Contractor’s Material Breach of Construction Contract Dooms Mechanics’ Lien and Breach of Contract Claims

In Kasinecz v. Duffy, 2013 IL App (2d) 121329-U, an August 2013 Second District case, a contractor suffered a three-pronged defeat in his lawsuit against a homeowner.  The Court affirmed the lower court’s bench trial judgment for the homeowner on the contractor’s breach of contract, mechanics’ lien and quantum meruit claims.

Facts: This is the second appeal involving the parties.  In 2004, defendant hired plaintiff to build a house pursuant to a verbal agreement which was later formalized in a written contract.  The contract required the plaintiff to submit invoices to defendant before defendant was obligated to pay plaintiff.  Kasinecz, ¶ 20.  Over several months, the plaintiff and his crew built part of the house until a payment dispute arose.  Plaintiff walked off the job and sued for breach of contract, mechanics lien foreclosure and quantum meruit.  The trial court entered a directed finding for the homeowner half-way through the first bench trial (because the contractor materially breached by failing to furnish a statutory lien waiver, among other reasons) and plaintiff appealed. 

In the first appeal, the Second District reversed on the ground that it was unclear whether defendant homeowner requested a sworn statement and because the factual record was too scant to uphold judgment in total for the defendant.  Kasinecz, ¶ 6.  On remand, the trial court received additional witness testimony and written submissions and again entered judgment for defendant.  This time, the Second District affirmed.

Reasoning: The Court sided with the homeowner on all three of the contractor’s claims. 

(1) Breach of Contract: the contractor materially breached (and therefore, couldn’t prove that he performed) the contract by not providing invoices to the defendant as required by the contract.  Kasinecz, ¶¶ 21-23.  The contractor admitted at trial that he didn’t supply invoices until after he walked off the job.  Since the contractor breached, he couldn’t prevail on his breach of contract claim.   

(2) Mechanics’ Lien claim:  The contractor lost his lien claim because he didn’t substantially perform.  A necessary condition to mechanics lien recovery is substantial completion of the contract.  Id., ¶ 25; Fieldcrest Builders, Inc. v. Antonucci, 311 Ill.App.3d 597 (1999)(note: Fieldcrest provides a thorough discussion of substantial completion/quantum meruit issues in the context of a construction case).  Here, the Court found there were holes in the roof, no windows or doors were installed, and the house lacked interior mechanical systems and finishes.  Id., ¶¶ 25-26.  Because the house was so incomplete when plaintiff and crew stopped work, plaintiff couldn’t show substantial performance.  This doomed his mechanics’ lien count.  Id., ¶ 25.

(3) Quantum meruit – the Court also rejected plaintiff’s quantum meruit claim based on the black-letter principle that quantum meruit recovery won’t apply where an express contract governs the parties’ relationship.  Kasinecz, ¶ 29; Installco Inc. v. Whiting Corp., 336 Ill.App.3d 776 (2002).  Since plaintiff and defendant had a written (express) contract for plaintiff to build defendant’s house, this defeated plaintiff’s quantum meruit count.  The fact that plaintiff couldn’t enforce the contract (since he breached it) doesn’t matter: the contract’s existence alone defeats the quantum meruit claim.  Kasinecz, ¶ 29.

Law of the Case.  The plaintiff contractor argued that the Second District’s reversal in his favor on the first appeal was law of the case to the trial court on remand and even moved for summary judgment immediately upon remand.  Id., ¶¶ 7, 14-15.  The law of the case doctrine provides that questions of law actually determined in a prior appeal are binding on the trial court on remand as well as on subsequent appeals. Id., Kreutzer v. Illinois Commerce Comm’n, 2012 IL App (2d) 110619.  Both the trial and appeals court found that the law of the case rule didn’t apply because the issues decided in the first appeal (whether the parties had an oral contract and whether the contractor provided statutory lien waivers) differed from the second appeal’s salient issues (whether plaintiff submitted invoices to defendant and whether plaintiff substantially performed).  Kasinecz, at ¶¶ 15, 20.  

Take-aways: A material breach will preclude contractual recovery; a contractor’s failure to substantially perform will doom a mechanics’ lien suit; and quantum meruit and a breach of express contract claim are mutually repugnant: they can’t co-exist.  The Court did appear to express surprise that the contractor didn’t argue that the homeowner waived strict compliance with the contract’s invoicing requirement.  The defendant made several progress payments to the plaintiff without first receiving invoices.  This would seem to give rise to a waiver of strict compliance argument.  However, since the contractor never argued waiver, the Court didn’t tip its hand as to how it would rule on the issue.

Mechanics’ Lien Enhancement Rule – Post-Cypress Creek

Section 16 of the mechanics lien statute (770 ILCS 60/17), which codifies the enhancement rule (please see prior post), was recently amended in the wake of 2011’s LaSalle National Bank v. Cypress Creek 1, LLP decision:

http://www.state.il.us/court/Opinions/SupremeCourt/2011/February/109954.pdf

In Cypress Creek, the Illinois Supreme Court severely diluted contractor’s lien rights by allowing a construction lender to trump contractors’ rights to sale proceeds.  The Court accomplished this by allowing the lender to take priority to the amount of property improvements it funded – even funds paid to contractors that didn’t record liens.  Essentially, as Justice Freeman said in his detailed dissent, the Court put lenders that fund property improvements on a par with contractor lien claimants and conferred lien creditor status on the lender by “judicial fiat”.  This resulted in the lender getting the lion’s share of sale proceeds while the contractors received only a  fraction of the monies. 

Another pro-lender, anti-contractor holding of the Cypress Creek was that lien claimants only took priority for the specific value of their individual improvements; as opposed to proportionally taking priority to the total value of all contractor improvements to the land. The result: banks and lenders were thrilled; contractors were furious.

After public outcry and warring legislative bills, the legislature passed H.B. 3636, and the bill was signed into law on February 11, 2013 as P.A. 97–1165.  It essentially reverses Cypress Creek and provides that a lender has priority only to the value of the land at the time of the owner-general prime contract and that lien claimants (contractors) take priority for the value of all improvements constructed after the prime contract (not just the specific improvements performed by an individual contractor).

770 ILCS 60/16 of the Act now reads:

When the proceeds of a sale are insufficient to satisfy the claims of both previous incumbrancers and lien creditors, the proceeds of the sale shall be distributed as follows: (i) any previous incumbrancers shall have a paramount lien in the portion of the proceeds attributable to the value of the land at the time of making of the contract for improvements; and (ii) any lien creditors shall have a paramount lien in the portion of the proceeds attributable to the value of all subsequent improvements made to the property.

 At this point it’s too early to tell what impact HB 3636 will have on construction lending and mechanics lien law in Illinois.  Stay tuned.

PBP

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.