The Illinois Supreme Court recently held that a construction lender is automatically vested with a status equivalent to perfected mechanic’s lien claimants for all disbursements on the loan, without proof of perfection or enhancement, and without regard to the nature or purpose of the disbursements. LaSalle Bank National Association v. Cypress Creek I, LP, Docket No. 109954 (Opinion filed February 25, 2011). The effect of this decision is that mechanic’s lien claims will be diluted by construction loans, substantially reducing the value of mechanic’s lien claims, and emasculating the protection provided by the Mechanic’s Lien Act.
This case involved a 13.79-acre parcel of real estate in Bolingbrook, Illinois which was classified as a planned unit development and zoned for senior apartments, and known as “Cypress Creek I Senior Apartments.” Cypress Creek was originally intended to include fifteen (15) seven-unit townhome buildings and a clubhouse, but only six (6) of the buildings were under construction.
LaSalle Bank National Association was the construction lender for the Cypress Creek project, and had a mortgage covering the underlying land, which was recorded in 2003.
In 2005, Edon Construction Co., Inc. entered into a written contract with the developer to provide rough and finished carpentry for the project. The last date of work performed by Edon in the project was August 10, 2005. The developer failed to pay Edon, and Edon recorded a Claim for Lien on November 21, 2005 in the amount of $285,826.80.
LaSalle’s construction loan was in default as of June 10, 2005. LaSalle never notified Edon that the LaSalle construction loan was in default, and Edon continued to provide carpentry labor and materials in the project. LaSalle funded the first eight (8) draws, but refused to pay the ninth (9th) draw.
LaSalle filed a Complaint to Foreclose Mortgage in Will County. A Judgment of Foreclosure and Sale was entered in the mortgage foreclosure proceeding on April 25, 2006, finding that the balance due on the construction loan was $8,621,109.93, and reserving finding as to priorities between LaSalle and certain lien claimants. The property was sold at a Sheriff’s Sale on May 31, 2006. LaSalle was the only party to submit a bid at the Sheriff’s Sale and was the successful bidder for the price of $1,300,000.
On August 28, 2006, Edon filed a Complaint to Foreclose Mechanic’s Lien in Will County. Edon’s mechanic’s lien foreclosure proceeding was consolidated with the mortgage foreclosure proceeding on October 16, 2006.
After a bench trial, the trial court found that Edon had perfected its mechanic’s lien claim and enhanced the value of the property. Based upon this finding, Edon’s mechanic’s lien should have been paid in full from the proceeds of the Sheriff’s Sale. However, the trial court, applying the doctrine of subrogation, held that LaSalle was entitled to share in the proceeds of the Sheriff’s Sale in a ratio established by the balance of the construction loan. As a result, the trial court allocated $471,614.06 of the Sheriff’s Sale proceeds to LaSalle and reduced Edon’s share of the Sheriff’s Sale proceeds from $285,826.80 to $50,000.
Edon appealed, and the Appellate Court for the Third Judicial District reversed the trial court’s ruling, finding that LaSalle could not improve its status to the position of a perfected lien creditor through the doctrine of subrogation. LaSalle appealed, and the Supreme Court granted LaSalle’s Petition for Leave to Appeal.
In a 5 to 2 decision, the Supreme Court reversed the Appellate Court and reinstated the trial court’s decision. The Supreme Court ignored the doctrine of subrogation, which was the basis of the appeal, and decided the case based upon an interpretation of Section 16 of the Mechanic’s Lien Act which was never argued and has never been considered by any other court.
Section 16 states that “… the lien creditor shall be preferred to the value of improvements erected on the premises.” Nevertheless, the majority found that “… it is only logical that each claimant would have priority only as to his own improvements …” (Slip Opinion, P. 7). Under the Supreme Court’s analysis, the carpenter would have priority as to the wood, the plumber would have priority as to the pipes, and the excavator would have priority as to the hole in the ground.
In a strong Dissenting Opinion, Justice Freeman noted that the majority decision will allow mortgagees to assume the position of lien creditors “by judicial fiat” (Slip Opinion, p. 18). Although the majority found that there was no meaningful distinction between owners and encumbrancers, Justice Freeman noted that the Mechanic’s Lien Act sets forth a statutory scheme which distinguishes owners, encumbrancers and lien creditors (Slip Opinion, p. 19), and that Section 16 clearly prioritizes lien creditors as to improvements (Slip Opinion, p. 21):
Under the plain language of section 16, LaSalle, an ‘incumbrancer’ (i.e., mortgagee) has priority with respect to only the value of the land before improvements. Everyone agrees in this case that the value of the land before any improvements were made was $1,360,000. According to the plain language of section 16, with respect to the priority as between ‘incumbrancers’ (mortgagees) and ‘lien creditors’ (mechanics lien holders), all ‘previous incumbrances’ (mortgagees) shall be preferred only to the extent of the value of the land (here, $1,360,000) ‘at the time of the making of the contract’ and the lien creditors (each mechanic lien holder) ‘shall be preferred to the value of the improvements erected on said premises [for Edon, $285,827; for Eagle $63,478].” 770 ILCS 60/16 (West 2006).
Justice Freeman concluded that “Section 16 does not otherwise permit LaSalle’s position as an incumbrancer to be equated with that of a lien creditor,” and “(t)hat would leave subrogation as the only means for doing so, as both parties in this case agree.” (Slip Opinion, p. 23).
The majority held that because the trial court applied the contract approach to value, it was correct to apply the contract method to value the improvements paid for through LaSalle’s construction loan. This finding ignores the fact that LaSalle was not a lien creditor and never perfected the lien claims evidenced by the construction disbursements.
The majority decision in Cypress Creek overrides Section 16 of the Mechanic’s Lien Act and eliminates the distinction between encumbrancers and lien creditors. A construction lender has the protection of the recorded mortgage and, under Cypress Creek, automatically assumes the status of a perfected lien creditor for all disbursements. Conversely, contractors are required to perfect their mechanic’s lien claims under Section 16 in order to preserve their liens, only to have the value of their liens diminished by the proportionality analysis adopted by the majority.
After Cypress Creek, the mechanic’s lien no longer provides protection to contractors. In order to assure payment, contractors will have to require payment in advance, which will increase the risk assumed by owners and developers, delay completion of troubled projects, and interfere with economic recovery. ■