Being a residential contractor in this economy, getting paid on foreclosed or failed projects can be difficult — be informed on a bonded stop notice.
By John E. Bowerbank
For years, unpaid contractors for construction projects have had the unique ability to record a mechanic’s lien against the property, making the contractor a secured creditor prior to getting a judgment, and therefore usually forcing the owner to pay the contractor to avoid a foreclosure of the mechanic’s lien. However, in this economy, many owners have no problem walking away from the property due to a foreclosure. As a result, many mechanic’s liens have no leverage for payment of amounts owing because the property may not have any equity or a lender may have a deed of trust that has priority over a mechanic’s lien.
Given that a mechanic’s lien may not have the teeth it used to have in years past, contractors should seriously consider serving a bonded stop notice on the project’s construction lender and pursue a claim on any undisbursed construction loan funds. What is a bonded stop notice? It is an equitable lien on undisbursed construction loan proceeds. Many of the failed projects today were financed with large construction loans. Often, we have seen that partially completed construction projects fail despite significant construction loan funds remaining that the lender refused to disburse due to a default by the owner. After the lender forecloses on the property, all junior liens, including junior mechanic’s liens are wiped out.
Regardless, if a foreclosure occurs by a lender, a contractor can still pursue a bonded stop notice claim directly against the lender to recover unpaid construction funds; provided the contractor timely perfects the stop notice and obtains a bond in the amount of 125 percent of the amount owing. In addition, the prevailing party on a recovery on bonded stop notice claim can recover their reasonable attorneys’ fees, costs and interest pursuant to statute. It bears noting that many people are under the misconception that a bonded stop notice constitutes a lien on further disbursements by the lender and not the undisbursed loan funds. California law provides that the bonded stop notices attaches to undisbursed funds remaining on the construction loan. Therefore, a lender should not be able to defeat a recovery on a bonded stop notice claim by merely refusing to disburse additional funds to the owner after receiving the bonded stop notice. Also a bonded stop notice may be able to retroactively attach payments of interest and fees by the owner to the lender.
The time period to perfect a bonded stop notice is very short and is based upon the deadlines to record mechanic’s liens. A bonded stop notice needs to be served on the lender and owner within 90 days of the project’s cessation or completion, unless a notice of completion or notice of cessation has been recorded in which case the period is reduced to 30 to 60 days; depending on if the contractor is a general contractor or subcontractor. A bonded stop notice claimant must also file a recovery on stop notice bond claim with the court within 90 days from the last day to record a mechanic’s lien.
Any contractor pursuing a bonded stop notice claim against a construction lender should be very careful about monitoring the project’s cessation or completion because the deadlines to perfect bonded stop notices are very short. Also, subcontractors and suppliers who are not under direct contract with the owner must serve a preliminary notice on the owner and construction lender.
Unpaid contractors should continue to use mechanic’s liens and other collection remedies, but a recovery on bonded stop notice claims against a lender may be the contractor’s best chance of getting fully paid in the event the owner goes bankrupt and loses the property in a foreclosure by a lender.
Use of the bonded stop notice against lenders isn’t the most complicated of remedies for unpaid construction projects, but it’s a legal strategy that has largely gone under utilized in this highly fluid real estate market that is experiencing severe losses across the participants in entire industry’s supply chain.
“Regardless if a foreclosure occurs by a lender, a contractor can still pursue a bonded stop notice claim directly against the lender to recover unpaid construction funds…”
John Bowerbank is a partner in the Newport Beach office of Newmeyer & Dillion, LLP, and specializes in business, insurance, real estate and construction litigation. He may be contacted at firstname.lastname@example.org.