples First Community Bank and Colonial Bank). They used the money to buy land and construct a condominium project called the Blue Heron Beach Resort. Some of the borrowers' principals guaranteed the loans too.

As the borrowers encountered trouble, the banks agreed to modify some terms of the loan documents. One of the banks also agreed to provide purchase money "end-loans" to the buyers purchasing completed condominium units from the borrowers.

Unfortunately, the banks ran into trouble too. Colonial failed. Then Peoples First failed too. The FDIC was appointed as receiver for each bank. The FDIC sold the Peoples First loan to Hancock Bank under a Purchase and Assumption Agreement.

When things promised by the banks didn't happen, the borrowers and guarantors sued Hancock. (To avoid too much repetition, from here on in I'm going to refer to the borrowers and guarantors together collectively as just the borrowers). Many of the borrowers' claims against Hancock were based on things that Colonial allegedly did, or didn't, do under the Colonial loan. But before the borrowers could hold Hancock responsible for the alleged transgressions of Colonial, the borrowers needed to somehow tie Hancock to Colonial. So, the borrowers claimed that Hancock's predecessor--Peoples First--was in a joint venture with Colonial. And under the joint venture, Hancock would be vicariously liable for things Colonial did and didn't do.

But the borrowers left something important out of their complaint against Hancock: a written joint venture agreement, or at least allegations that there was a written joint venture agreement.

Hancock's D'Oench, Duhme Arguments

Hancock's lawyers recognized that as the FDIC's assignee Hancock could use D'Oench, Duhme and Section 13(e) against the borrowers' claims that hinged on the joint venture. So, citing the absence of a written joint venture agreement, D'Oench, and Section 13(e), they asked Judge Patricia Fawsett to dismiss the borrowers' lawsuit.

The Borrowers' D'Oench, Duhme Opposition

The borrowers urged Judge Fawsett to deny Hancock's request for two reasons:

The loan documents were among Peoples First's records when Peoples First failed. So D'Oench's and Section 13(e)'s written agreement requirements were satisfied
Hancock had waived the defenses like D'Oench, Duhme and Section 13(e) under the Purchase and Assumption Agreement

Judge Fawsett's Decision

Judge Fawsett agreed with Hancock. She dismissed the borrowers' claims.

Although Peoples First, and later Hancock, may have had the Colonial loan documents in their respective records, those records didn't include a joint venture agreement between Peoples First and Colonial. If the alleged joint venture lacked a written agreement satisfying the 4 Requirements, the borrowers could not hold Hancock liable as Colonial's joint venturer. Paraphrasing Judge Fawsett:

[E]ven if Hancock's files contain a copy of the Colonial loan documents as the borrowers suggest the borrowers' claims are nonetheless subject to dismissal under the D'Oench doctrine because the Complaint does not allege the existence of a written agreement between Peoples First and Colonial establishing the joint venture relationship

And Hancock didn't waive defenses like D'Oench, Duhme and Section 13(e) under the Purchase and Assumption Agreement either. The borrowers cited a 1992 decision where the judges considered a waiver under a Purchase and Assumption Agreement. But in that case the purchasing bank agreed to assume liabilities for claims certified by the receiver to be valid and enforceable obligations, regardless of whether they were reflected on the books of the failed bank as of Appointment Date. But in this case Judge Fawsett observed:

In the present case, no provision of the Purchase and Assumption Agreement states that Hancock agreed to assume any liabilities that were not reflected in the written records of Peoples First

Conclusions and Observations

This case is unusual because the suspect agreement that gets D'Oenched isn't between the failed bank and the borrower. Instead it was, at least allegedly, between the failed bank and a third-party (who, incidentally, was a bank that later failed too)
And though Judge Fawsett dismissed the borrowers' lawsuit, she dismissed it for now without prejudice. That means the borrowers can amend their complaint and keep the lawsuit going for at least a little while longer. Judge Fawsett may even let them just allege a 4 Requirements complaint joint venture agreement exists and allow the borrowers to look for it in discovery

Chicago: Big Cement Pour on Wacker Drive

Joshua Glazov — Fri, 15 Apr 2011 14:04:09 -0500

Estimating that over 125 cement trucks will be delivering loads for a big pour today, the Chicago Tribune warned commuters to avoid Wacker Drive, especially around Randolph and Lake Streets. Here's crews and trucks at work as I walked past on the way to work this morning.....

Does D'Oench, Duhme Apply to Employment Contract Claims: Ortiz-Hernandez v. Westernbank of Puerto Rico

Joshua Glazov — Mon, 11 Apr 2011 07:39:21 -0500

A federal court in Puerto Rico recently decided that the D'Oench, Duhme doctrine applies to deny claims for breach of informal employment contracts by former employees of failed banks. And D'Oench's statutory supplement, Section 13(e) of the Federal Deposit Act (the "FDI Act", also referred to as 12 USC §1823(e)), applies too. The decision: Ortiz-Hernandez v. WesternBank of Puerto Rico (PDF).

Backstory: Ortiz-Hernandez v. WesternBank of Puerto Rico

Rafael Ortiz-Hernandez worked as an employee for Westernbank of Puerto Rico. He resigned in the spring of 2008 and, as part of his departure, entered into a severance contract with the bank. The severance contract didn't mention a Christmas bonus (the employee had traditionally received a $13,000 bonus each Christmas from the bank). Despite the omission, the employee claimed that bank executives assured him he would still receive $13,000 as a bonus the following Christmas. The assurances weren't written. When Christmas arrived, the bank paid him less than $13,000 as a bonus. So, the employee sued the bank for the remainder of his bonus.

But, while the employee's lawsuit was pending, the bank failed. The FDIC was appointed to serve as the bank's receiver. The FDIC repudiated the employee's contract, at least the part related to the Christmas bonus. Presumably the employee submitted an administrative claim against the receivership estate for his bonus. And when the FDIC denied that claim, the lawsuit resumed. The FDIC then asked the judge hearing the case, Chief Judge Jose Antonio Fusté, to dismiss the employee's lawsuit.

