Arizona Court of Appeals Rules Equitable Subrogation Doctrine No Longer Available in Mechanics Lien Priority Disputes
Commercial Litigation Law Alert 12/17/13 Edward Salanga
In Weitz Company, L.L.C. v. Heth, et al, No. 1 CA-CV 11-0788 (Ariz. Ct. App. Div. 1, Nov. 26, 2013), the Arizona Court of Appeals joined a handful of other jurisdictions in holding that the doctrine of equitable subrogation would not allow a subsequent lienholder to take a priority position over a mechanic’s lien.
First National Bank of Arizona provided a construction loan to Summit at Copper Square for the development of a 165-unit, mixed-use commercial and residential condominium project in downtown Phoenix, recording a deed of trust to secure Summit’s payment obligations. Summit later contracted with The Weitz Company, which served as the general contractor on the project. As the project neared completion, however, Summit still owed Weitz for billed work. Nevertheless, Summit began selling individual units in the project and applied the earnings toward its loan with First National. Commercial lenders provided financing for most of the unit sales.
Weitz complied with the statutory requirements in Arizona to obtain a mechanic’s lien on the project. After recording its lien, Weitz filed a complaint seeking to foreclose its lien and named as defendants the unit owners and the lenders who provided the funds used to finance the purchases of the units. Weitz argued that its mechanic’s lien was superior to the lenders’ security interests, based on Arizona’s mechanic’s lien statute: A.R.S. § 33-981, et seq. The lenders argued that they were equitably subrogated to the first lien position held by First National because the financing provided by the lenders was used to payoff Summit’s loan with First National. It seemed the lenders were on solid legal ground, based on prior decisions of the Arizona Court of Appeals, but the Court of Appeals in Weitz ended up rejecting its earlier rulings and sided with Weitz.
The Weitz court focused on the language of A.R.S. § 33-981, et seq., which governs mechanic’s liens in Arizona and provides that every person or company who provides labor or materials in connection with the construction of any building has a lien on the building for the work performed or materials supplied, provided that the potential lienholder complies with the procedures listed in the statute. The statute gives priority to mechanic’s liens over “all liens, mortgages, or other encumbrances upon the property attaching subsequent to the time the labor was commenced or the materials were commenced to be furnished.” Id.
Prior to Weitz, the Arizona Court of Appeals had allowed subsequent lienholders to “leapfrog” mechanic’s liens (thereby assuming a higher priority) through the doctrine of “equitable subrogation.” See Lamb Excavation, Inc. v. Chase Manhattan Mortgage Corp., 208 Ariz. 478, 95 P.3d 542 (App. 2004); Peterman-Donnelly Eng’rs & Contractors Corp. v. First Nat’l Bank of Ariz., 2 Ariz. App. 321, 408 P.2d 841 (1965).Equitable subrogation “allows one who fully performs an obligation of another, secured by a mortgage, to become by subrogation the owner of the obligation and the mortgage . . . .” Weitz, at 7. In other words, a creditor who paid off the debtor’s first loan could step into the shoes of the first creditor, despite the recording of an intervening mechanic’s lien.
Relying on the language of A.R.S. § 33-981 and decisions from Alabama, Indiana, Nevada, Utah, and Wyoming, the Arizona Court of Appeals in Weitz overruled its prior decisions in Lamb Excavation and Peterman-Donnelly, which allowed subsequent lienholders to take priority over mechanic’s lien claimants based on the doctrine of equitable subrogation.
What This Means for Lenders
For now, this latest pronouncement of the Court of Appeals will control the issue in Arizona, at least until the Arizona Supreme Court provides its view on the issue. Until then, lenders (and their title companies) will need to be extra diligent in confirming that the property being purchased (or built) by their borrowers is not subject to any mechanic’s liens because the doctrine of equitable subrogation won’t allow them to “leapfrog” ahead of an intervening mechanics liens.
If you have questions concerning Arizona mechanics lien issues, please contact Edward A. Salanga at (602) 229-5422 / [email protected], or your Quarles & Brady attorney.