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.