On Febr. 25, 2011 a divided Illinois Supreme Court decided an important case impacting the priority of mechanics lien holders and construction loan lenders when the proceeds of a foreclosure sale are not sufficient to satisfy all claims. The majority opinion, delivered by Justice Garman, was joined by Chief Justice Kilbride and by Justices Thomas, Karmeier and Theis, with Justices Freeman and Burke dissenting. The Court’s decision in LaSalle Bank National Association v. Cypress Creek 1, LLP, 242 Ill.2d 231, 950 NE2d 1109, 351 Ill.Dec. 281 (Ill. 2011) has been hailed by lenders as a reasonable interpretation of Section 16 of the Mechanic’s Lien Act (770 ILCS 60116) that recognizes the value of lenders’ contributions to improvements to the foreclosed property through construction loan disbursements. However, contractors and material suppliers have decried the decision for giving equal standing to unperfected liens and putting those who have recorded their mechanics liens on the same footing in terms of priority as construction loan lenders, and in practice making more money available to reimburse lenders at the expense of mechanics lien claimants. They assert that the decision rejects over 170 years of mechanics lien law precedent in Illinois. Now the Illinois General Assembly has passed House Bill 3636, which if signed by Gov. Pat Quinn, will overturn Cypress Creek. On Jan. 11, 2013, the bill passed the House of Representatives and was forwarded to the Governor, having previously passed the Illinois Senate. Not surprisingly, lenders do not want the bill to become law, while those who oppose Cypress Creek contend that the bill merely restores the prior status quo. The basic facts and procedural posture of the Cypress Creek case are as follows. LaSalle Bank made a construction loan to Cypress Creek, LLP for the development of over 13 acres of land in Bolingbrook, Ill. Cypress Creek hired Eagle Concrete and Edon Construction to perform work. LaSalle funded a total of eight construction draws before June 2005. Not all of LaSalle’s payments were made on perfected mechanics liens. In July 2005 LaSalle filed a foreclosure action after determining that there were insufficient funds to finish the project. In November 2005 Eagle Concrete and Edon Construction recorded their mechanics liens and eventually their foreclosure actions were consolidated with LaSalle’s foreclosure action. At trial the court came up with a formula for distributing the funds that were not sufficient to satisfy all of the claims in full. The mechanics lien claimants argued for priority of their liens over the mortgagee’s payments on the project. Instead, the trial court determined based upon the value of the property before and after improvements that 40% of the proceeds of the sheriff’s sale should go to LaSalle as the mortgagee, while 60% should be divided among those who had improved the land. The mechanics lien holders and LaSalle, which had made improvements by paying construction draws, were entitled to funds, regardless of whether or not LaSalle had paid on perfected mechanics liens. On appeal the lien holders again claimed they should have priority over the mortgagee for the funds attributable to improvements to the property. In a divided opinion the appellate court affirmed LaSalle’s priority to those foreclosure sale proceeds attributable to the value of the unimproved land (40% under the trial court’s formula), but held that LaSalle had priority to be paid for improvements only to the extent it paid on perfected mechanics liens. An appeal to the Illinois Supreme Court followed. The Cypress Creek Court framed the issue before it and summarize the lower courts’ decisions as follows: “The issue in this case is how to distribute foreclosure sale proceeds between a mortgagee and mechanics lien claimants when the mortgage predated the liens, the foreclosure sale proceeds are insufficient to satisfy all claims, and the mortgagee has paid for several improvements to the property through construction loan disbursements under Section 16 of the Mechanics Lien Act. The circuit court of Will County subrogated the mortgagee and gave it priority with respect to those improvements for which it paid, and gave the mechanics lien claimants priority with respect to the value of their individual improvements. The appellate court reversed, holding that the mortgagee was entitled to subrogation for payment of perfected mechanics liens, but that the value of those improvements paid for by the mortgagee where no lien was filed and perfected was to be first applied to the satisfaction of the mechanics liens.” In reversing the Third District Appellate Court’s decision, the Illinois Supreme Court determined that the Mechanics Lien Act clearly and unambiguously prioritizes lien creditors only to the value of their improvements and the prior encumbrancer (mortgagee) to the value of the land at the time the contract with the lien holder was made. The Court specifically rejected an interpretation of the act that would give a mechanics lien creditor priority to the added value of all improvements, not just the improvements for which he himself was responsible for adding to the property and which form the basis for the lien. Further the Court noted that its interpretation on this point was consistent with both the purpose of the act and the practicalities of construction lending. “By giving lien holders priority only with respect to their improvements, the act protects both the contractors and the prior encumbrancers.” To hold otherwise would unjustly enrich the lien claimants to the detriment of an owner or mortgagee who funded improvements other than those that form the basis for the liens. In other words, the act does not require that the payment for improvements by the mortgagee be for perfected liens for the mortgagee to have priority to payments from the foreclosure sale. The Court agreed with LaSalle that such a requirement would lead to lenders requiring perfected mechanics liens before paying construction loan draws, greatly complicating the process, and increasing paperwork. Such an approach would also result in multiple mechanics liens being recorded on every project, thus defeating one of the primary reasons for recording liens on “troubled” projects. The House bill seeks to amend Section 16 of the Mechanics Lien Act to specifically undo the Illinois Supreme Court’s statutory construction of the act concerning payments for improvements made to the property. Under the bill those with protected mechanics liens have a paramount lien, and the value of the lien is determined with respect to all subsequent improvements, not just as to the value of their individual improvement. The significant portion of the proposed amendment reads:
“When the proceeds of a sale are insufficient to satisfy the claims of both previous encumbrancers and lien creditors, the proceeds of the sale shall be distributed as follows: (i) any previous encumbrancers shall have a paramount lien in the portion of the proceeds attributable to the value of the land at the time of making of the contract for improvements; and (ii) any lien creditors shall have a paramount lien in the portion of the proceeds attributable to the value of all subsequent improvements to the property.”
The Cypress Creek decision led some commentators, as well as some in the construction industry and the Illinois legislature, to declare that the mechanics lien was dead in Illinois. If that is true, House Bill 3636 only awaits Gov. Quinn’s assent to bring the mechanics lien back to life.