Illinois Contractor’s Lien Issues: The Enhancement Rule

The enhancement doctrine comes into play when liened property goes to foreclosure sale and the sale proceeds are insufficient to pay off both the lender and competing lien claimants. The lender, who often records its mortgage before the contractor’s lien attaches, will argue that its mortgage interest takes priority over the contractor’s lien and any property sale proceeds should go first to the lender. 

The contractor will counter that it’s unfair for his lien to get extinguished after he furnished valuable improvements to the property just because his lien happened to attach after the lender recorded its mortgage against the property.  Recall that in Illinois, the lien attaches on the date of the owner-general contractor contract and relates back to that prime contract date.

Enter the enhancement rule.  Codified at Section 16 of the Mechanics Lien Act, 770 ILCS 60/16, it allows a contractor whose lien attached after the mortgage was recorded to still take priority over the lender to the value of improvements furnished to the property.  The theory being that the contractor should be able to defeat or “prime” the prior mortgage in the amount the contractor improved or “enhanced” the value of the property.

To prove enhancement, a contractor must demonstrate that: (1) the work was authorized by the owner; (2) the contract price was reasonable; (3) he performed his obligations under the contract; and (4) the work constitutes a valuable and permanent improvement. Lyons Sav. v. Gash, 279 Ill.App.3d 742 (1st Dist. 1996); Erickson Brothers, Inc. v. Jenkins, 41 Ill.App.2d 180 (1963).

The question then arises as to how to prove enhancement.  Typically, the contractor will employ the market value approach.  This usually requires the contractor to provide expert testimony and appraisals to show the “before and after” value of the property – by comparing the property value before the contractor’s improvements vs. the value after the liened improvements.

However, in Gash, the court held that the market value approach was not the proper method to prove enhancement and instead found that the contract price was the proper measure of enhancement.  The basis for this holding was that the amount of the contractor’s improvements was minuscule compared to the Property’s value. Gash, 279 Ill.App.3d at 747.

In Gash, the contractors’ liens totaled $78,411.55 and the property sold for over $4 million at foreclosure sale.  Because the market value theory of enhancement contained a 10% margin of error or variance, and because the property value far exceeded the lien claims, the court held that the market value theory was improper and instead the contract price was the correct gauge of enhancement. Id. at 745-47.

This is a significant holding for contractors because it dispenses with the time, expense and burden (evidential and time-wise) of hiring an expert to testify concerning before and after property values.

Going forward, if you represent a contractor whose lien attached after a mortgage was recorded on the property, it’s critical that you prove that your client enhanced the property’s value. 

Where the property value dwarfs the lien amount, the contract amount will be the presumed enhancement amount.  However, if it’s a closer call (there is not a huge gap between property value and lien amount), be prepared to hire an appraiser or similar opinion witness to testify concerning the value of the property before and after your client’s improvements.  Proving this amount will enable your client to trump a prior competing mortgage lien.

 

Illinois Mechanics Lien Basics

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The Statute: The Illinois Mechanics’ Lien Act, 770 ILCS 60/1 et seq.

Purpose: to provide a remedy to a contractor who provides valuable improvements to real estate by allowing him to lien the property (place a hold on the property to secure payment).

Once the lien is in place (or perfected), the lien clouds the property’s title and the contractor can sue to foreclose his lien and force a sale of the property.

Without this lien remedy, the contractor is at the mercy of the general contractor or owner.  If either runs out of money, the contractor gets nothing for his labor, materials, time and effort.

Cast of characters:

Owner = developer, person or entity that owns real estate

General Contractor (or Prime Contractor or Original Contractor or “GC”) = party that contracts with Owner

Subcontractor = party that contracts with General Contractor

Sub-subcontractor = party that contracts with Subcontractor

Lender (Mortgagee, Incumbrancer) = mortgage lender that funds construction activities on real estate

Notice and Timing Rules

General Contractor: “4 months/2 year rule”.  770 ILCS 60/7.  The GC must record lien within 4 months of last date of performance and must file suit to foreclose his mechanics’ lien within 2 years of last performance on the project.

Subcontractor: “90 days/4 months/2 years”.  770 ILCS 60/24.  The Subcontractor must serve notice to Owner within 90 days of last performance, must record its lien within 4 months of last performance, and must file suit to foreclose within 2 years of last performance.

Subcontractor on owner-occupied, single-family residential property: “60 days/90 days/4 months/2 years”.  770 ILCS 60/5.  A subcontractor on this type of property must serve notice on owner within 60 days of his commencement of work that he is a subcontractor on the property.  He then must serve notice on the owner of his intent to lien within 90 days of his last performance, record his lien in the Recorder’s offices within 4 months of last performance and file suit within 2 years of his last performance.

