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Construction Lenders Cannot Circumvent Stop Payment Notices

Construction Lenders Cannot Circumvent Stop Payment Notices – Jonathan H. Finke

 

Point Center Financial, Inc., served as a construction lender for a condominium project in San Diego, California. Included in lender’s construction funds were loans obtained from third-party investors, from which lender prepaid itself interest, loan underwriting and other fees totaling over $1.5 million.

 

Brewer Corporation provided labor and materials to the project, and in June of 2007, served on lender a bonded stop notice after the project’s developer went bankrupt. Prior to California enacting stop-notice laws, a contractor who filed a mechanics’ lien against a party for failure to pay still ran the risk of inability to collect due to bankruptcy or lack of assets. Mechanics’ liens lost effectiveness when lenders began recording construction loan trust deeds before construction began. Stop-notice laws were created to provide a more secure position to one who provides services to a construction project, by forcing lenders to retain funds upon receipt of notice of failure to pay. Here, although holding sufficient unexpended construction loan funds to cover Brewer’s claim, lender failed to withhold any funds, eventually disbursing all monies in the construction loan fund.

 

As a result, Brewer and three other contractors filed suit, claiming they were entitled to the construction funds lender prepaid itself, regardless that such payments were made prior to the stop notices being served. The court agreed, holding that a construction lender must make available to stop notice claimants those amounts from the construction loan that lender has already disbursed to itself, as such a disbursement of funds constitutes an improper “assignment” of the funds under California Civil Code Section 3166 (current Section 8544). In reaching its decision, the court cited Familian Corp. v. Imperial Bank (1989) 213 Cal.App.3d 681, 686-87, which held that preallocation of construction loan funds and periodic disbursements to the lender are assignments and therefore do not take priority over stop notice claims. The Court of Appeal affirmed.

 

This case strengthens the rights of stop notice claimants by preventing construction lenders from attempting to elude their stop payment obligations at the cost of the contractors actually performing the work on the project for which the loan was created. The court admonished Point Center, stating that a lender cannot avoid such stop notice payments through wily accounting methods, nor does it matter whether the assignment is made before or after a stop notice is served, whether or not the lender made money on the project, or whether the funds were earned or unearned by the lender. While nothing in the court’s ruling prohibited such pre-allocation or prepayments by the lender, the statutory scheme is intended to protect those entitled to stop payment notices, and contractors who improved the property will have a superior right to the funds.

 

Brewer Corporation v. Point Center Financial, Inc. (2014) 223 Cal.App.4th 831