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Logo Icon Protecting the Rights of Stop Notice Claimants to Undisbursed Loan Funds

In Brewer Corporation et. al., v. Point Center Financial, Inc., the California Court of Appeal confirmed that stop notice claimants retain priority to loan funds over construction lenders.

Brewer Corporation involved the development of a condominium project in San Diego, California. To construct this project, the owner borrowed $13,625,000 from Appellant Point Center Financial, Inc. (Lender). Lender "agreed that it acted as a '[c]onstruction [l]ender for purposes of the stop notice statutory scheme as defined in section 3087." To raise funds for this project, Lender entered into private loan servicing contracts with third-party investors and also contributed some of its own money to the project. In regards to the third party investors, Lender "paid the third party investors interest on their fractional loan interest and [concomitantly] paid itself a servicing fee...." All told, Lender pre-paid itself over $1.5 million in interest, loan fee/points, and other fees. Unfortunately, Lender disbursed all of the construction loan funds, so that bonded stop notice claims filed by various contractors could not be paid. As a result, the contractors filed actions against Lender to recoup the money that Lender paid itself. The contractors argued that the Lender violated former Civil Code section 3166 which "prohibits assignments, before or after receipt of a stop notice" and further, contractors argued, relying upon Familian Corp. v. Imperial Bank (1989) 213 Cal. App. 3d 681 (Familian) "that 'lenders cannot avoid a section 3166 priority by private agreement." (Id. at p. 686.) The trial court agreed with Contractors and awarded them the total amount Lender had paid itself.

Lender appealed the decision, predictively arguing that the self-paid amounts were not assignments, but simply bargained for consideration; that "section 3166 disallows an assignment only if the assignment reduces the unexpended funds available to satisfy a stop notice claim;" and that "'the funds paid to [it] and the private party lenders were used to satisfy legitimate costs of construction." The Court rebuffed each of these arguments.

Regarding the definition of "assignment", the Court affirmed the Familian court's interpretation of the word, finding that "a transfer of rights over the construction loan funds from the borrower to Lender [constitutes] an assignment." The Court, too, rejected the "timing" argument. The Court remarked, "[as] our high court sagely noted when it interpreted the predecessor statute to section 3166 (former Code Civ. Proc. section 1190.1, subd. (h)), if the terms of the construction loan agreement determined the rights of stop notice claimants 'the parties to the contract could effectively eliminate those rights.'" A-1 Door & Materials Co. v. Fresno Guarantee Sav. & Loan Ass'n (1964) 61 Cal. 2d 728, 734. Finally, with regard to Lender's argument that the pre-paid funds amounted to legitimate costs of construction, the Court dismissed this contention as Lender failed to present any supporting evidence. Finding all of Lender's arguments unpersuasive, the Court affirmed the trial court's award of pre-allocated interest, points, and fees.

Brewer Corp. emphasizes the importance of the bonded stop payment notice to laborers and materialmen who seek payment. As lenders increasingly resort to recording construction loan trust deeds before construction even begins, the value of a mechanics lien diminishes significantly. "The recorded construction loan trust deed is superior to any later recorded mechanics' lien; thus, if the lender forecloses on the property, the mechanics' lien has no value." (10 Miller & Starr, Cal. Real Estate 93ed. 2011) section 28:68, p. 234.) A timely served stop notice though provides the most vulnerable in the construction contract relationship with some recourse should payment issues arise. Brewer Corp. serves as an excellent primer for perfecting and defending against stop payment notice claims.