FDIC's Motion to Dismiss

The FDIC urged Judge Fusté to dismiss the employee's lawsuit because:

The agreement to pay the $13,000 bonus didn't comply with the 4 Requirements of Section 13(e)
Being unwritten and informal, the bonus agreement is unenforceable post-failure against the FDIC under the D'Oench, Duhme doctrine

Employee's Counter-Arguments Why Section 13(e) and D'Oench Shouldn't Apply

The employee argued that Section 13(e) and D'Oench shouldn't apply because Section 11(d)(6) of the FDI Act (also known as 12 USC §1821(d)(6)) allows those on the receiving end of a contract repudiation to submit a claim for damages they suffer as a consequence of the repudiation. Essentially, the employee argued that Section 13(e) and D'Oench are subordinate to Section 11(d)(6).

Judge Fusté's Decision

Judge Fusté agreed with the FDIC and dismissed the employee's lawsuit. He found that both Section 13(e) and the D'Oench, Duhme doctrine would operate to deny enforcement of the bonus assurances. He observed that Section 13(e) and D'Oench aren't subordinate to Section 11(d)(6). The reason: Section 11(e) of the FDI Act specifically requires repudiation claims to comply with Section 13(e). Those that don't are to be denied. Because the bank executives didn't comply with the writing requirement of Section 13(e), and because the unwritten bonus agreement wasn't recorded among the bank official records where it would be visible to banking regulators, the bonus assurance is unenforceable post-failure against the FDIC.

Conclusions and Observations

Despite the split among federal circuit courts of appeal on whether Section 13(e) has supplanted and retired the D'Oench, Duhme doctrine, Judge Fusté cited both in his decision
Section 13(e) and the D'Oench, Duhme doctrine aren't just for denying enforcement of informal loan terms and modifications anymore. If you're making agreements with, or relying on assurances from, a bank - regardless of whether it's related to a loan - you ignore the 4 Requirements at your peril

How Does D'Oench, Duhme Apply to Failed Credit Unions: Campbell v. Castle Stone Homes

Joshua Glazov — Tue, 22 Mar 2011 08:32:14 -0500

Like failed banks, the D'Oench, Duhme doctrine applies to claims against the National Credit Union Administration Board ("NCUAB") acting as liquidator for a failed credit union. And D'Oench, Duhme has a statutory companion for failed credit unions in the Federal Credit Union Act too: 12 U.S.C. §1787(p)(2). A federal court in Utah recently used the D'Oench, Duhme doctrine and §1787(p)(2). The decision: Campbell v. Castle Stone Homes, Inc. (PDF).

Backstory: Campbell v. Castle Stone Homes, Inc.

A Utah home builder known as Castle Stone Homes used the Internet, radio, and TV to solicit people with good credit scores to invest in a real estate investment scheme. The investors allege that the builder used their good credit scores to obtain loans, then used the loan proceeds to construct, market, and sell homes. Then the builder would split the home sale profits with the investors.

The builder arranged loans from HeritageWest Credit Union. The investors allege that they each submitted applications for “investment” home loans, only to discover that the final loan documents were changed to reflect “owner occupied” homes. The investors also claim the builder and the credit union began to tell them (the investors) that their construction loans were nearly exhausted, although many homes were only 50% to 75% complete.

The builder then sent a “Progress Report” to each investor saying that the builder had reached an agreement with the credit union to modify the investors' loans without pre-modification appraisals and that the builder's realtor “has found buyers to purchase virtually all our homes.” So, most of the investors entered into additional loans with the credit union.

The investors alleged that even after receiving additional loan funds, the builder didn't complete the homes on time. And as the completion deadline expired, the builder and the credit union negotiated a the terms of a series of loan extensions for offering to the investors. The investors claimed that throughout construction of their homes, the builder mismanaged money, completed homes late (or not at all), and provided work of poor quality, or none at all.

The Investors' Lawsuits

So, the investors sued the builder for an array of claims, including violating federal and state securities laws (e.g., selling unregistered securities, and fraudulent marketing of securities, both violations of the Securities Act of 1933), breaching contracts, and an array intentional and unintentional torts (e.g., negligent misrepresentation, conversion). And the investors sued the credit union too, alleging that the credit union was complicit in the builder's offenses and its representatives had given false representations and assurances to the investors.

Then the credit union failed. The NCUAB stepped in as liquidator for the credit union, a role similar to the FDIC acting as receiver for a failed bank.

The Credit Union Liquidator's Motion to Dismiss

The credit union's board of directors didn't approve any of the credit union's alleged representations or assurances (written or oral) to, or for the benefit of, the investors. Next, the NCUAB asked the judge hearding the case, Judge Ted Stewart, to dismiss the investors' claims against the credit union because the NCUAB is immune under the D'Oench, Duhme doctrine and §1787(p)(2). §1787(p)(2) is the credit union edition of the Section 13(e) of the Federal Deposit Insurance Act; they each impose 4 Requirements that must each be satisfied before a pre-failure agreement, representation, or assurance from a failed credit union or bank is enforceable against its liquidator or receiver respectively.

Judge Stewart's D'Oench, Duhme Decision

Judge Stewart agreed with the NCAUB and dismissed the investors' claims against the credit union. First, he noted that the D'Oench, Duhme doctrine and §1787(p)(2) apply to the investors claims against the failed credit union. And those claims must be dismissed because they don't satisfy each of the 4 Requirements: (a) the credit union's board didn't approve the alleged representations or assurances that the investors claim the credit union breached and (b) the board's minutes didn't reflect approval.

