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North Carolina Business Court Rules:  Ordinary Progress Payment Lien Waiver Operates to Waive and Subordinate Lien Priority.

Steve Hedges with Sparrow, Wolf & Dennis, PA

The North Carolina Superior Court, sitting as a specially designated Complex Business Court, recently ruled that an ordinary mechanic's lien waiver, submitted in connection with an application for progress payment, operated not only to waive the dollar amount for which the contractor could enforce a lien, but waived also the Contractor's "first date of furnishing," thereby resulting in a loss of statutory priority.

In North Carolina, mechanic's liens are granted a superior priority:

"A claim of lien on real property granted by this Article shall relate to and take effect from the time of the first furnishing of labor or materials at the site of the improvement by the person claiming the claim of lien on real property. "

NCGS §44A-10.

Also, in North Carolina, the grounds and consideration required for a general waiver of lien rights are narrowly proscribed:

"An agreement to waive the right to file a claim of lien on real property. . . which agreement is in anticipation of and in consideration for the awarding of any contract, either express or implied, for the making of an improvement upon real property under this Article is against public policy and is unenforceable. This section does not prohibit subordination or release of a lien granted under. . . this Article. "

NCGS §44A-12(f).

Accordingly, the typical interpretation in North Carolina is that a contractor has lien rights that date from its "first furnishing;" those lien rights may not be waived generally absent the payment of special consideration, and ordinary progress payment lien waivers operate only to reduce the dollar amount of an otherwise intact lien right for all unpaid sums.

In Wachovia Bank v. Superior Construction Corporation, North Carolina Superior Court, Mecklenburg County, 07 CVS 21256, the Court recently addressed the classic priority conflict between a construction lender's deed of trust and a general contractor's lien rights. The general contractor first furnished work on April 22, 2005. The construction lender's deed of trust was recorded May 19, 2005. Accordingly, under NCGS §44A-10, the general contractor's lien rights take priority over the lender's security interest.

However, the contractor had made several initial applications for progress payments, for which it had been paid. In connection with those applications, the contractor had submitted an interim lien waiver, stating that the contractor does hereby:

"waive, relinquish, surrender and release any and all lien, claim, or right to lien on the above described project and premises, arising under and by virtue of the mechanic's lien laws of the State of North Carolina on account of any labor performed or the furnishing of any material to the above described project and premises up to and including the 31st day of May, 2005. "

In a separate affidavit, the contractor purported to waive any claim of lien against the property "with regard to the amount of funds actually paid. "

Relying upon case law construing situations where a contractor's waiver or subordination of  lien rights was expressly bargained for in consideration of obtaining project financing, the Court in Wachovia found that the lender's ordinary funding of progress payments constituted the necessary contractual consideration for a general waiver of rights through May 31, 2005. As a result, the contractor's lien rights were not merely limited to unpaid sums. The contractor was deemed to have waived all lien rights for the period beginning with the date of first furnishing through May 31, 2005. Accordingly, all of the contractor's remaining lien rights, including rights to retainage withheld for the period prior to May 31, 2005, were now inferior to the lender's deed of trust.

The court rejected the contractor's arguments that the waiver was intended to waive only the dollar amount of the contractor's rights, but to retain all other rights, including its statutory priority. The court rejected the contractor's suggestion that the result desired by the lender required the execution of a formal subordination agreement.

Because construction financing is so often obtained before a contractor first furnishes work, it would be easy to dismiss this ruling as a hard result in an unusual case. However, should this ruling be sustained on appeal, it will create risks for contractors in circumstances other than the unusual chronological facts of this case. Having lost its priority each time it submits an interim lien waiver, the contractor could have an inferior priority claim to an expanding number of other creditors. For example, the contractor would be inferior to  any subsequent deed of trust for supplemental financing, or a simple judgment lien obtained by an unsecured creditor at any time prior to the contractor's last interim lien waiver.

The case is on appeal.

Steve Hedges
Sparrow Wolf & Dennis, PA