Venue (where to file): the lien is filed in the Recorder of Deeds for county where property is located (e.g. Chicago property = Cook County Recorder of Deeds; Waukegan property = Lake County Recorder of Deeds; Wheaton = DuPage County Recorder of Deeds).  770 ILCS 60/9.

Elements of a Mechanics Lien Claim (the Complaint):

A general contractor mechanic’s lien claimant must establish: (1) a valid contract; (2) with the owner of the property or someone authorized to contract on behalf of the owner; (3) for the furnishing of services or materials; and (4) performance of the contract or a valid excuse for non-performance.

A contractor can enforce a mechanic’s lien by proving that he substantially performed the contract in a workmanlike manner.

To perfect a mechanics lien, the subcontractor must serve the 90-day notice and record his lien within 4 months while  a general contractor must record his lien within 4 months of last performance.

A properly perfected lien will “relate back” and attach as of the date of the owner-general contractor prime contract.  This is important when the issue of priorities arises (e.g. when two liens are recorded against the same property, what takes priority?)

The general contractor does not have to serve a 90-day notice because he has contracted directly with the owner and so the owner presumably knows the general contractor’s identity.

Filing Suit to Foreclose the Lien

While recording the lien will certainly blemish the owner’s title and make it difficult to sell or refinance the property, to really go for the jugular, the contractor must file suit to foreclose his lien.  This sets in motion an eventual judicial sale of the property and provide sales proceeds from which to compensate the lien claimant.

To that end, a contractor suing to foreclose his lien must allege (a) a brief statement of the contract, (b) the date of the contract, (c) the date of last performance under the contract, (d) the amount unpaid, (e) a description of the premises, and (f) any other necessary facts.  770 ILCS 60/11(a).

The  contractor should name as defendants the owner, general, all other lien claimants and mortgage lenders on the property.  My experience is the vast majority of mechanics’ lien cases settle before trial.  However, the end-game is a foreclosure sale of the property with the court divvying up the sale proceeds among the various competing claimants (typically, the mortgage lender, general contractor, and at least one subcontractor).’

If You Didn’t Record the Lien On Time

If you fail to record a lien (such as in a situation where a client doesn’t tell you about its claim until more than 4 months have passed – it happens), you can still sue for breach of contract and alternatively for quantum meruit/unjust enrichment.  The limitations period for written contracts is 10 years (measured from the date of breach); for oral contracts, 4 years and for quantum meruit – 5 years.  Obviously, with these remedies, you run the risk of an insolvent or judgment-proof defendant.

Collecting Your Illinois Judgment Part II: the Citation Order

Per my earlier post – neophyte collection lawyers often wonder what they should put in the order once the citation examination concludes.  Section 2-1402(c) sets forth several possible orders that can enter.

The Citation Respondent Appeared and Answered

Broadly, if the debtor appears and you conduct the examination, you can either dismiss or discharge the citation, continue it, or order a turnover of funds or property.  I enter a dismissal if the debtor fully complied and has no assets, I continue the proceedings if the debtor does not produce the requested documents, and I enter a turnover order if the debtor or a third-party answers that there are funds or property that can be applied towards the judgment.

For a third-party citation, typically issued to the debtor’s bank, I enter a dismissal order which provides that the bank turnover the non-exempt funds within 7 days.  If the bank fails to pay, I move for a Rule to Show Cause and entry of conditional judgment.  This gets the bank’s attention.

Another possible order on the citation return date is an installment payment order which I file with the court.  An example of this is found at: http://12.218.239.52/Forms/pdf_files/CCG0105.pdf.

Citation Fails to Appear

Surprisingly, debtors often fail to appear on the Citation return date.  When this happens, you ask for a “Rule” – shorthand nomenclature for Rule to Show Cause.  That’s also a pre-printed form found in the courtroom.  You fill out the required information and have it served personally on the debtor.  If the debtor fails to respond to the served Rule, you request a body attachment or “writ of attachment”.  That order will contain a $1,000 bond amount (usually), and should be placed with the Sheriff, who – at some point – will contact the debtor and physically bring him/her to the courtroom.

Collection counsel should familiarize themselves with House Bill 5434 – eff. July, 2012 (http://www.ilga.gov/legislation/BillStatus.asp?DocNum=5434&GAID=11&DocTypeID=HB&LegId=65695&SessionID=84)

which added requirements specifically concerning body attachments.  Basically, no body attachment will issue until creditor obtains personal or abode service of a Rule to Show Cause on the debtor, there is a maximum $1,000 bond amount, and the body attachment expires after 1 year.