The investors urged Judge Stewart to preserve their claims because the representations and assurances at issue were distinguishable from the agreement in the original D'Oench decision. Focusing on the particular facts involved in the D'Oench decison, the investors contended that they weren't trying to avoid enforcement of a “secret” unwritten agreement. Instead they suggested that they were just trying to hold the NCAUB liable for the credit union's pre-failure violations of the securities laws, breaches of contracts, and tortious conduct (e.g., negligent loan administration, misrepresentation).

But Judge Stewart was not persuaded. Although the D'Oench, Duhme doctrine was born in the narrow circumstances of denying enforcability to a casual, or secret, agreement, Judge Stewart observed that since 1942, federal courts have expanded the doctrine beyond the narrow facts in that decision. The D'Oench, Duhme doctrine, and its statutory companions, deny nearly any claim, or defense, that impairs regulators' ability to accurately appraise the assets of credit union, bank, or other institution by preventing the regulators from relying solely on the face value of assets. The trend of legislative and judicial evolution of D'Oench jurisprudence has remained constant: its focus has shifted from the fraudulent, illegal, or secret character of a debtor's acts to the effect those acts have on a regulatory agency's ability to evaluate quickly and accurately an institutions' assets. So, Judge Stewart ruled:

Given this evolution, today the D'Oench doctrine is “applicable to virtually any claim or defense that has the effect of adversely impacting the value of assets held by a federal banking regulator as a consequence of liquidation or receivership of a failed institution.” Thus, “any claim or defense which the National Credit Union Administration Board was not placed on notice and could not have determined from the books and records of the failed institution” is barred by the D'Oench doctrine.

Conclusions and Observations

Though the result in this decision isn't a surprise, there are three things in this decision worthy of special notice:

Readers of a blog about construction law should note that this controversy, like so many others involving failed financial institutions, starts with troubled construction loans
The D'Oench, Duhme doctrine applies to claims and defense against credit union liquidators as well as failed bank receivers. When setting the terms of your deal with a credit union, comply with the 4 Requirements.
Mention of "secret" agreements in the original D'Oench, Duhme decision sometimes misleads those opposing its application. The connotation of "secret" has fostered the errant notion that for D'Oench to apply, there must be something clandestine about the suspect agreement, representation or assurance. There must be covert concealment, and maybe a sinister motive too. But while those elements certainly make a more dramatic story, they aren't necessary. The D'Oench, Duhme doctrine and its statutory companions apply just as long as an agreement, representation, or assurance isn't obvious to a financial regulator from the face of an asset (in this case a note or a loan agreement)

Illinois Supreme Court Decides Mortgage vs. Mechanics Liens: LaSalle Bank, N.A. v. Cypress Creek 1, LP

Joshua Glazov — Fri, 25 Feb 2011 11:21:34 -0500

LaSalle Bank, N.A. v. Cypress Creek 1, LP Decision from Illinois Supreme Court

In past posts we've been following this case as it wound its way through the Illinois judiciary up the the Illinois Supreme Court. This morning, the Supreme Court issued this decision (PDF). The Justices decided that a lender gets priority to the extent their loan proceeds paid for property improvement, regardless of whether the contractors paid with those proceeds timely, or properly, perfected mechanics liens.

FDIC Sues Georgia Lawyers For Professional Malpractice in Closing Development Loans

Joshua Glazov — Thu, 10 Feb 2011 08:30:16 -0500

For the first time since the S&L crisis, the FDIC is suing a failed bank's former lawyers for professional malpractice.

The claims come against lawyers who formerly represented the now failed Neighborhood Community Bank in Newman, Georgia. The FDIC's complaint (PDF) alleges that the lawyers deviated from the bank's instructions and colluded with a borrower to falsely represent disbursement of loan proceeds. Important for those in the construction industry, each was an acquisition and development loan.

The complaint also alleges that the lawyers represented both the bank and the borrowers in various capacities at the same time, subverting the lawyers' loyalty to the bank and violating their fiduciary duties.

D'Oench, Duhme Active in California

Joshua Glazov — Wed, 09 Feb 2011 14:32:57 -0500

The D'Oench, Duhme doctrine and Section 13(e) of the Federal Deposit Insurance Act (a/k/a 12 U.S.C. §1823(e)) were active in Sacramento late last month to deny a borrower's claim for reformation of her loan documents. The decision: Magdaleno v. IndyMac Bancorp, Inc. (PDF).

Backstory: Magdaleno v. IndyMac Bancorp, Inc.

Catalina Magdelano borrowed money from IndyMac. Her mortgage broker assured her that the interest rate on her loan would be a 30-year fixed rate with interest at 1% per year. But the documents for the loan set an adjustable rate starting at 1% per year, with a 9.950% maximum. Then IndyMac failed and the FDIC was appointed as IndyMac's conservator. Ultimately, the FDIC transferred the borrower's loan to a new lender: OneWest Bank.

Reformation Under California Civil Code §3399

In her lawsuit against the new lender, the borrower asked Judge Frank Damrell to reform the loan documents under California Civil Code §3399 to reflect the terms that she claims her mortgage broker assured her of.

D'Oench, Duhme and Reformation

The new lender urged Judge Damrell not to reform the loan documents. They argued that under the D'Oench, Duhme doctrine and Section 13(e), assurances from the mortgage broker qualify as secret agreements that are not enforceable against the FDIC, or the FDIC's successors.

Judge Damrell's Decision

Judge Damrell agreed with the new lender: D'Oench, Duhme and Section 13(e) stop the borrower from reforming her loan documents. And on that, Judge Damrell dismissed the borrower's reformation claim without leave to amend.

Construction Contracts: Top 10 Terms - Changes (Change Orders)

Joshua Glazov — Mon, 17 Jan 2011 10:05:53 -0500

No. 4: Changes

Changes are No. 4 on the list of top ten construction contract terms. Few construction projects go from start to finish without a change. It could be a change in the work, a change in the price, or a change in the schedule. Usually, there's changes to more than one, and often more than one change. Here we're going to cover the different kinds of changes, how your contract affects them, and how they affect your contract.

