Construction Law Update: Iowa Supreme Court Decision Creates Mechanic's Lien Risks For Contractors
On April 12, 2019, the Iowa Supreme Court issued a decision that creates significant mechanic’s lien risks for contractors (and their subcontractors and suppliers) who perform work on projects for lessees. In Winger Contracting Co. v. Cargill Inc., 2019 WL 1574672 (Iowa 2019), the Court held that subcontractors performing work on a lessee-owned construction project could not lien the lessor’s property, and that the lessor’s construction mortgage lien against the lessee’s leasehold interest and property trumped the mechanic’s liens. This case should serve as a warning to all of those performing work on lessee-owned construction projects that their mechanic's lien rights may be significantly curtailed.
Cargill owns land in Eddyville, Iowa. It entered into a fifty-year lease with HF Chlor-Alkali, LLC (“HFCA”) which allowed HFCA to construct a chlor-alkali manufacturing facility and other improvements on Cargill's Eddyville land; Cargill would continue to own the land while HFCA would own the chlor-alkali facility. The lease also required Cargill to purchase and HFCA to supply a long-term supply of chemicals used by Cargill at its processing facilities, and required Cargill to process, treat and sell water that HFCA needed to produce the chemicals at the facility.
To finance construction of the facility, Cargill assisted HFCA in obtaining $80 million in bond financing through the Iowa Finance Authority, and HFCA also obtained at least $40 million in financing from a Cargill subsidiary. U.S. Bank issued a letter of credit guaranteeing the $80 million payment to the bond trustee, and HFCA agreed to reimburse U.S. Bank for payments made under the letter of credit. HFCA also delivered to U.S. Bank a leasehold mortgage which granted U.S. Bank a first priority leasehold mortgage lien and security interest that encumbered all of HFCA’s rights in the leasehold estate and the facility. A condition to U.S. Bank issuing the letter of credit guaranteeing payment to the bond trustee was Cargill’s agreement to purchase the rights and obligations of U.S. Bank in the event HFCA defaulted; this condition is described as a “put agreement.” In July 2016, U.S. Bank declared HFCA in default thereby causing the bond trustee to declare about $80 million under the bond financing due immediately. U.S. Bank paid off the bond under the letter of credit, and then it demanded Cargill pay it the $80 million under the “put agreement.” Cargill made the payment to U.S. Bank who then transferred to Cargill all of U.S. Bank’s right, title and interest in and to the construction mortgage related to HFAC’s leasehold interest and property.
HFCA had entered into contracts with two general contractors, who in turn had entered into subcontracts with various subcontractors, including Winger, PCI, Tri-City Electric, TAI Specialty, and American Piping. When the project fell apart, contractors and subcontractors were not paid in full, so mechanic’s liens and lawsuits were filed. The district court held that the mechanic’s liens attached only to HFCA's leasehold interest and property, but not to Cargill’s property, and that Cargill’s mortgage and security interest against HFCA’s leasehold interest and other property was superior and prior to the mechanic’s liens. The Iowa Supreme Court agreed with the district court. The result was that Winger and the other subcontractors did not receive any money on their mechanic’s liens.
On the issue of whether the mechanic’s liens attached to Cargill’s property, the Court noted that “[g]enerally, the mere existence of a contract with a lessee does not give rise to a mechanic’s lien against the property of the lessor,” and that “ordinarily, mere knowledge or consent to the making of improvements d[oes] not subject the interest of the owner to a mechanic’s lien.” The Court recognized, however, that an exception to the general rule of lessor non-lienability existed under Iowa’s mechanic’s lien statute at Iowa Code Chapter 572 “if the lessor has by express or implied agreement contracted for the improvement of his real property, [then] the mechanic’s lien attaches to the property of the owner”; it noted that “such express or implied agreement particularly arose in situations where the building or improvements became the property of the lessor after a comparatively short term,” and that in such situations “the lessee is considered to be the agent of the lessor within the meaning of Iowa Code Section 572.2.” The Court noted, however, that the exception was based on statutory language in the mechanic’s lien statute that existed before the legislature’s recent 2012 amendments to the statute.
The Court explained that in the 2012 amendments to Iowa Code Section 572.2(1), the legislature removed contracts with the “owner’s agent” as giving rise to mechanic’s liens on the property of the owner, and that the amendments also removed the term “owner’s agent” from other provisions of Chapter 572. Additionally, the amendments limited and narrowed the definition of “owner” at Iowa Code Section 572.1(8); before the amendments, the statute had defined “owner” as the “the record titleholder” and “every person for whose use or benefit any . . . improvement is made.” The amendments deleted that latter language so that the definition of “owner” is now limited to the “legal or equitable titleholder of record.” The Court ruled that the 2012 amendments eliminated the exception to the general rule of lessor non-lienability. Therefore, Winger’s and the other subcontractors’ mechanic’s liens did not attach to Cargill’s property; they attached only to HFCA’s leasehold interest and property.
On the priority dispute, the Court held that Cargill’s mortgage and security interest trumped the mechanic’s liens. The Court recognized the general rule that in certain circumstances, “when an owner of land in fee simple acquires a leasehold interest in property, the interests merge” thereby extinguishing the leasehold interest. However, it concluded that no merger occurred with respect to Cargill because it did not acquire HFCA’s leasehold interest but rather only acquired U.S. Bank’s interest in a construction mortgage against HFCA’s leasehold interest.
Although this is a bad decision for contractors, subcontractors and suppliers, there is one issue the Court did not address which could potentially help contractors, subcontractors, and suppliers facing similar issues in the future. Iowa Code Section 572.2(1) reads,
1. Every person who furnishes any material or labor for, or performs any labor upon, any building or land for improvement, alteration, or repair thereof, including those engaged in the construction or repair of any work of internal or external improvement, and those engaged in grading, sodding, installing nursery stock, landscaping, sidewalk building, fencing on any land or lot, by virtue of any contract with the owner, owner-builder, general contractor, or subcontractor shall have a lien upon such building or improvement, and land belonging to the owner on which the same is situated or upon the land or lot so graded, landscaped, fenced, or otherwise improved, altered, or repaired, to secure payment for the material or labor furnished or labor performed.” (emphasis added).
On appeal, Winger and the other subcontractors argued that despite the 2012 amendments, their mechanic's liens still attached to Cargill’s property under the emphasized language above. The Iowa Supreme Court refused to consider the argument because it concluded that Winger and the subcontractors had not properly raised the argument before the district court. Therefore, any contractor, subcontractor, or supplier who has a similar mechanic’s lien dispute in the future should be sure to make this argument before the courts.
For more information on this and other mechanic's lien issues, contact Steve Marso at 515-288-6041.