Mortgage Lenders Can’t Jump Ahead of Mechanic’s Liens

In Weitz Co., LLC v. Heth, 223 Ariz. 442, 314 P.3d 569 (Ct. App. Nov. 26 2013), the Arizona Court of Appeals held that the plain language of Arizona’s mechanic lien statute, A.R.S. § 33-992(A), does not allow a lender to jump ahead of a mechanic’s lien under the doctrine of “equitable subrogation.”

In Weitz, First National Bank of Arizona lent a developer $44,000,000 to build a 165-unit, mixed-use commercial/residential project in downtown Phoenix.  The bank secured repayment of the construction loan by recording a deed of trust against the project.

The developer hired The Weitz Company as its general contractor.  The developer fell behind on payments to Weitz, and in January 2006, Weitz recorded a preliminary 20-day mechanic’s lien notice pursuant to A.R.S. § 33-992.01.

Before the project was complete, but after Weitz recorded its 20-day notice, the developer began selling individual condominium units.  Most of the purchasers obtained financing (the “New Lenders”) and secured their purchase loans with liens against the unit purchased.  Proceeds from these sales were applied to pay off portions of First National Bank of Arizona’s construction loan.

By mid-2008, the developer owed Weitz upwards of $4,000,000 so Weitz recorded a formal mechanic’s lien against the entire project.  When Weitz sued to foreclose its lien, it sued all of the purchasers and New Lenders arguing that the mechanic’s lien had priority over all other liens that attached after commencement of the project – including the liens in favor of the New Lenders.  The trial court agreed, and the New Lenders appealed.

The Court of Appeals affirmed, holding that the plain language of A.R.S. § 33-992(A) clearly provides that mechanic’s liens have priority over all liens except for construction loans “attaching subsequent to the time the labor was commenced or material provided.”  Because it was undisputed that Weitz appropriately perfected its mechanic’s lien and that the New Lenders’ liens attached after commencement of construction, the trial court correctly determined that the mechanic’s lien had priority.

The New Lenders argued that notwithstanding the plain language of the statute, the doctrine of equitable subrogation allowed their liens to jump ahead of the mechanic’s lien and gain the same priority as First National Bank of Arizona’s construction lien.  Equitable subrogation generally allows a subsequent lender to assume the lien priority of an earlier lender, if it pays off the earlier lien.  The Court of Appeals rejected this argument, noting that “equity” cannot supersede an otherwise unambiguous statute.

Weitz is interesting not only because it reverses the course of Arizona law on the “equitable subrogation” concept, but the opinion highlights the unique set of problems when competing interests of property owners collide.  One can imagine a fact pattern similar to Weitz in which the contractor, construction lender, property owner, title company, and purchasers all assert competing interests in a project.  As in Weitz, some interest holders will probably win, and some will probably lose.  Any one purchasing into a half-built project may wish to use extra diligence to ensure that their interests are adequately protected in light of all of the competing parties.

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The Arizona Supreme Court reviewed this decision.  Click here for a blog on that decision:  http://www.swlaw.com/blogs/real-estate-litigation/2014/08/29/arizona-supreme-court-to-contractor-sorry-but-equitable-subrogation-of-a-banks-later-deed-of-trust-trumps-earlier-mechanics-lien-rights/