Does preparatory site work, such as clearing or grading, constitute commencement of construction for purposes of lien priority?: The dangers of failing to file a notice of lending and when a contractor’s mechanic’s lien takes priority over a construction loan mortgage

From a construction lender’s perspective, intuition would say that a subcontractor’s lien rights would never take priority over that of the lender’s unless and until general construction on a project site has visibly begun. This is because, until the Great Recession, the majority of jurisdictions had interpreted their respective state statute’s definition of the “date of commencement” for when a mechanic’s lien priority attaches to be the date when materials or labor is first provided by a contractor or subcontractor for the visible improvement of the subject property (and/or the date a Notice of Commencement is issued by the project owner to the contractor – so long as an inchoate lien is filed or recorded).1 Simply put, the majority of jurisdictions had previously viewed site preparation work – such as site demolition, clearing, pit testing, and grading – as non-“visible improvements” whereby the contractor or subcontractor’s mechanic’s lien rights for such work would always be junior to and not take priority over that of a construction lender’s since such activity, by its very definition, fails to constitute visible commencement of “actual, on-site construction” and improvement of the subject property. 2 Thusly, construction lenders never saw a reason to file or record a Notice of Lending or Deed of Trust prior to its borrower’s commencement of its actual general, on-site construction work.

Unfortunately, due to changes in how courts have begun to interpret what constitutes visible improvement of, or on-site construction activity on, a subject property, such intuition and practice is beginning to erode and prudence would dictate that building and construction lenders rethink their timing of when they file their notices of lending. In the same majority jurisdictions which previously concluded that site preparation work was the type of nonvisible preparatory work that failed to establish construction commencement and an attachment of mechanic’s lien rights, these same majority jurisdictions are now adopting the position that the entire scheme of a property’s improvement – including all work, materials and equipment to be used in or for the construction, alteration or repair of that property – should be considered when deciding whether or not a contractor or subcontractor’s activity constitutes a lienable “improvement.” Now, the “overall construction” of the improvement as a whole is evaluated when determining whether or not lienable construction has commenced rather than whether or not the activity constitutes preparatory, structural or vertical construction work.3 Stated differently, more and more jurisdictions have recognized that the interests of a construction lender who fails to timely file a notice of its lending are subordinate to a preconstruction contractor or subcontractor’s mechanic’s lien rights when preconstruction activity of such contractor or subcontractor is integral to the improvement of the subject property. 

A clear example of this rising trend is the decision handed down by the Nevada Supreme Court in Byrd Underground, LLC v Anguar, LLC (332 P3d 273,130 Nev Adv Op 62). For purposes of determining lien priority, the Court in Byrd was asked whether the placement of fill materials, clearing and grading of a construction site constituted “construction of a work of improvement,” even when such work is not, by its nature, a visible commencement of construction.

In Byrd, two limited liability companies (“Joint Venture”) purchased a parcel of unimproved property with the intent of eventually constructing a strip mall (the “Project”). Prior to the Joint Venture’s selection of a general contractor for the project, (x) two different contractors (the “Dirt Subcontractors”) were directed by the Joint Venture to place and spread more than 200 truckloads of dirt at the site of the Project, (y) one of the bidding general contractors (“General Contractor”) directed its site preparation subcontractor (the “Site Preparation Subcontractor”) to dig test pits to determine how much dirt/material had been brought to the subject property by the Dirt Subcontractors, and (z) the Site Preparation Subcontractor was directed by General Contractor to begin preparation of the site of the Project for the commencement of the general construction work. After General Contractor and Joint Venture executed a written agreement for the construction of the Project, the Site Preparation Subcontractor commenced its demolition and grading of the project site. Although having obtained financing for the project some three weeks earlier from the construction lender (“Lender”), a notice of such financing and funding of the Project was not filed until some thirty days after Subcontractor commenced its site preparation work (but prior to the commencement of general construction). 

One year later, both the Dirt Subcontractors and Site Preparation Subcontractor remained unpaid for their respective site preparation, demolition and grading of the project site, and commenced mechanic’s lien actions in State court, obtaining judgments against both Joint Venture and General Contractor. After the construction of the Project was completed, Joint Venture filed for relief under Chapter 11 whereby the Joint Venture and Lender entered into a forbearance agreement and plan of reorganization, stating that Lender was the only “Class 1” secured creditor. 

As lien claimants, both the Dirt Subcontractors and Site Preparation Subcontractor objected to the Joint Venture’s and Lender’s forbearance agreement and plan of reorganization on the basis that they, too, were “Class 1” secured creditors, and filed an adversarial complaint in bankruptcy court to determine the priority of their liens against that of the Lender. Specifically, both contractor lien claimants alleged that, because they began their construction activities prior to the filing of Lender’s Deed of Trust/Notice of Lending, their mechanic’s liens were superior to the creditor claims of Lender. Finding that the determination of when construction has commenced relies upon when a “visible commencement of construction” has occurred on a project site, the bankruptcy court disagreed with the Dirt Subcontractors and Site Preparation Subcontractor and found that their clearing and grading preconstruction activities failed to constitute visible commencement of actual, on-site construction. Thusly, the bankruptcy court held, the Dirt Subcontractor and Site Preparation Subcontractor’s interests could never be superior to that of Lender’s because their interests never attached to the subject property since commencement of construction never really began. 

The Nevada Supreme Court disagreed, reversing the bankruptcy court’s findings and holding that preparatory work, such as the contribution and incorporation of soil by the Dirt Subcontractors and the project site clearing and grading completed by the Site Preparation Subcontractor, could constitute a “work of improvement” when such work is compared against “the entire structure or scheme of improvement as a whole … rather than evaluating the activities based on whether they are preparatory or structural or vertical construction, in determining whether construction on a work of improvement has commenced.” There, the Court found that, although construction contract dates, permit issuance dates and commencement of actual construction were irrelevant when determining whether or not lienable improvements of a work had commenced, same can be supporting evidence in determining the scope of the work of the improvement and when visible improvement of the project site began. A trier of fact, the Court reasoned, need only look to the entire structure or improvement as a whole rather than individual scopes or phases of work to determine when improvement of a property becomes lienable. Thusly, the Court declared, the mechanic’s lien claimants in Byrd could claim lien priority over all other interests, including that of Lender’s, based on the work they performed – even if such work was completed months before a building permit was issued – provided that such work is intergral to the improvement of the property and no notice of lending or similar notice is filed prior to or contemporaneously with the commencement of such work.4 

Based on the decision in Byrd and others that have come before and after it5 , good construction lending prudence and practice, therefore, dictates that construction lenders be highly incentivized to file as soon as possible and, ideally, prior to the commencement of any work on the subject property – regardless of whether such work is considered preparatory, vertical or horizontal construction work – notice of their lending, especially once a disbursement of funds from that lender has occurred. With the evolving and changing interpretation by the majority jurisdictions of what constitutes the “commencement of construction,” gone are the days of when the filing of such lending notices are inconsequential. Today, in order to properly protect a construction lender’s rights, a lender should never hesitate to file its notice of lending with any transaction where funds are advanced for the purpose of completing construction. Regardless of whether or not a lender views the activity of a contractor or subcontractor to be general construction work or site preparation work, the majority of jurisdictions have begun to make it clear that, if a lender does not timely file or record notice of its lending, then a contractor or subcontractor’s mechanic’s lien rights and interests may take priority over the interests of that construction lender.