Illinois Governor Signs Law Affecting Priority of Mechanics Lien Claims on Distressed Projects

PDF
February 13, 2013
Matthew Horn
SmithAmundsen Construction Alert

Authors

Practice Areas

Subscribe

Yesterday was a good day for the construction industry in Illinois. Governor Quinn signed into law a bill that effectively overturned the Illinois Supreme Court’s 2011 decision, LaSalle Bank v. Cypress Creek, and in doing so, re-established the importance and value of a contractor’s mechanics lien rights.

In Cypress Creek, the Supreme Court stuck a major blow to the construction industry. The Court ruled that when the proceeds from the foreclosure sale of a derailed construction project are insufficient to satisfy all encumbrances on the property (mortgages, mechanics liens, etc.), the mortgage holder not only has priority to those sale proceeds attributed to the value of the land on the project, but also to the improvements constructed on the project by the contractors, which the mortgage holder’s loan proceeds were used to pay for.

This ruling diverted from earlier Illinois rulings on the issue, which typically held that the mortgage holder was entitled to priority for the sale proceeds attributed to the value of the land and the mechanics lien claimants were entitled to the sale proceeds attributed to the value of the improvements constructed on the property, whether paid for with the mortgage holder’s loan proceeds or not. The bill signed into law yesterday codified the rule typically employed by the Illinois courts prior to the Cypress Creek decision, much to the chagrin of the financial industry.

For example:

A mortgage holder has a $2,000,000 mortgage on a project, and the land is worth $2,000,000. Contractor 1 has completed $1,000,000 worth of work on the project, has not been paid, and has a $1,000,000 mechanics lien on the project. Contractor 2 has completed $1,000,000 worth of work on the project, and has been paid with loan proceeds secured by mortgage holder’s mortgage. The improvements constructed on the project are worth $2,000,000 total. That is to say that the value of the land on the project is 50% of the total project value, and the value of the improvements on the project are 50% of the total project value.

If the project goes to foreclosure sale, and is sold for $3,000,000, the mortgage holder receives $2,000,000 for its mortgage and Contractor 1 receives $1,000,000 for its mechanics lien. However, if the project goes to foreclosure sale, and is sold for $2,000,000 (not enough to satisfy mortgage holder’s mortgage and Contractor 1’s mechanics lien claim), then under the Cypress Creek decision, the mortgage holder would receive $1,000,000 for the land plus $500,000 for Contractor 2’s improvements which mortgage holder’s loan proceeds paid for, and Contractor 1 would only get $500,000 for its $1,000,000 mechanics lien. Under the bill signed into law yesterday, the mortgage holder would get $1,000,000 for the land, and Contractor 1 would get $1,000,000 for its $1,000,000 mechanics lien.