May 29, 2008

Ohio's Tenth Appellate District Addresses Priority Between Mechanics’ Liens and Mortgages; Prejudgment Interest on Mechanics’ Liens

On May 20, 2008 the Tenth Appellate District Court of Appeals issued an opinion in Guernsey Bank v. Milano Sports Enterprises, LLC holding on several issues of priority between mortgages and mechanics’ liens as well as the application of prejudgment interest on mechanics’ liens. 

In the case, Joseph Milano purchased property containing an indoor tennis court which he sought to convert into an ice rink. Before purchasing the property, Milano entered into a lease agreement allowing the renovations to begin, and contracted with several companies to perform work or provide materials. The purchase of the property was financed through a mortgage note with Guernsey Bank, and all documents were recorded on July 10, 2003. Milano and his company, Milano Sports Enterprises, LLC were parties to this note. When the work and materials went unpaid, the contractors filed mechanics’ liens with the Recorder. 

On January 27, 2004 Guernsey filed a foreclosure action against the Milanos and their company, including as defendants all of the contractors that had recorded mechanics’ liens. Guenrsey prevailed at summary judgment and the property was foreclosed and sold by the Sheriff. Guernsey purchased it at the appraised value of $525,000. The lien-holding defendants moved for summary judgment against Guernsey, asserting the priority of their liens. Guernsey in turn filed summary judgment motions against each defendant. The trial court found for the lien-holders, granting them summary judgment and ruling their liens had priority over Guernsey’s mortgage. Prejudgment interest was included in the amounts awarded. Guernsey’s motion for summary judgment was denied.

On appeal, Guernsey challenged the validity and priority of the liens, and the awarding of prejudgment interest. Guernsey challenged the validity of one lien as it did not correctly state the amount due. However, as the party moving for summary judgment, Guernsey bore the burden of producing evidence that the amount was incorrect. In the absence of evidence, and based solely on Guernsey’s conclusory statements, the Court affirmed the validity of the lien.

Guernsey attacked the validity of a lien based on the work described in the lien being outside the ambit of the lien-holder’s contract. However, the Court affirmed the validity of the lien, as the contract granted the company a broad mandate regarding electrical work.

As to priority, the Court held that mechanics liens under R.C. 1311.13(A)(1) may take effect before being recorded, while mortgages take effect upon their recording. Without a notice of commencement filed, the mechanics’ liens took effect from the “date the first visible work or labor [was] performed or the first materials [were] furnished.” The first work or delivery of materials occurred on June 16, 2003, almost a month before the recording of the mortgage. As such, all of the mechanics’ liens properly filed took effect on that date. The Court noted that R.C. 1311.13 requires courts to focus on the first visible work or delivery of materials as opposed to the results of actions taken on site. 

Guernsey also alleged that its mortgage fell under R.C. 1311.14, the construction mortgage statute. This statute creates an exception to the general rule that a mortgage is subordinate to mechanics’ liens with an effective date prior to the mortgage’s recording. Under the statute, a mortgage used to finance improvements or pay off prior encumbrances has priority over mechanics’ liens. Guernsey’s mortgage had been used to pay off a prior mortgage on the property. In support of this fact, Guernsey provided a settlement statement. The trial court ruled this evidence inadmissible, and as such, the Court could not consider it. The priority of the liens was affirmed.

Finally, Guernsey challenged the application of prejudgment interest to the award. Following established precedent, the Court stated the nature of a mechanics’ lien is that it arises from law and not from a written instrument or verbal contract, precluding the availability of prejudgment interest. 

The Guernsey holding may not break new legal ground, but highlights the importance of basic procedures regarding mortgages. Early recording of the mortgage, alongside keen attention to detail regarding work being performed or materials delivered to the property can become deciding issues regarding priority between a mortgage and a mechanic’s lien. Recordkeeping and evidentiary issues are highlighted, as Guernsey may have prevailed had it submitted proof of the actual amount due on one of the liens. Further, if Guernsey had proven that its mortgage was a construction mortgage it may have defeated the mechanics’ lien priority. These important considerations can make the difference between the collection of an unburdened mortgage or one affected by mechanics’ liens.

This E-alert was prepared by Francisco Luttecke. Please contact any member of the Bricker & Eckler Creditor Rights & Bankruptcy group for more information.