In Carmel Development Co., Inc. v. Anderson, 48 Cal.App.5th 492 (2020), Carmel Development Company, Inc. (“Carmel”) agreed under an oral contract with Monterra LLC to provided design and construction work to create a luxury subdivision called Monterra over 10+ years. Monterra LLC was unable to pay so Carmel recorded two liens to collect the unpaid obligations. The water lien burdened only the 85 unsold lots, but the work benefited all 170 lots. The site improvement lien burdened only lots in Phases 7 and 9, because they were the only lots benefited by that work.
Carmel sued several of Monterra LLC’s investors with property interests in unsold lots, alleging causes of action for breach of contract and foreclosure of the liens. After a long bench trial, the trial court validated the water and site improvement liens. Defendants appealed.
- Maximizing Lien Amounts
Defendants challenged whether Carmel appropriately applied Monterra LLC’s prior payments to satisfy the correct obligations. California Civil Code section 1479 provides the following framework on how to apply a debtor’s payments which could be applied to multiple obligations:
- At the time of payment, if the debtor communicates that he/she intends or desires that a payment be applied to a particular obligation, then the creditor must apply the payment as instructed. (, subd. One.)
- If the debtor does not instruct the creditor regarding how the payment should be applied, then within a “reasonable time” after the payment the creditor may apply it toward any obligation due for payment. (, subd. Two.)
- If neither party applies the payment to a particular obligation, the creditor must apply the payment to the obligations in the following order: (1) interest due at the time of performance, (2) principal due at the time of performance, (3) the obligation earliest in date of maturity, (4) an obligation not secured by a lien or collateral, and (5) finally to any obligation secured by a lien or collateral. (, subd. Three.)
Monterra LLC made undesignated payments “on account,” which means Monterra never designated its payments to any specific invoice or category of work. The Court of Appeal held that Carmel applied Monterra LLC’s payments to specific categories of work when it prepared the two liens. Also, Carmel applied the payments within a reasonable time because the applications were made before Carmel filed suit. Therefore, Carmel correctly maximized their lien amounts by selecting which obligations to include in the liens and which to consider paid by prior payments.
- Substantial Evidence Determines Lien Allocation
Defendant argued the water and site improvement liens were not allocated to the correct lots. The California Supreme Court has observed that the “question is not so much as to the amount to land required for the area to be occupied by the [improvements], but rather as to the amount of land to be improved or benefitted by the creation and used of the [improvements].” (California Cor. Culvert Co. v. Stewart (1934) 220 Cal. 104, 106–107.)
In a matter of first impression, the Court determined that the substantial evidence standard of review should be used to decide the amount of land associated with a mechanic’s lien, because this issue requires a trial court to resolve disputed evidence and make factual findings.
- Water Lien Work Benefited All Lots, Not Just the Unsold Lots
The Court held that the water lien’s improvements were designed to serve and benefit all 170 lots in Monterra and the allocation of liability for this lien to the 85 unsold lots was incorrect (i.e., the lien liability for each of the 85 unsold lots in the water lien should be a proportional share based on all 170 lots, rather than the lien liability divided by just the 85 unsold lots).
- Site Improvement Lien Work Benefited Only the Lots in Phases Seven and Nine
The Court of Appeal agreed that attaching the site improvement lien only to the lots in phase seven and nine rather than all of the lots in Monterra was correct because the site improvement lien “involved building … infrastructure serving only the lots in phases seven and nine,” which were the only lots included in this lien.
- No Contractual Interest Allowed in the Liens
Defendants argued that the trial court incorrectly included contractual interest in the water and site improvement liens. The Court agreed and explained that the amount of a mechanic’s lien is the lesser of: (1) the reasonable value of the work provided, or (2) the contract price. (See former Cal. Civ. Code section 3123 (current section 8430).)
The Court held that the contractual interest was improperly included in the liens, because the contractual interest did not add “value to the liened work” but it was just a way of compensating Carmel for Monterra LLC’s untimely payments.
- Prejudgment Interest
- Mechanic’s Liens are a Cause of Action in Contract Under Section 3287(b)
Defendant argued that Carmel should not be awarded prejudgment interest. Section 3287(b) provides prejudgment interest for damages in “a cause of action in contract.” The Court of Appeals took up the question of first impression of whether a mechanic’s lien foreclosure action is a cause of action in contract under section 3287(b).
The Court of Appeals held that “a mechanic’s lien foreclosure is sufficiently like a contract action to be considered a ‘cause of action in contract’ for purposes of section 3287(b).” Thus, Carmel could be awarded prejudgment interest in this action. Also, there was no abuse of discretion in awarding prejudgment interest.
- Finding the Proper Prejudgment Interest Rate
California Constitution Article XV, section 1 states that the “rate of interest upon the loan … shall be 7 percent per annum” unless the parties “contract in writing for a rate of interest.” Section 3289(b) provides a 10 percent per annum interest rate for breaches of contract if a contract does not stipulate a legal rate of interest.
The Court of Appeals held that the investor defendants “owed prejudgment interest by operation of the mechanic’s lien laws and not because they breached a contract.” Therefore, the 7 percent prejudgment interest rate under Article XV, section1 should be applied. The Court of Appeals recognized their apparent inconsistency and explained that although a mechanic’s lien is a cause of action in contract under section 3287(b), section 3289 did not apply because there was no contract between Carmel and the investors so there could be no breach of contract.
Carmel provides insight into some of the nuances of mechanics lien law. Carmel is a reminder that in the absence of a payment designation, contractors may apply the payment to preserve their lien. It is a cautionary tale to contractors to carefully consider the extent to which the improvements provided a benefit to which land when recording a mechanic’s lien.
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Luke Landers is an associate in the Westlake office of Gibbs Giden where he represents clients in the areas of construction claims and litigation in addition to business and commercial transactions.
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