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February 2013

Nevada Supreme Court Holds that Equitable Subrogation Doctrine Cannot Subordinate Other Lien Claims After Construction Begins

In a case of first impression, the Nevada Supreme Court recently held that the doctrine of equitable subrogation cannot be used to subordinate mechanic’s lien claims to the liens, mortgages or other claims of lenders that attach to the subject property after the commencement of the construction.  The court further held that rights of mechanic’s lien claimants can only be subrogated in a manner harmonious with Nevada’s mechanic’s lien statute.  As we will see, this is not easily done.
This case provides a compelling reminder that very real differences exist between states with regard to mechanic’s liens.  Industry stakeholders should seek out advisors, such as Gordon & Rees, which have national reach and experience for advice on state-specific laws and their impact on transactions and potential litigation.  Even though this case is one of first impression, the outcome was not surprising to this author and many who practice in this area.

This case, In Re Fontainebleau Las Vegas Holdings, 128 Nev. Adv. Op. No. 53, arose out of a dispute between lenders and various contractors over which group had priority claims over the proceeds of the sale of the as yet unfinished Fontainebleau Hotel and Casino near the north end of the Las Vegas Strip.  Fontainebleau Las Vegas Holdings, LLC (Fontainebleau) sought to develop and construct this $2.8 billion project, but funding for the project dried up when the construction was (by some estimates) more than 90 percent complete.  Fontainebleau then filed a bankruptcy petition in the Southern District of Florida and almost 300 different contractors and suppliers asserted mechanic’s liens in excess of $300 million against the property.  The property and unfinished improvements  subsequently were sold out of bankruptcy free and clear of any liens, and the lenders and lien claimants have been asserting priority to the proceeds of the sale before the Bankruptcy Court in Florida since that time.  The question of priority is controlled by Nevada state law, so the Florida court certified several questions to the Nevada Supreme Court.

The first question addressed by the court dealt with whether the Nevada mechanic’s lien statute prohibited the application of equitable subrogation in determining the relative priority of competing lien claims.  Courts in several states have applied the doctrine of equitable subrogation where subsequent construction lenders have been able to step into the shoes of the original lenders for purposes of determining the priority of liens.  However, the Nevada court declined to follow these jurisdictions.  In doing so, it affirmed the Nevada court’s position that a Nevada court, sitting in equity, cannot ignore the plain language of a statute, and that the plain language of Nevada Revised Statutes §108.225 clearly prefers mechanic’s liens to “any lien, mortgage or other encumbrance which may have attached to the property after the commencement of construction of a work of improvement.”  NRS 108.224.

“Commencement of construction” is further defined by the Nevada statute as the date on which a reasonable visible inspection of the site reveals “work performed” or “materials or equipment furnished in connection with a work a work of improvement.”  In light of this case and the clear language of the statute, construction lenders on projects in Nevada would do well to visually inspect any construction site in Nevada prior to lending in order to assure that their lien would be in first priority.

In some jurisdictions, lenders can rely on a subordination agreement provided by various contractors to assure themselves of first position.  However, the Nevada statute is hostile to this approach, and the Nevada Supreme Court discussed this in their decision.  Their discussion of this item lacks some clarity unfortunately.  On the one hand, the Nevada court held that “prospective subordination agreements are unenforceable” given language in Nevada’s mechanic’s lien statute that voids contractual provision that would impair any rights a claimant may have under the statute.  Advanced Opinion, page 34.  But then the court noted that lien claimants could waive their rights “after those rights arose provided that the requirements of NRS 108.2457 were met.”  Id.

In a vacuum, this seems to leave the subordination door open a crack, but the court failed to inform the reader that there is nothing in NRS 108.2457 that would allow for a mechanic’s lien claimant to agree to change the priority date of its mechanic’s lien claim.  All NRS 108.2457 includes are the forms that must be used for conditional and unconditional waivers and releases of lien rights upon progress payment or final payment.  Embedded in this language are requirements that payments for work performed must actually have been received prior to any release of mechanic’s lien rights could be effective.  In short, if a lender is junior in time to the mechanic’s lien claimants on a project in Nevada, the only way for that lender to be first in priority would be to assure that each lien claimant has been paid and an unconditional final waiver (in the statutory form) has been received.