A mechanics lien is one of the most effective payment recovery methods that can pressure construction clients to pay up. Mechanics liens are a public record, so potential buyers and financiers can see all the outstanding claims related to a property. This, in effect, forces property owners to settle the debts and get rid of the liens.
Sometimes, however, construction clients may be dealing with deeper financial issues on their own. They may not have the funds to settle all the outstanding debts, which could lead to the foreclosure of a property. When a property gets foreclosed or goes bankrupt, all construction parties with a valid mechanics lien against the property may still recover payment through the proceeds of the foreclosure sale.
Because multiple parties can have a valid mechanics lien on a property, there must be a system that will determine who will receive payment first. This is where lien priority comes in. Some liens have higher priority than others, and it is very important for potential lien claimants to know how their liens are prioritized in the event of a bankruptcy or foreclosure.
If you’re a contractor, subcontractor, or material supplier in California, this guide will answer the basic questions you might have on how lien priority works in the state.
- What is lien priority?
- Why is lien priority necessary?
- When does lien priority become an important issue?
- In general, how is lien priority determined?
- What is the general rule for the priority of a mechanics lien claim?
- How does lien priority work in California?
- What does having lien priority imply financially?
- What date is used to establish lien priority for a mechanic’s lien in California?
- Can a mechanics lien have higher priority over a mortgage lien in California?
- What is a super-priority mechanics lien in California?
- What should I do to ensure higher lien priority in California?
- What happens to my lien priority if I don’t submit a preliminary notice?
What is lien priority?
Lien priority is a ranking, so to speak, that determines which lienor can claim their payment first after a property has gone bankrupt or has been foreclosed.
When multiple parties are trying to secure compensation from a single property, these parties must be ranked according to lien priority so there is a sense of order in distributing the payment.
Why is lien priority necessary?
Lien priority is necessary because a property is not always valued at a price that can cover the payment for all creditors that have valid claims against the said property. In other words, a property can only be worth so much that its market value may not be able to pay all the debts attached to it.
None of the creditors would want to get left behind and end up not receiving the payments that are rightfully theirs. And given the limited pool of money, there must be a system that will determine which among these creditors should get paid first. Establishing lien priority is the system that addresses this problem.
When does lien priority become an important issue?
Lien priority becomes an important issue when a property is foreclosed.
When a foreclosure is initiated against a property, the property may be sold at an auction and the proceeds are used to pay the creditors with outstanding lien claims. A property typically has multiple liens attached to it, from voluntary liens such as mortgages to involuntary liens such as homeowners association liens and mechanics liens.
Let’s illustrate this further with a sample scenario.
Say, for example, that a property has gone bankrupt and now there are multiple parties trying to ensure that they still get their payment for the services that they have rendered to this property.
These parties could involve construction professionals—contractors, subcontractors, materialmen—and they could also be mortgage lenders or homeowner association representatives.
Because multiple parties are trying to secure payment from the limited value of this soon-to-be-foreclosed property, sorting out which party to pay first can be a big issue. The lien priority cleans up this mess by ranking the parties according to their priority.
For mechanics lien claimants, the foreclosure of a property is probably the only reason to pay attention to lien priority. Most of the other lienors, however, would care about their priority ranking especially if mechanics liens could get ahead of them.
In general, how is lien priority determined?
Generally speaking, lien priority is determined according to the date of recordation or the date in which the lien was filed. This means that the ranking of which lienors get to receive payment first is established based on which liens were recorded the earliest.
This is also known as “first in time, first in right.”
Here’s an example of liens ordered according to date of recordation:
- Deed of Trust recorded January 2009 for when owner buys a home via purchase-money mortgage
- Deed of Trust recorded February 2019 for when owner secures a home improvement loan
- Mechanics lien recorded August 2019 for when home improvement contractor files a mechanics lien against the property after a payment dispute with the owner
On a “first in time, first in right” basis, the distribution of payment following the foreclosure of the property will be based on the date in which the liens were filed.
What is the general rule for the priority of a mechanics lien claim?
Mechanics liens also typically follow the “first in time, first in right” rule. Most states follow this principle, and so the priority for mechanics liens are determined based on the date in which the lien has been recorded in the local county clerk office.
This recordation date of a mechanics lien date will then be compared against the filing dates of the other liens, and whichever lien has been filed first will get the highest priority.
How does lien priority work in California?
California lien laws also follow the general rule in which lien priority is ranked according to the date in which the liens were created (i.e. from earliest to latest recordation date). However, the state slightly diverts from this “first in time, first in right” rule when it comes to California mechanics liens.
According to statutory rules, lien priority in California may be determined based on when the work was first performed on a property. This means that mechanics liens could relate back to when labor and/or materials were first furnished to the project, even if the actual lien document has been filed at a much later date.
For example, even if a deed of trust for a home equity loan has been recorded earlier, a mechanics lien in California may still be ranked higher in lien priority if the mechanics lien claimant has provided labor or materials earlier than when the deed of trust was recorded.
Let us once again illustrate this with a scenario.
