July 19, 2011

Construction projects are being foreclosed and sold for a fraction of their once-expected value. The money these sales yield often isn't enough to pay lenders and mechanics lien claimants in full. As a result, these parties frequently become rivals over what little money there is. In deciding who gets how much and when, priority is paramount.

In February 2011, the Illinois Supreme Court recently decided who has priority and to what assets that priority applies. Their decision: LaSalle Bank, N.A. v. Cypress Creek 1, LP.

It all started with a troubled senior living project. The developer borrowed approximately $8 million from its lender, LaSalle Bank, to buy land and construct the project. When the developer defaulted, the bank was still owed more than $3 million. The developer also underpaid Eagle Concrete and Egon Construction. These entities respectively recorded mechanics liens against the project for roughly $63,000 and $285,000.

Both the lender and the contractors foreclosed on the project. The lender then bought it at a sheriff's sale for $1.3 million—far less than the grand total owed of nearly $3.4 million. That left an important question for the Illinois Supreme Court: How should the $1.3 million be split?

Essentially agreeing with the lender's position on how to set priority, the court decided the following:

  1. The money would be split into two pots. One pot would represent the value of the project before any construction (the "unimproved land"): $1.36 million (40%). The second would represent the value that construction added to the project: nearly $2.1 million (60%). With two pots, there would be two queues of creditors to be paid—one before each pot.

  2. Because the lender's mortgage was recorded before either contractor had a contract for the project, the lender would get first priority and stand alone at the front of the first queue.

  3. The lender and the contractors would stand shoulder-to-shoulder at the front of the second queue. The contractors would move to the front of this queue because their own labor and material added value to the project. The lender would get there because its loan proceeds went to pay others who provided labor and material that added value to the project.

  4. The lender's and the contractors' respective shares of money from the second pot should be set in proportion to the value they each added to the project, whether from labor and material they themselves provided, or by paying another party that had provided labor or material and removing that entity from the list of those going unpaid (or at least reducing the amount that the third party was owed).

Applying this analysis and finding that nearly $1.6 million of loan proceeds went to pay for construction costs, the Illinois Supreme Court divided the second pot. Roughly 81% went to the lender, 15% to Eagle and 4% to Egon.

Following are important highlights for lenders, contractors and other mechanics lien claimants:

  • LaSalle Bank, N.A. v. Cypress Creek 1, LP effectively gives construction lenders the same priority position as contractors and other mechanics lien claimants when it comes to money in the second pot (i.e., money representing value that construction added to the project and, presumably, the price paid at the foreclosure sale).

  • This decision has aroused significant controversy. In fact, at least one bill has already been introduced in the Illinois General Assembly to amend the state's Mechanics Lien Act and change the result in future cases.

If you have questions about how this decision—and proposed legislation to overturn it—affects your business and how you can respond to protect your interests, contact your Much Shelist attorney or a member of the firm's Construction Law practice.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.