Illinois Trial Court Finds Mechanic’s Liens Subordinate to Bank’s Lien

Introduction

In February, in REEF-PCG, LLC v. 747 Properties, LLC et al. ("747 Properties"), the Circuit Court of Du Page County, Illinois, effectively subordinated $15 million in perfected mechanic’s liens to a $12 million new loan earmarked to fund tenant buildouts for the General Services Administration (GSA). At the end of June, the Appellate Court in the Second District reversed that decision, based on the lack of a sufficient record justifying the subordination of the liens. One of the lien claimants is now seeking relief from the Illinois Supreme Court, arguing that the trial court did not have the authority to subordinate the lien claimants’ interests. 

This case bears on the rights of contractors, suppliers, and lenders regarding lien priorities, including any risk of lien re-prioritization.

Background

747 Properties, LLC (“Borrower”) financed the purchase and remodeling of a four-story office building by taking on a $16.9 million mortgage with various lenders, who named REEF-PCG, LLC as Lenders’ agent. Borrower then leased two floors of the building to Pomeroy IT Sales, and the other two floors to the GSA. Pomeroy IT Sales hired a general contractor and various subcontractors to complete approximately $15 million in repairs. After Pomeroy IT Sales allegedly breached its lease, Borrower defaulted on payment obligations to Lenders and the general contractor. Unpaid subcontractors filed mechanic’s liens. During this time, Borrower agreed to complete over $8 million in tenant buildouts for the GSA, which was to be repaid by the GSA over the term of its 10-year lease. The buildouts never commenced, and the GSA’s two floors are vacant.

Following Borrower’s alleged defaults under the loan agreements and citing the attachment of the mechanic’s liens on the property, REEF-PCG, LLC filed a mortgage foreclosure action against Borrower, naming the mechanic’s lien claimants as additional defendants, and seeking the appointment of a receiver over the property, as provided for in the loan documents. After Receiver was appointed, Receiver and REEF-PCG, LLC filed a joint motion seeking court approval for a $12 million new loan to be evidenced by Receiver Certificates, which would have priority over all prior encumbrances, including the mechanic’s liens and the mortgage.

Trial Court’s Decision

The trial court granted Receiver / REEF-PCG, LLC’s joint motion, determining that such a loan was both in the best interests of all the parties and necessary to preserve the property. In justifying its decision, the court voiced its beliefs that (1) without the new loan, the property would certainly lose the GSA as a lessee, which was the best possible lessee under the circumstances; (2) litigating the issue of enhancement for the mechanic’s lien claimants would take at least a month and provide them at most 30 cents on the dollar; and (3) Receiver would be required to use its best efforts in the marketplace to find loan terms that are more favorable to receivership property.

On Appeal

In reversing the trial court’s decision, the Appellate Court in the Second District acknowledged that a trial court has the power to authorize Receiver to issue super-priority Receivership Certificates and to subordinate mechanic's lien claimants’ interests under applicable Illinois statutes. However, the Appellate Court found that in this case, there was no evidence in the record to support the trial court’s decision that the new super-priority loan was necessary to preserve the property, or that it was in the best interests of all involved. The Appellate Court remanded the case back to the trial court for it to take evidence on issues such as the current and post-buildout value of the building and the value of the building with the GSA as a tenant versus without the GSA as a tenant, additional appraisals, estimates, and expert testimony. 

On July 30, 2020, one of the subcontractors filed a petition for leave to appeal the Second District’s decision to the Illinois Supreme Court. The subcontractor argues that in subordinating its lien interest to a new loan, the trial court violated 770 ILCS 60/16, which states:

No incumbrance upon land, created before or after the making of the contract for improvements under the provisions of this act, shall operate upon the building erected, or materials furnished until a lien in favor of the persons having done work or furnished material (hereinafter "lien creditor") shall have been satisfied.

Moving Forward

747 Properties demonstrates that in extending financing or in agreeing to perform work or provide materials for a construction project, contractors, suppliers, and lenders should be aware of their rights regarding lien priority and of the various legal and financial strategies available to protect these rights. This knowledge is necessary for evaluating payment risk associated with a project and to properly price the work and loans. Attorneys at Lewis Rice have significant experience litigating lien priority issues. Please reach out to the Construction Law Team or the Lending Team at Lewis Rice with any questions or concerns related to these issues. You can also visit the Lewis Rice COVID-19 Resource Center for additional information and guidance related to the current environment.

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