The Statewide Title Newsletter and Legal Memorandum

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Issue  184  Article  317
Published:  12/1/2010

New Contract Resets Date of First Furnishing in Ch. 44A Action
Chris Burti, Vice President and Senior Legal Counsel

Lawyers Title Insurance Corporation, v. Zogreo, LLC, COA09-1304, November 16, 2010 is a case excellent analysis of the relevant statutes, case law and transactional expectations of the public as applied to Chapter 44A lien law by the North Carolina Court of Appeals' in this well reasoned opinion. The appeal was from the trial court's order of partial summary judgment declaring Plaintiffs' security interests in property located in Garner, North Carolina to have priority over materialmen's liens perfected by Bunn Construction Company, Inc. ("Bunn") and C.C. Mangum Company, L.L.C. and enjoining the sale of the property by execution sale.

The statement of facts set out by the Court of Appeals in the opinion is complex and extensive, but will serve the purpose of this article more concisely summarized as follows. The subject property is the site of a residential development project divided into three tracts, encumbered by various security interests held by the parties. "Specifically, the entire Property is subject to two claims of lien: one filed by Mangum on or about 5 October 2006, and one filed by Bunn on or about 18 December 2006. Additionally, portions of the Property are subject to deeds of trust: one held by BB&T recorded 22 February 2005 ("BB&T DOT"), and the other originally held by Cardinal State Bank ("Cardinal") recorded 29 April 2005 ("Cardinal DOT")..."

On 8 April 2004, the owner of Tract 1 at the time, entered into a contract with Bunn for land clearing, grading, and erosion control services and on 19 April 2004, another contract with Bunn for sewer, water, storm drain, and roadway construction services. Bunn ceased work on or around 16 June 2004 for non-payment and timely filed a claim of lien on Tract 1 in the principal amount of $180,495.24 for "clearing and grading of property[.]" asserting a first furnishing date  of April 2004. Bunn timely filed suit to enforce the claim of lien. In its complaint, Bunn alleged that the owner owed Bunn the principal amount of $180,495.84 for labor and materials supplied to the property. On 12 January 2005, the owner entered into a third contract with Bunn for silt basin/erosion control services for $27,555. This contract was paid in full in cash when the contract was signed. 

On 22 February 2005, Trinity Builders, LLC ("Trinity") purchased a controlling interest in the entity that owned the property which then conveyed Tract 1 to Trinity. "Also on that date, BB&T loaned $975,000 to Trinity and Trinity executed a promissory note in favor of BB&T. BB&T recorded its deed of trust in Tract 1 as security for Trinity's promissory note, and Lawyer's Title issued a lender's policy insuring BB&T. A portion of the proceeds from the BB&T loan were used to pay the debt on which Bunn's claim of lien was based. As a result, Bunn cancelled its claim of lien on 28 February 2005 and dismissed with prejudice its action to enforce the lien on 10 March 2005." Subsequently, Bunn submitted a contract proposal to Trinity for sewer main, water main, storm drain, roadway, construction road, pump station, and force main construction services for $1,813,631. Trinity then acquired Tracts 2 and 3 giving Cardinal a deed of trust on Tracts 2 and 3 to secure the purchase price recorded simultaneously with vesting deed on 29 April 005. Subsequently, Trinity's agent signed the contract, drafted by Bunn, which stated: "This proposal contract replaces any others discussed or written in the past[.]" Bunn thereafter entered into a written contract for defendant Mangum to "furnish all materials and labor and perform all the work required" for the project for a total contract price of $1,086,545.80. 

Bunn and Mangum subsequently ceased work on the project due to non-payment for their services and Mangum timely filed a claim of lien on all three tracts asserting a claim for $389,438.41, and listing a date of first furnishing of 15 May 2006 and a date of final furnishing of 22 September 2006. Bunn then filed a claim of lien on all three tracts asserting $895,483.86 owed, a date of first furnishing of 5 May 2004, and a date of final furnishing of 29 September 2006. An action to enforce the lien was filed against Trinity, the plaintiff mortgagees were not made parties to the action and an unopposed summary judgment order was entered in favor of Bunn declaring that the judgment lien on the property related back to May 5, 2004, and ordering a sale of the property to satisfy the judgment. Subsequently, Bunn assigned its judgment to the defendant Zogreo. In December 2008 the plaintiffs filed the action which resulted in the present appeal. On appeal, the defendants first unsuccessfully argued that the plaintiffs' civil action represents an improper collateral attack against valid lien judgments. The Court's discussion of the standard of review is not required for this discussion and that its review of the lien law can also be omitted on the assumption that the interested reader is familiar with it purview.