Generally, changes fall into one of three types:

Change Orders
Construction Change Directives
Minor Changes

Change Orders

"Change Order" is a just a technical term for an amendment to a construction contract. When you hear Change Order, think contract amendment. Why? Because a Change Order is a bilateral agreement between parties to the contract - an owner and prime contractor, prime contractor and subcontractor, two or more subcontractors - to change the contract. A Change Order represents the mutual consensus between the parties on a change to the work, the price, the schedule, or some other term of the contract. And, because it represents a mutual consensus, a Change Order is usually the best, and least controversial, way to make changes.

Like any other contract amendment, a Change Order must satisfy each requirement of original contact formation: offer, acceptance, reasonable identification of changed terms, and exchange of consideration. Each party's signature on a Change Order satisfies the offer and the acceptance requirements.

Identifying Changes

Take extra care in identifying the changes your Change Order will make. Refer back to the parts of the original contract, and any earlier amendments or Change Orders, that you are changing or that your new changes may affect. You may need to inventory and audit the original contract and previous amendments to do that. And if you are changing the work, refer in your Change Order to the news design documents that reflect how the work is changing. Better yet, attach the new design documents as exhibits to your Change Order.

Change Order Consideration

Consideration can be tricky. Each side must either (a) promise to do something they're not already legally obligated to do (including getting some third party to do or not do something), or (b) promise to not do something that they're otherwise legally free to do. A Change Order where one side makes these kinds of promises, but the other doesn't, is suspect and may be unenforceable.

A classic example: a foundation subcontractor approaches their prime contractor and says that they (the subcontractor) need to increase the price five percent. Because they don't want to lose time (and perhaps money too) trying to get a substitute foundation subcontractor, the prime contractor reluctantly says "OK." They enter into a Change Order increasing the subcontract price by five percent. But there is no other change. The subcontractor doesn't promise to provide additional work or different material. They don't promise to complete the foundation work any earlier. Instead, the Change Order merely obligates the prime contractor to pay an extra five percent for the same foundation work promised in the original subcontract.

That Change Order may be unenforceable because consideration from the subcontractor is missing; the subcontractor is getting something - an extra five percent - for nothing. Luckily, there are some simple ways to ensure that a Change Order includes an exchange of consideration and avoids this problem.

Change Order Confusion - Who Issues Change Orders

There's a lot of confusion surrounding Change Orders. One brand concerns who may issue a Change Order. The answer: no one can issue a Change Order.

A Change Order is a bilateral amendment to a construction contract. Each party to the contract must agree to the Change Order, usually by signing it. No one can unilaterally issue or impose a Change Order. Not the owner, not the contractor, not a subcontractor, and not the architect or any other designer. Anyone may propose a Change Order. But that's just a proposal (or, if you're a lawyer getting technical, it's an offer to amend the contract). But a Change Order is something you and the other side must both agree to; neither can issue one unilaterally .

Where does the confusion come from? Perhaps it's the AIA contract documents? The widely used A201 General Conditions of Construction Contract refer to Change Orders in ways that suggest they are something other than a specialty contract amendment. They mention Change Orders being issued, suggesting that the owner, the contractor, or perhaps even the architect may unilaterally impose one. They can't. But this language has circulated for decades, fostering a trade myth, or at least a cherished superstition, that someone can issue a Change Order all by themselves.

This confusion isn't just semantics. It has real consequences. More than once I've observed disputes where one side resolutely contends that their contract was amended by a Change Order they'd issued. They relentlessly insist, usually in vain, that the price was increased, or a completion deadline postponed. The result: they merely proposed a Change Order without agreement from their counterparty. Neither the price, nor the deadline, was changed. Nevertheless both sides spend precious resources on the dispute (including money on professionals fees that come along with disputes). That's money they instead could have re-invested in operations, used to pay down debt, paid in bonuses to personnel, or dividended to owners.

Remember: if you want a Change Order, you can't get one by yourself.

Other Parties Signing Change Orders - Guarantors and Sureties

In addition to the parties to the contract itself, you may need to get other people to sign a Change Order, or at least sign something else granting their approval of, or consent to, a Change Order. Generally, if someone has guaranteed one of the contracting parties' performance under the contract, you'll need to have the guarantor sign on to, or consent to, the Change Order so their guaranty applies to the change too. In some circumstances, amending a contract without a guarantor's consent can release the guaranty, something you'll usually want to avoid. The same goes for sureties who guaranty contractual performance under a performance bond or a payment bond.

Conclusions on Change Orders

Change Orders are necessary and very useful. But remember:

Specifically identify what your Change Order is changing, especially changes to the work, the price, and deadlines for completion
Get each party to the contract (the original parties, plus any others who've joined under previous amendments) to sign. Moreover, if there are others who have obligations affected by the contract you're changing (e.g., guarantors, sureties), you should probably get their approval or consent too

Coming Up Next

No. 4 on changes continues: Changes you can make unilaterally - Construction Change Directives and orders for a minor change in the work.

How Enforceable Are Limitations of Liability: Something a Contractor, Architect, and Engineer Would Like to Know

Joshua Glazov — Tue, 28 Dec 2010 10:15:00 -0500

How enforceable are contractual limitations of liability? According to a panel of Illinois judges recently: very enforceable. Their decision: Zerjal v. Daech & Bauer Construction, Inc. (PDF)

Summary: Zerjal v. Daech & Bauer Construction, Inc.

This decision concerns the limitation of liability in a home inspector’s contract. But the principles involved affect building contractors, architects, engineers, other professionals, and anyone else who would also like to contractually limit their exposure. And it's all the more compelling because these judges enforce the limitation not against a Fortune 100 company, but against that most sacred of judicially protected constituencies: the homeowner.

