Illinois Bar Journal

November 2012Volume 100Number 11Page 574

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Debate continues over controversial mechanics lien bill

An attempt to legislatively overturn a recent supreme court ruling is pitting developers against bankers over whose claims have priority in foreclosure sales.

Debates are expected to continue over a controversial Illinois House bill that has real estate developers sparring with bankers over who has secured priority status in recouping their claims against properties undergoing foreclosure sales.

According to lawyers from both sides of the debate, the bill was designed to undo a recent supreme court decision that allowed a mortgagee to assume priority status over a secured lien creditor, which the dissenting justices believed to be in direct conflict with provisions of the Illinois Mechanics Lien Act.

"[House Bill] 3636 is a controversial bill attempting to reverse the Illinois Supreme Court holding in the case of LaSalle Bank National Association v. Cypress Creek," said Arnstein & Lehr LLP partner Samuel H. Levine, who is a member of the ISBA Real Estate Law Section Council.

"The issue in Cypress Creek was how to distribute foreclosure sale proceeds between a mortgagee and a mechanics lien claimant when the mortgage predated the liens, the foreclosure sale proceeds were insufficient to satisfy all claims, and the mortgagee has paid for several improvements to the property through construction loan disbursements under section 16 of the Mechanics Lien Act," Levine said.

The 5-2 supreme court majority in Cypress Creek held that under the plain language of section 16 of the Act (770 ILCS 60/16), "it is only logical that each claimant would have priority only as to his own improvements" on the property. After reversing the appellate court, the matter was remanded to the trial court, which then allocated almost $500,000 to the mortgagee, while reducing the mechanics lien holder's share of the proceeds from more than $285,000 down to $50,000.

The dissenting justices, along with contractors, subcontractors and other real estate developers throughout the state, believe the majority's logic created a major conflict with section 16, which states that "the lien creditor shall be preferred to the value of the improvements erected on the premises."

"The Illinois Supreme Court…found that the value of the foreclosed property that is attributable to those improvements paid for by the mortgagee should be applied first toward the satisfaction of the mortgage," Levine said. "It held that section 16 of the Act gave mechanics lien claimants priority only with respect to the value of the property attributable to those improvements for which they furnished material or services, rather than with respect to all improvements made subsequent to the mortgage."

No middle ground

A few months after the Cypress Creek decision, HB 3636 was filed in the General Assembly, sparking heated debates in the Capitol and among attorneys active with the ISBA Real Estate Section.

Section chair Ralph J. Schumann said that prior to Cypress Creek, it was clear to attorneys, lien holders, and mortgagees that foreclosure proceeds would be paid first to the secured creditors and that the lenders could not benefit from the improvements later made by carpenters, plumbers, and other developers.

"The line was drawn in the sand," Schumann said. "It was always viewed before this that the banker - the lender - would have a pro rata share in the value of the land when they issued the mortgage. The mortgage encumbers the land and they would share in the value of the unimproved land. As developments went up, that's when the mechanics liens come into play."

House Bill 3636 seeks to undo the effects of Cypress Creek, Schumann said, but the opposing sides are so adamant about their positions that he doubts whether any bill could satisfy all the players, no matter how artfully crafted.

Schumann compared the controversy surrounding this bill to the debates over civil unions, which ultimately were legalized in Illinois despite the opposing sides not finding middle ground.

"This is one of those issues where both sides have good reasons for standing firm on what they believe in," Schumann said. "It's so polarizing, but it's never as black-and-white as the advocates on either side would have you believe."

Schumann said the banking lobby - and attorneys in his ISBA section council who represent banks - generally oppose HB 3636 because they much prefer the elevated status they obtained from the Cypress Creek decision. On the other hand, he said his council members representing the construction industry believe the bill is necessary "to have a more even playing field."

"The way some practitioners see it is that [Cypress Creek] gives a windfall to the bankers. They are treated as a lien creditor with perfected lien rights even without having gone through the statutory procedures for perfecting their claims," Schumann said. "It really boils down to whether your interests lie with the bankers or the developers, and the thing to understand here is that the arguments are very, very carefully drafted and vociferously made by both sides."

The legislative floor and committee debates over HB 3636 began in February of 2011, and the following April 14 the House voted unanimously to approve the bill, according to legislative reports. The first reading in the Senate took place the next day, but debates continued until the Senate voted 34-10-5 to approve the bill at the end of March 2012.

Two Senate amendments were later tacked on to the bill, which then was sent back to the House where it currently remains stalled in the Rules Committee until the legislature reconvenes for its next session.

Adam W. Lasker <> is a Chicago-based lawyer and writer.

Member Comments (3)

Although this was a well balanced article, I would like to clear up one statement. House Bill 3636 does not "pit" developers against lenders, It is a Bill that protects contractors and subcontractors. House Bill 3636 is an attempt to correct a misinterpretation of Section 16 of the Illinois Mechanics Lien Act which overturned over a hundred years of juris prudence. The Mechanics Lien Act is an Act designed to protect contractors and subcontractors who perform work on a project. Lenders are able to protect their investments through other means such as their due diligence prior to loaning out money. Additionally, lenders can require that the loan be cross collateralized, that there be an assignment of rents if the project fails and that the developers provide personal guarantees. None of these protections are available to contractors and subcontractors which was why the Mechanics Lien Act was first enacted; to protect the payment of those who improve property.

Contractors do not want to have to file foreclosure suits in order to get paid. The contractors look to the construction lender to receive their progress payments. If the bill passes, the lender will require each contractor entitled to a draw to perfect its lien rights and to assign those lien rights to the lender. Only then will the lender disburse. If later a contractor is not paid and has to foreclose, the lender will have the benefit of the lien rights that were assigned to it. If the proceed of foreclosure are insufficient to satisfy the lender and the mechanics liens, including those that were assigned to the lender, the proceeds will be distributed to the lien claimants including the lender as assignee. The net results will be the same as in the Cypress Creek case. The only difference will be that costs will increase because of all of the additional paperwork. The county recorders may like it though because lots more lien claims will be recorded.

BTW, a contractor has every right to demand a personal guarantee and other security.

The mortgagee has long had subrogation rights to the extent of its payment to mechanics lien right holders. The SC overturned what was a reversal of 100 years of juris prudence by the appellate court's finding the mortgagee had to take an assignment of the contractor's perfected mechanic's lien to realize on those subrogation rights. That will pose no problem for the mortgagee but will drive up the cost of mortgage lending for the contractors, owners, and lenders. The SC's opinion stated prior law and practise and should stand.

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