The section of the Court of Appeals opinion dealing with effect of the failure to join a proper party is concise, straightforward and follows unedited.

"A lien enforcement action "is designed to enforce the lien by the sale of whatever interest the person who caused the building to be erected or repaired had in the land improved by the labor or materials of the contractor at the time the lien attached." Equitable Life Assurance Soc. v. Basnight, 234 N.C. 347, 353, 67 S.E.2d 390, 395 (1951). 

[T]he action to enforce the lien is not created to determine the validity or the priority of the adverse claims of third persons in the premises subject to the lien. The contractor can obtain the complete relief sought, i.e., the sale of the interest owned by the person who caused the improvement to be made at the time the lien attached, in his action against the landowner, without having the rights of adverse claimants ascertained and settled. 

Id. Thus, "[o]nly the owner of the property subject to the materialmen's lien is required to be a party to an action to enforce the claim of lien." Miller v. Lemon Tree Inn, Inc., 32 N.C. App. 524, 527, 233 S.E.2d 69, 72 (1977). Although "subsequent encumbrancers and other adverse claimants are proper parties to such action, for they have ascertainable interests in the subject matter of the controversy[,]" Equitable Life Assurance Soc., 234 N.C. at 353, 67 S.E.2d at 395 (emphasis added), "subsequent encumbrancers and other adverse claimants are not necessary parties to an action to enforce a contractor's lien." Id. (emphasis added). 

"[I]t is axiomatic that a judgment cannot be binding upon persons who were not party or privy to an action." Miller, 32 N.C. App. at 527, 233 S.E.2d at 72. Thus, subsequent encumbrancers and other adverse claimants who are not made proper parties to an action to enforce a lien are not bound by the lien judgment. Equitable Life Assurance Soc., 234 N.C. at 353, 67 S.E.2d at 395 ("If a subsequent encumbrancer is not joined, he is not bound by the judgment in the action between the contractor and the owner . . . ."). Accordingly, an adverse claimant who has not been made a party to a lien enforcement action may bring a subsequent action to determine the priority of its interest in the property. See Metropolitan Life Ins. Co. v. Rowell, 115 N.C. App. 152, 444 S.E.2d 231 (1994) (beneficiary of a deed of trust brought an action challenging the priority of the supplier's lien that had been reduced to judgment); Miller, 32 N.C. App. 524, 233 S.E.2d 69 (plaintiff holder and beneficiary of deed of trust brought suit against lienor-judgment creditor to foreclose under a judicial sale and alleged plaintiff's deed of trust had priority over defendant's judgment lien in the proceeds from the judicial sale); Priddy v. Kernersville Lumber Co., 258 N.C. 653, 129 S.E.2d 256 (1963) (holder of deed of trust brought declaratory judgment action against lienor-judgment creditor to determine priority of liens after property offered for sale under execution)."

It is obvious that the plaintiffs were not made parties to the actions to enforce the materialmen's lien claims. It is equally obvious that parties not joined in an action are not bound by the judgment in the action and are free to bring a subsequent action to determine their interests. The defendants argued that this action "constitutes an impermissible collateral attack on the Bunn and Mangum Judgments". The Court of Appeals held under well established law that this was not a collateral attach as it was not an attempt to invalidate, void or set the judgment aside, but rather one seeking a determination of priority. As the plaintiffs were not parties to the prior action and as the judgment did not purport to determine this priority, this was not an impermissible collateral attack. Having thus disposed of the issue, there was no need for the Court to address whether the judgment was void as to the plaintiff's for failure to join them and then whether they a failure to plead that the judgment was void necessitated dismissal.