In enforcing the limitation, the judges hold that contractually capping liability to a refund of fees paid:

Isn't “unconscionable,” and
Doesn’t violate “public policy"

Limitation of Liability Tips for Contractors, Architects, Engineers, Owners, and Everyone Else Too

Limitations of liability are usually suspect. Judges in some states just refuse to enforce them. And judges in the states that will enforce usually impose rigorous requirements before they do. The result: limitations of liability are like structural joints, a weak point that needs careful and often intense reinforcement. That reinforcement is one of those things my colleagues and I devote a lot of effort and ingenuity to
If you're on the other side submitting to a limitation of liability, be sure you understand how much risk you're really taking. Do you really appreciate how limited your recourse will be if things go badly? If that limit still doesn't sit right with you (not to mention your management, board, investors, and lenders), there are alternatives. Considering those alternatives, negotiating limit changes, and carving out exemptions is another thing my colleagues devote a lot of effort and ingenuity to as well

How Does D'Oench, Duhme Affect Fraud Claims

Joshua Glazov — Tue, 21 Dec 2010 11:20:09 -0500

The D'Oench, Duhme doctrine is active again, this time barring guarantors' fraud claims and defenses in Minnesota.

Outsource Services Management, LLC v. Ginsburg

Earlier this month, Judge Donovan Frank applied the D'Oench, Duhme doctrine's statutory companion, Section 13(e) of the Federal Deposit Insurance Act, a/k/a 12 U.S.C. §1823(e), to dismiss fraud claims and defenses alleged by a group of investors who guaranteed a construction loan for the construction of the Northern Winz Casino in Box Elder, Montana. The case: Outsource Services Management, LLC v. Ginsburg (PDF).

Backstory

A borrower and group of guarantors borrowed money from BankFirst for the construction of the casino. BankFirst representatives made numerous representations about timing and funding to the borrower and guarantors that the borrower and guarantors relied in deciding to go forward with the project, including putting their own money in and promising to repay the BankFirst loan
Problems arose. In their wake: construction delays, late casino opening, and poorer than expected casino performance. The borrower defaulted on the loan. BankFirst sued the borrower and guarantors to recover principal, interest, and other costs
The borrower and guarantors defended and counter-sued BankFirst alleging that BankFirst representatives intentionally and materially misled (i.e., defrauded) them about the loan, and, therefore, the guarantors' guarantees should be rescinded
Then BankFirst failed. The FDIC became receiver for BankFirst and sold select rights under the loan to Outsource Services Management, LLC, d/b/a Presidium Asset Solutions (the "Successor Lender") under an Assignment and Assumption Agreement
Under the Assignment and Assumption Agreement, the FDIC didn't transfer certain liabilities to the Successor Lender. So, the guarantors asserted their misrepresentation allegations as (a) a defense against the Successor Lender's efforts to collect on the loan and (b) counterclaims for damages against the FDIC, as receiver for BankFirst
The FDIC and the Successor Lender asked Judge Frank to summarily dispose of the guarantors' defenses and counterclaims based alleged misrepresentations by BankFirst representatives

FDIC and Successor Lender's Arguments for Summary Judgment

Among the many reasons they cited, the FDIC and Successor Lender suggested that because assurances from BankFirst representatives to the borrower and guarantors were informal (i.e., not in the loan documents or guarantees and didn't comply with the other 4 Requirements), under Section 13(e), the guarantors can't enforce those assurances as a defense against the Successor Lender's efforts to collect under the loan or as counterclaims against the FDIC as receiver for BankFirst.

Judge Frank's Decision

Judge Frank agreed with the Successor Lender and the FDIC - because of Section 13(e), the guarantors can't continue to assert pre-Appointment Date misrepresentations by BankFirst personnel as a defense against the Successor Lender, or as a claim for damages against the FDIC. He specifically mentioned that the Successor Lender, as the FDIC's assignee, may also use Section 13(e) against the guarantors' fraud allegations.

Judge Frank granted summary judgment against the guarantors resulting in:

A judgment of $14,738,359.65, plus daily interest and fees for the Successor Lender against the guarantors
Dismissal of the guarantors' misrepresentation (i.e., fraud) claims

Other Observations

Other interesting things about this decision:

The FDIC didn't argue that under the FDIC failed bank administrative claims process under 12 USC §§1821(d)(3)-(d)(9), Judge Frank didn't have subject matter jurisdiction to hear the guarantors' misrepresentation claims
Another reason for ruling against the guarantors: the loan documents contradicted the misrepresentations that the guarantors alleged they relied on and loan agreement and each guarantee included a merger and integration clause saying that those documents superseded any other oral, or written, agreements, assurances, or representations
Another reason for ruling against the guarantors: the alleged misrepresentations weren't included in a written agreement signed by representatives of both the borrower and BankFirst, as required by Minnesota's "statute of frauds" for Credit Agreements. Several other states have statutes like this too. They essentially privatize the D'Oench, Duhme doctrine and Section 13(e). So, under these statutes, banks can enjoy immunity against alleged casual agreements and assurances without failing or going into receivership

Conclusion: D'Oench, Duhme is Active Once Again and Neutralizes Fraud

This decision is just one example of how, as litigation over delinquent loans formerly held by failed banks proliferates, we're going to see more of the D'Oench, Duhme doctrine and Section 13(e). They put powerful weapons in the arsenal of the FDIC and those who buy loans from failed bank receiverships. Those weapons allow both to summarily dispose of borrowers' and guarantors' defenses and counterclaims; even fraud is in their crosshairs. Borrowers and guarantors need to keep that in mind when considering settlements and restructuring, as well as when planning litigation strategy and tactics in cases involving failed bank loans.

Construction Contracts: Top 10 Terms - Deadlines and Delays

Joshua Glazov — Fri, 17 Dec 2010 08:10:14 -0500

No. 3: Deadlines and Delays

Deadlines and delays are No. 3 on the list of top ten construction contract terms. A construction contract will often have many deadlines, but one deadline looms largest: substantial completion. That's because substantial completion is when the Work reaches the point where an owner can rent it, sell it, or work or live in it. And there's usually a tight schedule for reaching that point.

