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.

Diane