Business Law by Tom Ramsey
February 14 – Contractors working on construction sites and suppliers of materials to such sites routinely serve what is known as a 20-day preliminary notice on the projects’ owners and construction lenders. One purpose of the notice is to alert all who receive it to the fact that the contractor or supplier is working on the project. Generally, the notice is also a condition precedent to the contractor or supplier making a claim to stop the construction lender from paying others out of the construction loan until sufficient funds are set aside to meet the contractor or supplier’s claim for its work or materials.
What happens if the wrong lender receives the 20-day preliminary notice?
92 Magnolia LLC owned property in Riverside where it was constructing a condominium project. Magnolia hired Force Framing, Inc., for a portion of the work, for which Force was to receive $1,460,233. Once Force started its work, Magnolia provided Force with a list of the parties involved in the project. East West Bank was identified by Magnolia as the construction lender.
As expected, Force prepared and served its 20-day preliminary notice to those named in the list provided by Magnolia, including East West Bank.
Although its work was completed, Force was not paid. Its claim totaled $1,398,882. It served a very surprised East West Bank with what is known as a stop notice which, if effective, would generally prevent East West Bank from disbursing loan funds to others unless enough remained to pay Force.
East West Bank had nothing to do with the project. The construction loan was made by Chinatrust. Of course, Chinatrust received neither the 20-day preliminary notice nor the stop notice.
Force was not paid. It moved to the courts. In its complaint, Force sued Chinatrust because Chinatrust disbursed funds to others rather than to Force after the stop notice was sent (to the wrong bank). Force wanted Chinatrust to make up the shortfall.
Chinatrust moved for a summary judgment (a judgment in Chinatrust’s favor without the necessity of a trial because there are no factual issues in the case and the only facts before the court support such a judgment).
The trial court agreed with Chinatrust and found against Force because Force had a duty to investigate and determine the identity of the construction lender. Inasmuch as Force failed to verify the identity of the construction lender, it could not be excused from serving the wrong bank.
On appeal, Force argued that it served the reputed lender, the lender identified on Magnolia’s list. After all, it was reasonable for Force to rely on Magnolia’s representation that East West was the lender. In this setting, Force argued it was not obligated to search the official records of the Riverside County recorder for Chinatrust’s deed of trust securing the actual construction loan.
In response, Chinatrust asserted that Force failed to comply with the statutory notice requirements because it failed to serve Chinatrust with a 20-day preliminary notice or the stop notice. After all, Chinatrust had recorded a deed of trust against the property to secure its construction loan to the owner. This gave Force constructive notice that Chinatrust was the lender.
The decision of the Court of Appeal appeared to hinge on the section of the Civil Code setting forth the rule concerning service of the 20-day preliminary notice. That section provides that the notice must be given to the construction lender or the reputed construction lender. The court stated that a “reputed construction lender” is the entity that Force reasonably and in good faith believed was the actual construction lender.
Although the cases appear to diverge with regard to how a claimant may prove that it held a good faith belief that the reputed lender was the actual lender, here the Court of Appeal concluded that Force might be able to depend on the information given to it by Magnolia (the owner of the property) to prevail since there was no reason for Force to doubt the accuracy of this information. If so, Force could have held a good faith belief that East West was the actual lender.
Rather than allowing the judgment against Force to stand, the judgment was reversed and the case was sent back to the trial court to determine, by way of a trial, whether Force’s 20-day preliminary notice was properly served in the manner allowed by the Civil Code, in this case to the reputed construction lender. This will require a determination as to whether Force’s action was based on a good faith belief that East West was indeed the lender.
The case is entitled Force Framing, Inc., v. Chinatrust Bank (USA). It was decided in 2010.
(Tom Ramsey is a Long Beach attorney who has specialized in business law for more than 40 years. He may be reached at firstname.lastname@example.org.)