The deadline for substantial completion is often also critical to satisfy obligations to third-parties: local government requirements for completion by a specified date, availability of public incentives (e.g., tax credits or subsidies for a "green" building), or refinancing a construction loan before a permanent loan commitment expires.

Areas we'll cover here:

Identifying deadlines
"Excused Delays" that postpone deadlines
Delays caused by an owner, or another, up-the-chain, contractor that postpone deadlines and increase contract prices
Delay notices
Delay damages

Identifying the Deadline

First and foremost, you must identify the deadline. You can either identify a specific date and time: March 1, 2013 at 5:00 PM local time at the project site. Or you can set a length of time that runs after a specified date or event: 360 days after the date of the contract or 435 days after the city issues the first building permit for the Work. If you use the second type of deadline, be careful to avoid controversy about when the time starts. And when you're setting your deadlines, check to ensure they don't expire on weekends or holidays.

Construction Delays

Nearly every project encounters delays. The bigger and more complex the project, the better the odds for longer delays. Delays pose three big issues:

Who or what caused the delay and should those affected have expected that kind of delay?
Will the delay postpone deadlines?
Will the price be increased to compensate for additional costs imposed by delay?

Excused Delays

When an "Excused Delay" occurs, deadlines get postponed. Contracting parties often focus a lot of negotiation on what qualifies as an Excused Delay. Usually these are events, things that could not be foreseen or predicted before the parties entered into the contract. They're often called force majeure (French for a "major force" that interrupts progress on the Work).

Sometimes the criteria for what qualifies as an Excused Delay is stated generally. And sometimes the qualification criteria is stated very specifically, identifying select events that, if they delay Work under only specified circumstances, will qualify as an Excused Delay that extends a deadline. Will these qualification criteria be exclusive, or may delays caused by other events also qualify?

Where you fall on the spectrum depends on what kind of project you're working on, what your role in the project is (e.g., owner, prime contractor, subcontractor), and how much bargaining power you have when you negotiate these terms. Regardless, it's usually a good idea to focus special attention on what qualifies as an Excused Delay and, to avoid controversies later, make it as clear as possible.

Another issue that Excused Delays bring up is whether the price will be increased for the additional costs that an Excused Delay imposes. You can say yes or no. Or you can classify Excused Delay and provide that if an Excused Delay of one type occurs, the price will be increased, but if the Excused Delay is of another type, the price will not increase. Of course, if you provide for an increase, you should probably also identify how that increase will be calculated.

Owner-Caused Delay

Some delays come from one of the parties. A classic example is delay imposed because the owner changes the project, a problem with the design reveals itself after Work is under way, or the owner defers making a critical decision. Subcontractors can find themselves in the same situation when a prime contractor (or another subcontractor up the chain), instead of the owner, makes an error or doesn't make timely decisions.

What qualifies as an Owner-Caused Delay is often a contentious issue. It's usually best to address it in the contract, before there's any delays. A frequent issue is whether a delay caused only in part by the owner (or an up-the-chain contractor) qualifies, or whether the owner, or other contractor, must be the exclusive cause.

I tend to consider Owner-Caused Delay to be a special sub-category of Excused Delay. So, it usually postpones deadlines. And because the party imposing the delay is also the one paying for paying for Work, it's usually fair to increase the price too. How much that increase should be is another issue best identified in the contract at the beginning, before any delays occur.

I often like to use a formula based on the additional cost of labor, material, and equipment the contractor incurs, plus a set percentage of that cost to compensate for overhead and profit. This is easier to do in a guaranteed maximum price contract because the parties have already identified what costs qualify as "costs of the Work" in the original contract and are used to accounting for and reporting it.

Delay Notices

Contracts often require a delayed contractor to give notice to their counterparty (e.g., owner, subcontractor) that they are delayed. There is often a deadline for giving this notice: usually a select number of days after the delay sets in. Failing to properly and timely give a delay notice will often waive the contractor's right to postpone deadlines and increase the price.

The idea behind requiring these notices is ensure that delays are authentic. Owner, and contractors too, don't want to reach a delayed completion of a project and then have the delayed contractor claim that completion isn't late because the deadline was postponed by Excused Delays that occurred months, or even years, ago. Owners are wary of late completing prime contractors inclined to retroject all sorts of dubious reasons why late completion was due to Excused Delays. And prime contractors are wary of subcontractors doing the same.

But delay notice requirements have costs too. They can be the catalyst for frequent notices from the contractor that become a clerical headache, not to mention the polarizing effect they can have on the relationship between the contracting parties.

Delay Damages

Someone usually suffers damages if delays extend completion beyond its originally scheduled date.

Owner Delay Damages - Owners may lose rent, tenants, sales, public incentives, or financing opportunities, just to name the top five. They may also have to pay additional interest on their construction loans
Contractor Delay Damages - Contractors will often incur additional overhead costs and may lose the opportunity to engage other work because their forces are still held up on the delayed project

Like many other issues, it's usually best to identify what is at stake if a delay occurs and address these issues in the initial contract before delays impose additional costs and either side suffers.

Many of the damages that arise from delay are considered consequential damages. Depending on what the parties' pre-contracting communications and the language of the contract, it may be impossible to recover consequential damages. And if the contract includes an enforceable waiver of consequential damages, it will be.

Moreover, damages caused by delay are often dependent on the outcome of future events; some are really speculative. That makes them difficult to prove with "reasonable certainty." And damages you cannot prove with "reasonable certainty" are damages you will not get.

Liquidated damages are often a good way to avoid consequential and reasonable certainty problems. But, as we've discussed in past posts, they have their own issues. So, you must use great care if you decide to put them in your contract.

Coming Up Next

Coming up next at No. 4: Changes to the contract and the Work.

