California Civil Code § 3097 sets forth a subcontractor's
obligation to serve a 20-day preliminary notice on an owner and
a lender in order to maintain its "third-party rights," i.e.,
mechanic's lien rights and stop notice rights. Due to misinformation
or a lack of information, it is possible that a subcontractor may
serve its preliminary notice on a party other than the actual owner
or lender.
Depending on the circumstances, a subcontractor may still
have the ability to maintain its mechanic's lien or stop notice
claim
against the owner or the lender despite having failed to serve
its preliminary notice on the actual owner and/or lender. Section
3097
states that the preliminary notice must be served on the owner/lender
or reputed owner/lender.
The question arises: What qualifies as a reputed
owner or lender such that service of a preliminary notice on that
entity meets a subcontractors requirements under Section 3097?
The
California courts have addressed this question in a handful of
cases. In one case, Romak v. Prudential, a subcontractor had
served a timely preliminary notice on various parties, but failed
to serve the actual lender on the job. Prior to serving the preliminary
notice, the subcontractor had asked the general contractor whether
a construction loan would be obtained by the owner.
The general
contractor told the subcontractor that it was unsure at that
time whether a loan would be obtained. In the space on the preliminary
notice reserved for identifying the lender, the subcontractor wrote, "not
known." There was already a
lender on the job, however, and the lender had recorded its loan
with the county recorder at some time prior to the date that the
subcontractor's preliminary notice was sent to the subcontractor
and owner.
The subcontractor later served a stop notice on the lender and
then filed suit to enforce this stop notice (the general contractor
had filed for bankruptcy, and the lender had foreclosed on the property,
which defeated the subcontractor's contract claim and mechanic's
lien claim). The court held that the subcontractor had "constructive
notice" of the identity of the lender at the time it served
its preliminary notice due to its ability to research the construction
trust deed that had been recorded by the lender at the county recorder's
office.
The court held that the stop notice claim by the subcontractor
was invalid due to the failure by the subcontractor to serve
the lender with a preliminary notice. The court recognized that
mechanic's
lien and stop notice laws were created to protect a subcontractor's
ability to collect amounts owed to it, but also stated that a
lender on a job has a right to be made aware of potential stop
notice
claims. Under these circumstances, the subcontractor's
stop notice claim was held invalid.1
California courts have ruled in favor of a subcontractor on slightly
distinguishable circumstances, however. In Brown Co. v. Appellate
Dept., the court considered circumstances very similar to those
in the Romak case. In Brown Co., a subcontractor was given inaccurate
information by an employee of the general contractor as to the identity
of the owner and lender.
Relying on this misinformation,
the subcontractor served its preliminary notice on the parties described
by the employee. The subcontractor then recorded a mechanic's
lien and later sought to foreclose on its mechanic's lien in
court.
The actual owner had not been served with the preliminary notice,
however, and argued that the mechanic's lien claim therefore
must
fail. The court held that the preliminary
notice had been successfully served on a "reputed owner," thereby
meeting the preliminary notice requirements of California Civil
Code § 3097.2
What was the distinction between the situations in the Romak case
and the Brown Co. case? First, there is the distinction of one case
involving an owner and another involving a lender, but this distinction
was not relevant as between these two circumstances - the same general
notice standard applies to owners and lenders. In each of these
two circumstances, the subcontractor failed to serve a preliminary
notice on the actual owner/lender.
The distinction
appears to be within the state of mind of the subcontractor. In
the Romak case, the subcontractor was told by an employee of
the
general contractor that it was not clear whether the owner would
be obtaining a construction loan. In the Brown Co. case, the
subcontractor was told (by what the court concluded was
a source whose reliability the subcontractor could trust) of the owner's identity, even though this information was incorrect.3
The
court in the Brown Co. case noted the Romak ruling and stated
that it was unreasonable for the subcontractor
in the Romak case to halt its inquiry into the lender's identity
upon hearing only that the general contractor was unsure if a
construction loan was obtained or would be obtained by the owner.
The Brown Co. court then distinguished the subcontractor within
its
own case and pointed out that the subcontractor had reasonably
relied
on what amounted to be a trustworthy source.
These cases were expanded upon in the case of Kodiak Industries
v. Ellis. In the Kodiak case, the court considered a subcontractor
that diligently investigated whether a lender existed on the subject
job at the time it was commencing its work on the job. This investigation
took place at some time after the subcontractor had begun work on
the job but within twenty days after the subcontractor had begun
work.
After diligently researching the county recorder's office
and finding no loans recorded, the subcontractor served its preliminary
notice on the owner within twenty days of beginning work on the
job. There was a lender on the job, however, but because
the lender recorded its loan after the subcontractor had researched
the property at the recorder's office, the subcontractor was not
aware of the loan at the time it served its preliminary notice.
The subcontractor then served a stop notice on the lender and
sought to enforce its stop notice in court.
In court, the lender argued
that the subcontractor had failed to serve a preliminary notice
and therefore the subcontractor was
precluded from recovering on its stop notice claim. The court
confirmed the holding in Romak that a subcontractor was responsible
to investigate
the existence of a loan with the county recorder. However, the
court
clarified that a subcontractor need inquire into these title
records only one time between the day it first begins work on the
job and
its twentieth day on the job, and that once
the subcontractor has checked with the county during this time period,
it has no obligation to investigate again.
The court addressed the rules pronounced in the Romak and Brown
Co. case, and while it did not actually set forth a clear rule,
it suggested strongly that the standard to be applied was one of
good faith. Specifically, the court implied
that the question to be asked was whether the subcontractor's belief
as to the identity of the lender or owner was both reasonable and
in good faith. The court noted that efforts expended by
a subcontractor to research the identify of an owner or lender
were
a factor in favor of a subcontractor, but that the
end test depended on the state of mind of the subcontractor.4
So,
the good news for a subcontractor is that California law does
not always require that a preliminary notice be sent to the true
owner or lender on a job. The bad news is that there is no precise
rule that can be easily applied to any particular set of facts.
Any case that goes to trial will likely be decided according
to
the answer to this broad, ambiguous question: Did
the subcontractor believe that the party to whom it sent its preliminary
notice was the actual owner/lender, and, if so, was this belief
both reasonable and in good faith? A trial court will
have broad discretion to address the issues of fact raised by
this standard.
While the above-described case law may allow, in some instances,
a subcontractor to retain its mechanic's lien and stop notice rights
despite its failure to serve a preliminary notice on the actual
owner or lender, it would be ill-advised for
a subcontractor to do anything other than aggressively investigate
the actual owner and lender on any job.
It appears that while
courts are willing to protect a subcontractor in some instances,
those instances will likely be limited to the situations in which
the subcontractor has made more than a passing effort to identify
the true owner and lender and honestly believes that the parties
to whom it sent its preliminary notice are the actual owner
and/or
lender. Therefore, while a subcontractor should
be aware of the above-cited law, the subcontractor should never
assume that its stop notice and mechanic's lien rights will be
preserved unless it timely serves its preliminary notice on the
actual owner
and/or lender.
This article is intended as a topical discussion of general legal
principals. While general rules may exist, there are many exceptions
and qualifications to these general rules, and the state of the
law may have changed since the date this article was authored.
No party should use this article as a substitute for obtaining specific
legal advice from a qualified attorney on that party's specific
circumstances.
David Barnier is an attorney with the law firm of
Barker Olmsted & Barnier Law Group which is located in San Diego, California. Mr. Barnier will answer most general construction-related questions free of charge when those questions are submitted here.