A residential property owner in California wants to renovate part of their house, so they hire a contractor to do the job. The contractor starts delivering materials and incorporating them into the house in January 2019.
By March 2019, the property owner decides to get a home improvement loan to fund the rest of the renovation project. The deed of trust is signed in the same month.
After a few months, however, a payment issue arises between the property owner and the contractor. The contractor files a mechanics lien against the property in July 2019.
If the contractor initiates foreclosure against the property, they will still have higher priority over the home improvement loan lender, even if the lender has recorded the deed of trust before the mechanics lien has been filed.
This is because California determines lien priority based on when the work has commenced. Since the contractor has provided materials and earlier than when the home improvement loan has been signed, the mechanics lien will be prioritized.
What does having lien priority imply financially?
Having lien priority implies that you get to take first dibs on the proceeds of the property after its foreclosure. So if a property has been sold for $500,000, this value will be used to pay the lien claimants and whoever has top lien priority will receive their payment first.
Lien priority becomes highly critical if the valid claims against the property is worth more than the property’s value. Say in this example that the claims against the property is altogether worth $550,000. If you have first lien priority, then you will automatically get your payment in full.
However, if you are on the tail-end of the lien priority ranking, it’s possible that there may not be enough money to get you paid. If the other higher priority claimants have collected their share and only $10,000 is left in the pool, then that is all the money you are going to get, even if your mechanics lien claim amount is worth, say, $50,000.
Potential mechanics lien claimants in California should keep this in mind, especially since the statutory laws generally favor them by allowing their lien claim to relate back to their first day of work, regardless of when the mechanics lien claim has been filed.
What date is used to establish lien priority for a mechanic’s lien in California?
Mechanics liens in California get lien priority based on the date in which the work has commenced. This could be the first day when the materials were delivered to the job site or the first day when labor has been performed on a project.
Under California Civil Code §8450(a):
“A [mechanics] lien…has priority over a lien, mortgage, deed of trust, or other encumbrance on the work of improvement or the real property on which the work of improvement is situated, that (1) attaches after commencement of the work of improvement or (2) was unrecorded at the commencement of the work of improvement and of which the claimant had no notice.”
So even if a deed of trust has been signed and filed before a mechanics lien has been recorded, the mechanics lien in California could get first priority so long as the work has been performed before the other liens have been recorded and so long as the mechanics lien is valid.
Can a mechanics lien have higher priority over a mortgage lien in California?
Yes, it can. As stated in California Civil Code §8450(a), a mechanics lien can hold higher priority over other liens, including mortgage liens.
Say, in a hypothetical scenario, that a material supplier delivered materials to a residential property before the mortgage has been recorded. If the material supplier files a valid mechanics lien against the property and the owner defaults on the mortgage, the material supplier may get higher priority over the mortgage lender.
What is a super-priority mechanics lien in California?
The term “super-priority” is typically used to refer to the fact that mechanics liens in California can get higher priority over other types of liens. Super-priority essentially describes the capacity of a mechanics lien to be a first priority lien, even if it has been recorded later than the other liens.
However, note that the potential to skip ahead in the lien priority ranking does not necessarily mean that all mechanics liens in California are automatically valid. Even if a mechanics lien can be a first priority lien, the statutory rules and regulations on how to properly file a mechanics lien in California must still be followed for the lien to be considered enforceable.
What should I do to ensure higher lien priority in California?
Even if labor and materials have been furnished to a project before other non-mechanics liens have been recorded, the mechanics lien will still not get priority if it has not been filed properly.
California is one of the states that require construction project participants to submit preliminary notices. Unless you are a general contractor in direct contact with the property owner, you must submit a preliminary notice to the owner, the general contractor, and the construction lender within 20 days after the first day of rendering service to the project.
The mechanics lien must also be filed within 90 days after work has been completed. Without serving the necessary notices and following the deadlines and other lien requirements, the mechanics lien will still be declared null and void and its lien priority will ultimately be pointless.
For the Preliminary Notice, here’s a checklist of the information that must be included:
- A – Name of the owner (or reputed owner*)
- B – Name of the contractor director and their address
- C – Name of the lender and their address, if any
- D – A general statement of the work provided
- E – A financial estimate of the price of total work provided
- F – The name and address of the person or entity who provided the work or materials
- G – The name and address of the person or entity to or for whom the work or materials is provided
- H -Description of the site for identification, including street address if possible
What happens to my lien priority if I don’t submit a preliminary notice?
Invalid mechanics lien equals no priority. There is after all nothing to prioritize if your mechanics lien claim is null and void to begin with.
Serving the preliminary notice in California must be one of the first items in your to-do list upon commencing work on a construction project. This preliminary notice must be served within the first 20 days after you begin your work.
If you missed the 20-day window, you can still file the notice at a later date. However, a late preliminary notice will only relate back 20 days prior to the day you finally submit this notice.
So if you submit your notice on January 1 and this date is past the deadline, your potential mechanics lien can only claim an amount that corresponds to the work you have performed in the last 20 days before January 1.