How Asset Valuation and Appraisal Really Work (or Better than Rochefort on Midway)

Joshua Glazov — Mon, 13 Dec 2010 09:16:58 -0500

Have you recently wondered how asset valuation or appraisal works? Surely over the last three years you may have pondered one of these:

How much value did a contractor's work add to a piece of property?
How much is collateral worth? Should a borrower be required to fund more money to restore a loan's minimum debt-to-equity balance? How much money?
How much is a loan, or portfolio of loans, worth? How did they decide how likely a borrower, or a bunch of borrowers put together, is to default?

What is "indubitably equivalent value (PDF)" for an asset under the Bankruptcy Code?

Maybe the answer lies in the movie Midway? It was a favorite of my brother and me when we were kids - lots of ships and airplanes shooting each other up. But watching it on TV recently I noticed a piece of dialogue that went over the heads of two grammar school boys. It's between the fictional Captain Matt Garth (Charlton Heston) and cryptanalyst, Commander Joseph Rochefort (Hal Holbrooke). They're talking about breaking Japanese naval codes early in 1942. Could you hear the same exchange with MBAs or analysts in the past week, or decade?

"Analysis" by Rochefort and his team actually succeeded in cracking critical parts of the Japanese code, playing a pivotal role in Second Word War. Are contemporary analysts and appraisers as successful today?

Where Does Your Mechanics Lien Claim Need to Identify the Last Date You Worked

Joshua Glazov — Tue, 16 Nov 2010 08:02:49 -0500

Must a claim of mechanics lien identify the date when the contractor (or other lien claimant) last provided labor, other services (including design services), material, or equipment for a piece of property(all together collectively "work")?

Yes in Cook County. But no after the Appellate Court (Second District) decision in National City Mortgage v. Bergman (PDF) in these counties: Jo Daviess, Stephenson, Winnebago, Boone, McHenry, Lake, Carroll, Ogle, Lee, DeKalb, Kane, Kendall, and DuPage.

Yes - Last Work Date Is Required: Merchants Environmental Industries, Inc. v. SLT Realty Ltd. Partnership

Ten years ago, the First District of the Illinois Appellate Court presiding over Cook County held that to be enforceable against later property purchasers, lenders, and the like, a claim of mechanics lien must identify the last date the contractor provided work on the project. That decision was Merchants Environmental Industries, Inc. v. SLT Realty Ltd. Partnership (PDF).

The idea behind that decision: ensure that anyone reading a claim of lien can determine, just by reading the claim of lien and nothing else, whether the contractor had recorded the claim in the official county land records within four months after they last provided work as required under Section 7 (PDF) of the Illinois Mechanics Lien Act.

From the perspective of a lender, purchaser, and especially a title insurance underwriter, this sounds like a good idea. It's a lot easier to determine whether a claim of lien was timely filed by looking at just the claim itself, without having to resort to (a) other documents that may, or may not, be publicly available or (b) communicating with anyone else (i.e., the right person at the lien claimant contractor who personally knows and can tell you when they last worked on this or that project a year or two ago).

No - Last Work Date Is Not Required: National City Mortgage v. Bergman

But there's a problem with imposing this requirement: Section 7 of the Mechanics Lien Act identifies a list of what must be in a claim of lien, and the last date of work isn't on the list. So, invoking traditional principles of statutory construction and equity, and notions of the separation of powers between the legislative and judicial branches of government, Judge Michael Burke writing for the Appellate Court decided in the Bergman case that if this requirement isn't in Section 7, then the contractor needn't include it in the claim they record to perfect their mechanics lien.

Judge Burke recognized policy arguments for requiring identification of the date of last work in a claim of lien, but said: "[b]alancing dueling policy concerns is a more appropriate role for the legislature than this court."

Interested in more on the National City decision? Listen to the oral argument on the player below:

Conclusions

To sum it up:

Claims of lien recorded in Cook County must still identify the last date of work, at least for now
Claims of lien recorded in other counties listed above don't need to identify the last date of work, at least for now
Consider identifying the last day of work in claims of lien anyway. You never know when the Illinois Supreme Court may decide it's required, or the Illinois General Assembly will amend the Mechanics Lien Act to require it

FDIC Sues Former Heritage Community Bankers in Chicago

Joshua Glazov — Mon, 08 Nov 2010 06:59:48 -0500

The FDIC (as receiver for the failed Heritage Community Bank) recently sued the bank's former Chairman and Chief Executive Officer along with ten other former bank officers and directors.

Bank Failure Video

In a post last fall, CLT brought you a 60 Minutes video segment on how the FDIC takes over an insolvent bank. That segment gives an intimate glimpse into the lead-up to, and closing of, the Heritage Community Bank, including footage of the bank's former Chairman and CEO as the closing unfolded.

FDIC Professional Liability Complaint

The FDIC's complaint (PDF) seeks more than $10 million in damages, alleging that the the bank's former Chairman and CEO, along with the ten other officers and directors, were negligent, grossly negligent, and breached fiduciary duties they respectively owed to the bank. The allegations focus on:

Mismanagement of commercial real estate and construction loans
Dividend payments to shareholders, and incentives payments to senior management, even after the bank was already to serious financial trouble

Lawyers Make the Law Too Difficult

Joshua Glazov — Mon, 04 Oct 2010 14:08:23 -0500

A US Supreme Court justice once lamented how lawyers make the law incomprehensible to most who must live and work under it:

"The legal profession, like many another, tends to become over-professionalized. We forget that the law is the rule for simple and untaught people to live by. We complicate and over-refine it as a weapon in legal combat until we take it off the ground where people live and into the thin atmosphere of sheer fiction. "

-- Robert H. Jackson

The Struggle for Judicial Supremacy

292 (1941)

And that was in 1941! Back when, by today's standard, the law was a lot simpler.

One of the principal goals of this blog is to counter the trend Justice Jackson lamented. So, please e-mail and post comments on how you think we can do it better.

