Non-payment can place contractors, subcontractors, and suppliers in a precarious cash-flow situation. On most jobs, they outlay their capital and hard work in advance of payment by the owner. They rely on the owner to pay the correct amount at the time provided in the agreement. When private owners fail to pay, contractors, subcontractors, and some suppliers can generally resort to filing liens to encourage payment. As one case illustrates, liens do not always provide adequate security of payment.
Liens are statutory creations that may be filed against an owner’s property interest, as long as the lien claimant strictly complies with the lien law. However, in some instances, even if the claimant does everything correctly, the lien will not overcome a previously filed lien or security interest.
A recent opinion by the Georgia Court of Appeals addressed the issue of priority in connection with a contractor’s lien. To purchase property, Owner obtained a loan and gave a bank a security interest in the property. Owner hired Contractor to perform work on the property. After Contractor performed the work, and when Owner had trouble paying off the bank loan, Owner and a bank executed a modification agreement for security deed, but did not file the modification agreement. The “modified” security deed provided that the bank would be entitled to additional amounts (“Foreclosure Costs”) if Owner defaulted on the bank loan.
After Owner failed to pay for Contractor’s work, Contractor filed a lien on the property. Shortly thereafter, Owner failed to pay on the bank loan, and the bank then foreclosed on the property and attempted to sell it at auction. When no third parties bid on the property, the bank acquired it via a bid credit at less than the amount owed on the bank loan.
Contractor believed that the property’s fair market value was higher than the bank’s purchase price, and that the excess value should have been applied toward Contractor’s lien. The bank responded that any excess value was eliminated by Foreclosure Costs, which were recoverable pursuant to the unrecorded modification agreement. Contractor disagreed and filed suit against the bank to recover the disputed excess.
Priority of Liens Vis-a-Vis Security Deeds
In general, a “bona fide holder of a security deed executed before the first material was furnished, and therefore necessarily prior to the recording of the materialman’s claim of lien, will take priority of the lien, even if the security deed itself was not recorded until after the first material was supplied.”
In this case, Contractor did not dispute that the original security deed was filed before it worked on the project. Contractor argued, however, that the “modified” security deed should not have priority over its lien, in part, because it was never filed in the property records.
“Modified” Security Deed Does Not Lose Priority Vis-a-Vis Contractor’s Lien
The court disagreed with Contractor and ruled that the “modified” security deed still had priority over Contractor’s lien. The court reasoned that a security deed may be modified without affecting its priority where it is merely modified, not cancelled. In this case, the security deed was merely modified. The court further held that the failure to file the modification agreement did not affect its superior priority. As a result, the modified security deed kept its priority over Contractor’s lien. And the bank’s entitlement to Foreclosure Costs (as permitted by the modification agreement) eliminated any excess to which Contractor otherwise would have been entitled.
The case illustrates that contractors, subcontractors, and suppliers cannot always depend on liens against property to recover payment from the owner. Even if a lien claimant jumps through all the hoops, it still may find itself behind a bank with a superior interest in the property. Accordingly, before performing substantial work or providing expensive materials, it is advisable to check the property records for any existing security interest or other liens on the property to be improved.
In addition, lien claimants should provide notice of beginning work to the owner and, if applicable, contractor by a statutory Notice to Contractor. Such a notice is not only required by the lien law, it would provide further evidence of the lien claimant’s beginning work on the project, which is necessary to establish the lien claimant’s priority.
Further, a potential claimant may also need to check whether a prior security interest has been modified by an unfiled modification agreement. As this case illustrates, such modification agreements could increase the prior claim amount — which would decrease the lien claimant’s possibility of recovery.