The defendants also contended that because lien enforcement actions have been held to be "actions in rem," the resulting lien judgments established the validity and priority of the liens,  "as against the entire world." The Court observes, in response, that the North Carolina Supreme Court "has noted that a proceeding to enforce a mechanic's lien is in rem. Vick v. Flournoy, 147 N.C. 209, 212, 60 S.E. 978, 979 (1908); Bernhardt v. Brown, 118 N.C. 700, 706, 24 S.E. 527, 528 (1896). A judgment in rem binds the world to any decision affecting the res involved in the litigation. Cole v. Hughes, 114 N.C. App. 424, 427, 442 S.E.2d 86, 88, disc. review denied, 336 N.C. 778, 447 S.E.2d 418 (1994). In this way, property rights may be determined with great certainty, allowing the owners of the property interests to use the property more efficiently, or to transfer their interests more easily. Branca v. Security Ben. Life Ins. Co., 773 F.2d 1158, 1162 (11th Cir. Fla. 1985). A proceeding to enforce a mechanic's lien, and the resulting judgment, determines the contractor's lien on the property at issue and orders the sale of the property." However the Court goes on to say: "In this case, we do not adjudicate any property rights already determined in the lien enforcement actions or order the sale of the Property to satisfy a judgment, but consider the fact of the date of first furnishing upon which Bunn's and Mangum's claims of lien were based to determine the priority of Plaintiffs' security interests in the Property. 'We see no reason why we should allow a judgment in rem to establish the facts on which that judgment is based in another suit, and we decline to do so.' Id. at 1163 (footnote omitted). In Becher v. Contoure Laboratories, Inc., 279 U.S. 388, 73 L. Ed. 752 (1929), a case concerning the validity of a patent, Justice Holmes enunciated this policy by writing for the United States Supreme Court that '[a] judgment in rem binds all the world, but the facts on which it necessarily proceeds are not established against all the world.' Id. at 391, 73 L. Ed. at 754; accord Cannon v. Cannon, 223 N.C. 664, 671, 28 S.E.2d 240, 244 (1943)." 

The defendants' next argument was to the effect that even if the challenge to the judgments were permissible, the trial court erred in granting partial summary judgment in favor of Plaintiffs because genuine issues of material fact existed. The Court of Appeals did not agree and in a lengthy discourse that can be summarized more briefly. Since Bunn cancelled the first claim of lien after receiving payment for the amount claimed and then entered into a "new contract, under which it commenced work, it was the commencement of work under a distinctly new contract that effectively 're-set' the date of first furnishing at issue here."

"The BB&T DOT was recorded 22 February 2005. The Cardinal DOT, which was transferred to Clark's Creek, was recorded 29 April 2005. As these instruments were recorded before 25 May 2005, the BB&T DOT and the Cardinal DOT have priority over Bunn's and Mangum's liens as a matter of law. Frank H. Conner Co., 294 N.C. at 667, 242 S.E.2d at 789. Accordingly, the trial court did not err in granting Plaintiffs summary judgment."

While the court did not address the doctrines of contract construction or estoppel, this unanimous opinion clearly is in accord with those principles as well. The evidence set out by the court clearly states that Bunn drafted the agreement, thus any issue in its interpretation should be resolved as a matter of strict construction in favor of the plaintiffs as a matter of law. When they stated in the proposal that "This proposal contract replaces any others discussed or written in the past[.]", they eliminate any ambiguity about it being a new contract. If there is a new contract with new owners and the old claim against the old owners was "dismissed with prejudice" there can be no claim of a different first furnishing as between those parties other than as plainly evidenced by their own statements in the contract they drafted. Further, the facts clearly showed that all parties, the lenders in particular, proceeded forward with the transaction in reliance on the fact that all prior claims had been fully acquitted and that the security instruments collateralizing the funds for payment for the new work were to have priority. The equitable doctrine of estoppel would prevent the defendants from accepting payments under the agreements satisfying the old claims as well as under the new contract and then to subsequently try claim priority based upon the fully satisfied prior claim against a prior owner.

It seems that the clear lesson for the practitioner in dealing with construction contract default workout situations is that a "new contract" is essential in order for the project to proceed with certainty and for the reasonable expectations of the parties to be met in the event of a subsequent default. If a contractor walks off the job after becoming insolvent or as the result of a contract dispute, proceeding forward in a workout arrangement without such certainty is extremely perilous for lenders and for title insurers. By entering into a new and well drafted agreement that clearly "resets" the date of first furnishing, a lender should be able to safely disburse the funds necessary to finish the project and pay those continuing the work. Had this case been decided otherwise, no title insurer would be willing to insure a lender agreeing to fund the workout of a defaulted construction project against Chapter 44A lien claims. Without title insurance coverage for subsequent Chapter 44A liens, few lenders, if any, would agree to fund such a workout. This would eliminate workout as an option as a practical matter.

Care will need to be taken in such agreements to make the parties' relative lien rights in the prior work absolutely clear without violating N.C.G.S. Section 44A-12(f) concerning the prospective work. There should be reliance and estoppel provisions included as well so that it is clear that the parties acknowledge that third parties will be advancing funds, providing title insurance coverage as well as other assurances and benefits relying on the agreement and forming part of the consideration for its existence. The new North Carolina Land Title Association Form 4 lien waiver, effective December 3, 2010, will be useful for this purpose in simpler and more straightforward situations.

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