Subcontractors and Material Suppliers Cannot Rely on the Mechanic’s Lien Foreclosure by Their General Contractor or Superior Subcontractor

Subcontractors and material suppliers that are owed money on a project sometimes allow the amount owed them to be included in the Mechanic’s Lien of the entity with whom they contracted. This is done primarily to save the cost (and hassle) of filing their own lien.

Subcontractors and material suppliers have felt secure in the knowledge that when the money is received to satisfy the lien they will be paid because a provision of the Mechanic’ Lien Statute, 514.02, Subd. 1, requires the proceeds of payments for improvements to real estate be held in trust by the recipient for the benefit of those who furnish labor or material. Further, those proceeds are not subject to garnishment, execution, levy, or attachment. The Mechanic’s Lien Statute also puts teeth behind this requirement by providing that anyone who fails to use the proceeds to pay subs or material suppliers has committed theft. Now, however, because of a recent ruling by the Minnesota Court of Appeals, subcontractors and material suppliers cannot be certain they will be paid when their general or sub receives payment from an owner.

The Minnesota Court of Appeals ruled in Seimens Building Technologies, Inc. v. Peak Mechanical, Inc., —N.W.2d — (2004 WL 1774774), that the rights of an unpaid subcontractor under Minn.Stat.§514.02 are not superior to the rights of a secured creditor. Further, the theft penalties outlined in the Mechanic’s Lien Statute do not apply to banks collecting what would otherwise be a bad debt.

In Seimens, Seimens provided services to Peak, a subcontractor to the general contractor. The project owners defaulted on their payments to the various contractors and subcontractors. Peak became a party to a Mechanic’s Lien foreclosure action, asserting a lien which included the amount it owed Seimens. Seimens was not a party to the foreclosure action, but instead relied on Peak’s lien to secure payment from the owners.

At this same time, Peak defaulted on its loan to a bank which had a perfected security interest in Peak’s inventory, accounts, and proceeds. Peak surrendered control of its accounts receivable to the bank. After Peak defaulted on the bank loan, it entered into a Settlement Agreement in the Mechanic’s Lien case, and a joint check was issued to Peak and the bank in the amount of $215,088.00. Both Peak and the Bank knew Peak owed Seimens $106,781.75 for labor and materials supplied for the project, and although the Bank paid one of Peak’s subcontractors (who had participated in the Mechanic’s Lien foreclosure action), it refused to pay Seimens.

Seimens sued the Bank for theft of proceeds pursuant to Minn.Stat. §514.02. The District Court ruled that the theft of proceeds provision did apply, but the Court of Appeals reversed the District Court. The Court of Appeals ruled that the conduct of the Bank: (1) taking over Peak’s accounts receivable; (2) receiving proceeds for improvement to real property; and (3) refusing to pay Seimens - who had contributed materials and labor which created those proceeds, did not subject the Bank to liability. This is because the penalties and remedies provided in Minn. Stat. §514.02 do not apply to a third party who receives a payment in the ordinary course of business, and banks collect loans in their ordinary course of business. While there are several problems with the Seimens decision, which will hopefully be corrected if the case is reviewed by the Minnesota Supreme Court, subcontractors and material suppliers must be wary.

The lesson learned from the Seimens decision is that no matter how much you like your general or subcontractor, you cannot rely on their lien to secure payment to you. Be vigilant in perfecting your own Mechanic’s Liens - otherwise, you may never get paid.

Ryan J. Hatton is an associate with Rinke-Noonan and practices in areas of construction law and litigation, Mechanic’s Liens, Bond claims, and land use litigation.