People do the darnedest things. The next case, Carmel Development Company v. Anderson, Case No. H041005, 6th District Court of Appeals (April 30, 2020), involving a 10-plus year oral design and construction contract, inconsistent accounting practices, two mechanics liens, and side-agreements, takes us down some well traveled paths but also covers some new ground.
Carmel Development Company v. Anderson
Carmel Development Company, Inc. provided design and construction services at a luxury subdivision known as Monterra Ranch located in Monterey under an oral contract with developer Monterra LLC which spanned over more than a decade.
Between 1996 and 2008, Carmel was involved in the infrastructure design and construction of the subdivision including lot design and layout, the location of building envelopes on each lot, water and sewage system layout and design, and roadway design, construction and repair. When roughly half of the lots were developed and sold Monterra ran out of money and Carmel sued.
Carmel sued Monterra for breach of oral contract. In addition, Carmel sued Monterra and several of its investors who had real property interests in unsold lots in the subdivision to foreclose on two mechanics liens, known as the “Water Lien” for the layout and design of potable water and sewer systems and construction of a reverse osmosis water plant, and the “Site Improvement Lien” for the design, construction and repair of roads, driveways, retaining walls, and utilities.
Before trial, Carmel and Monterra stipulated that: (1) Monterra owed Carmel over $9 million; (2) the amount due would be satisfied by foreclosure of: (a) the Water Lien against the 85 unsold lots in the subdivision; and (b) the Site Improvement Lien against eight unsold lots in phases seven and nine that benefitted from the work underlying the Site Improvement Lien: and (3) that any amount not satisfied by foreclosure would become a judgment against Monterra.
The case proceeded to a lengthy bench trial tried in two phases, liability and damages, respectively. Following the liability phase of trial, the trial court ruled that:
Monterra and the defendant investors were liable under the Water Lien and the Site Improvement Lien;
The two liens would accrue contractual interest at the rate of ten percent (10%) per annum as had been agreed verbally between Plaintiff and Monterra in late 2000; and
Carmel and Monterra could agree that the two liens would only apply to the 85 unsold lots in the subdivision “to avoid financial injury to third-party purchasers who had already purchased lots which were to be free of mechanic[‘s] liens”
Following the damages phase of trial, the trial court apportioned the two liens to specific lots. The trial court allocated the Water Lien to the 58 unsold units in the subdivision and allocated the Site Improvement Lien to eight unsold lots in phases seven and nine. In addition, the trial court applied prejudgment interest at the rate of ten percent (10%) per annum, under Civil Code Section 3287, commencing one year after Carmel filed its complaint.
The investor defendants appealed arguing that the trial court had erred in:
Allowing Carmel to maximize the amount of money owed under the two liens by selectively applying payments it had received from Monterra to amounts owed for work that were not liened;
Allowing Carmel and Monterra to stipulate to application of the two liens to only unsold lots in the subdivision as opposed to each lot in the subdivision whether unsold or sold;
Applying contractual interests to amounts found to be owed under the two liens; and
Applying prejudgment interest.
Carmel’s Selective Application of Payments from Monterra to Amounts Owed
At issue was application of Civil Code Section 1479. Under Section 1479, where a debtor owes amounts under several obligations (e.g., owes money under several outstanding invoices), and performs an act or makes payment that could be applied to any of those obligations, such performance can be applied in one of three ways:
If, at the time of performance, the debtor indicates that its performance is to be applied to a particular obligation, then the performance must be applied to the particular obligation specified.
If no such indication is made by a debtor, then within a reasonable time after performance by the debtor, the creditor may apply such performance to any obligation he or she desires.
If no indication is made by a debtor, and a creditor does not apply a debtor’s performance to a particular obligation within a reasonable time after performance by the debtor, the performance is to be applied in the following order: (a) to interest due at the time of performance; (b) to principal due at the time of performance; (c) to the obligation earliest in date of maturity; (d) to an obligation not secured by a lien or collateral; and, finally (e) to an obligation secured by a lien or collateral.
The investor defendants, in an effort to lower the amount secured by the Water Lien and Site Improvement Lien, argued that the third methodology should apply because Carmel’s office manager kept a spreadsheet and applied payments to the oldest outstanding amounts and, further, because Carmel did not allocate payments until shortly after recording its two liens and that this occurred months and years after payment had been made.
In response, Carmel argued that the spreadsheet prepare by its office manager was kept merely used to show Monterra the “order of magnitude” between work performed and amounts owed, and that Carmel later prepared a color-coded spreadsheet, admittedly after the two liens were recorded, showing how Carmel applied the payments made by Monterra.
The Court of Appeal, relying on “longstanding authority interpreting section 1479 to the effect that ‘where the debtor has made no designation, the creditor, if entitled to make application, must make the application before suit is brought,'” found that because Carmel presented evidence that it had applied the payments made by Monterra in a certain way, and had done so before filing suit, that second methodology of Civil Code Section 1479 applied.
Carmel and Monterra’s Agreement to Limit the Two Liens to Specified Lots
The California Supreme Court, explained the Court of Appeals, has observed that with respect to the extent of real property to which a mechanics lien attaches, the “question is not so much as to the amount of land required for the area to be occupied by the [improvements], but rather as to the amount of land to be improved or benefitted by the creation and use of the [improvements].”