Mechanics Lien Priority: Contractor vs. Lender - Part 5: How Much Lender Subrogation

Joshua Glazov — Thu, 30 Sep 2010 11:36:08 -0500

In Mechanics Lien Priority: Contractor vs. Lender - Part 4, we talked about how the Perfected Contractors got priority to a part of foreclosure sale money, known as the added value pitcher, ahead of other rival creditors. Now we're going to talk about the Lender's attempt to get equal priority in front of the added value pitcher of foreclosure sale money.

Lender Seeks Enhancement Priority

In LaSalle Bank, N.A. v. Cypress Creek 1, LP (PDF), the Lender wanted to join the Perfected Contractors at the front of queue that had lined up before the added value pitcher (a/k/a queue Queue #2). Why should the Perfected Contractors share space, and money, with the Lender? According to the Lender:

Loan proceeds from the Lender's construction loan paid many of the contractors, other than the Perfected Contractors, who worked on the project (each a "Lender Paid Contractor")
Presumably the Lender Paid Contractors' work added value to the project, i.e., their work put more lemonade in the added value pitcher, yielding more money when the project was sold at a foreclosure sale
Because many Lender Paid Contractors were paid with construction loan proceeds from the Lender, under the principle of subrogation the Lender gets to take over the Lender Paid Contractors' place in Queue #2
Moreover, had the Lender not paid the Lender Paid Contractors, the Lender Paid Contractors would have claimed liens against the project. And had they properly claimed liens against the project, they would stand at the front of Queue #2, at parity right beside the Perfected Contractors
So, by paying the Lender Paid Contractors and taking over their (the Lender Paid Contractors') position, the Lender should stand beside, not behind, the Perfected Contractors at the front of Queue #2 as foreclosure sale money is poured out from the added value pitcher

Perfected Contractors Oppose Lender Enhancement Priority

According to the Perfected Contractors, regardless of whether the Lender Paid Contractors were paid with construction loan proceeds from the Lender, the Lender shouldn't get to stand at the front of Queue #2. Here's how the Perfected Contractors explained it:

To get to the front of Queue #2, you must have a properly perfected mechanics lien. That's either one you perfect yourself securing payment for your own work, or one you get from someone else (for example, by assignment or subrogation)
Each Perfected Contractor perfected their own mechanics lien against the project. But the Lender Paid Contractors didn't
By paying the Lender Paid Contractors, the Lender does subrogate into the position each Lender Paid Contractor once occupied
But a traditional, and critical, tenet of subrogation is that when you pay someone and subrogate into their position, you inherit the position they (the person you paid) had and no better. If the Lender Paid Contractors didn't perfect mechanics liens against the project and enjoy the senior priority position that comes with a perfected mechanics lien, then the Lender doesn't enjoy that senior priority position either

Putting the Perfected Contractors' argument another way: by paying the Lender Paid Contractors for their work, the Lender steps into their shoes. But those shoes don't get resoled and polished just because the Lender pays for them with construction loan money.

Judges' Decision: No Mechanics Lien Means No Priority Subrogation

Two of the three judges agreed with the Perfected Contractors: to enjoy the same priority and stand at the front of Queue #2, the Lender's loan proceeds must pay off contractors holding properly perfected mechanics lien claims. The Lender steps into the Perfected Contractors' shoes, but doesn't improve them.

Dissenting Judge

One dissenting judge agreed with the Lender. He cited two reasons:

Earlier judicial decisions - some going back to the 19th century - mandate allowing lenders to subrogate to the priority of contractors they pay as if those contractors (a) hadn't been paid and (b) had properly perfected mechanics liens. In this case the Lender Paid Contractors didn't perfect mechanics liens against the project. Why? Because they were paid on time. Had they not been paid, they would have recorded and perfected mechanics liens against the project. Construction loan money from the Lender averted those liens. So, the Lender shouldn't be penalized with junior priority just because the they paid on time, preventing at least some mechanics liens against the project

Also, putting the Lender behind, instead of beside, the Perfected Contractors would unjustly enrich the Perfected Contractors. They (the Perfected Contractors) would get a larger share of the foreclosure sale money then they are equitably entitled to

These are some good arguments. But the first rests on the assumption each contractor, if not paid, will timely and properly perfect a mechanics lien against the project. It equates lienable with perfected lien. If you've observed a few mechanics lien disputes, you've probably recognized by now that assuming timely and proper perfection of a mechanics lien is assuming quite a lot.

The second argument defies a longstanding subrogation jurisprudence: it grants the Lender more than the Lender Paid Contractors had. But the Lender has urged that subrogation, founded on notions of fairness and equity, is a flexible enough concept to sustain an exception to the traditional rule that says you can't subrogate to more than what the person you pay has. Perhaps the Lender is right?

Illinois Supreme Court Appeal

Dissatisfied with the majority of the judges' decision, the Lender asked the Illinois Supreme Court to hear the case. The Supreme Court said yes. Earlier this summer the Lender submitted this brief (PDF) stating the issue:

Whether, in determining priority under §16 of the Mechanics Lien Act, the Appellate Court erred in finding that the Lender was subrogated only to the extent the owner or the Lender paid mechanics liens which were perfected by recording instead of being subrogated for payments made for lienable improvements

Responding, the Perfected Contractors submitted their own briefs. One brief from Edon Construction Company (PDF) and one brief from Eagle Concrete (PDF).

Read on to see how the Justices decided this issue.

What Are the World's Most Important Architectural Works Since 1980

Joshua Glazov — Tue, 31 Aug 2010 06:51:01 -0500

Vanity Fair magazine asked a panel of 52 experts to pick the world's five most important post-1980 architectural works. The Guggenheim Museum in Bilbao, Spain by design architect Frank Gehry (below) topped the list. And there's a slide show of the others in the top 21.

Photo: Peter Knaup