In other words, the extent of real property to which a mechanics lien attaches turns less on the physical dimensions of the real property upon which work was performed, but rather, on the extent of real property that benefitted from the work performed.
The Court of Appeal, noting that a substantial evidence standard of review applies when reviewing a trial court’s determination of the extent of real property to which a mechanics lien attaches, found that the Water Lien benefitted the entire subdivision rather than just the 85 unsold lots agreed to by Carmel and Monterra because the work performed (the construction of a water treatment plant) was intended to provide water to all lots in the subdivision.
However, with respect to the Site Improvement Lien, the Court of Appeal held that because the roads and related infrastructure were only connected to the lots in phases seven and nine — and, while noting, that there was an interconnection with the rest of the infrastructure serving the subdivision, such interconnection was “far more attenuated than the connection between the water improvements and all of the lots in Monterra” – that the Site Improvement Lien only benefited the costs in phases seven and nine.
Assessment of Contractual Interest to Amounts Owing Under the Two Liens
The trial court awarded contractual interest on the amount owing under the two liens based on the oral agreement between Carmel and Monterra in late 2010 that unpaid amounts would bear interest at the rate of ten percent (10%) per annum.
On appeal, the investor defendants argued that no contractual interest should be awarded. The Court of Appeal agreed. The amount of a mechanics lien, explained the Court, is the lesser of:
The reasonable value of the work performed; and
The contractual price agreed for the work.
And here, because the trial court found that the contract price agreed to by Carmel and Monterra was commercially reasonable, the trial court in essence, had found that the reasonable value of the work performed was the same as the contractual price agreed for the work. However, held the Court of Appeal:
[R]ather than awarding plaintiff the “reasonable value” of the liened work — which the court found was equal to the contract price without interest – as required by former section 3123, the trial court added contractual interest to the reasonable value. The contractual interest added no value to the liened work; it was instead a method of compensating plaintiff for Monterra LLC’s failure to timely pay invoices. Because the court found that the reasonable value of the liened work equalled the contract price without interest for that work, and the contractual interest provision added no additional value to the lien work, the trial court erred by including contractual interest in the amount of the liens.
Assessment of Prejudgment Interest to Amounts Owing Under the Two Liens
Finally, the trial court awarded prejudgment interest at the rate of ten percent (10%) per annum under Civil Code Section 3287 commencing one year after Carmel filed its complaint.
On appeal, the investor defendants argued that no prejudgment interest should be awarded under Civil Code Section 3287 because a mechanics lien foreclosure action is not a “cause of action in contract,” and that even if prejudgment interest were available under Civil Code Section 3287, the interest rate should be seven percent (7%) per annum as opposed to ten percent (10%) per annum.
The Court of Appeal agreed in part and disagreed in part. As to the investor defendants’ argument that no prejudgment interest should be awarded under Civil CodeSection 3287 because a mechanics lien foreclosure action is not a “cause of action in contract,” the Court of Appeal of explained that while “[f]oreclosing on a mechanic’s lien does not technically enforce a contractual provision, . . . the statutory scheme is closely related to contract and quasi contract actions.” Thus, held the Court, “[w]e conclude a mechanics lien foreclosure action is sufficiently like a contract action to be considered a ’cause of action in contract’ for purposes of section 3287(b).”
However, the Court of Appeal agreed with the investor defendants that the trial court had applied an incorrect prejudgment interest interest. According to the Court, the ten percent (10%) interest rate under Civil Code Section 3289 (which applies to breach of contract claims) would apply to claims between a mechanics’ lien claimant and a party with whom it is in direct contract explained the court. However, the lower seven percent (7%) interest rate under Constitution (which does not require that there was a contract) would apply to claims between a mechanics’ lien claimant and a party with whom it is not in direct contract.
Noting the apparent inconsistency between its holding that prejudgment interest could be awarded because a mechanics’ lien foreclosure action is sufficiently close to being a “cause of action in contract” under Civil Code Section 3287, on one hand, but that prejudgment of interest of seven percent (7%) should be awarded rather than ten percent (10%) because the claim was essentially not a breach of contract claim, on the other hand, the Court of Appeal noted:
We acknowledge what may appear to be an inconsistency in determining that a mechanic’s lien foreclosure action is an action in contract under section 3287(b), but that the 10 percent interest rate for breach of contract judgments under section 3289, subdivision (b) does not apply. But looking at the text of the statutes at issue, section 3287(b) applies broadly to any cause action in contract, whereas section 3289 applies only to breach of contract actions. Like section 1717, section 3289 provides tools to aid contract interpretations and thus assumes a contract been the parties. As there was no contract between plaintiff and defendants, there could be no breach, and section 3289 therefore does not apply.
Carmel involved some unusual facts: An oral agreement spanning more than a decade, some inconsistent accounting, and side-agreements regarding the application of two mechanics liens. Yet, Carmel, offers some well established reminders – that the extent of real property to which a mechanics lien attaches is based on the benefit provided by the work performed and not just to the immediate area where such work is actually performed – to some new ones applicable to the 6th District Court of Appeals – that an award of contractual interest is not available in mechanics’ lien foreclosure actions and that, while prejudgment interest is awardable, whether the applicable interest rate is ten percent (10%) or seven percent (7%) depends on who the defendant is.