Deficiency Judgments Increasing in Number

According to this piece written by Kris Hundley in the St. Pete Times, lenders are becoming more and more likely to seek a deficiency judgment after a foreclosure. There has been some thought that lenders have been uninterested in pursuing deficiency judgments. "Two years ago, a waiver of the deficiency was normal course, but it's been eroding ever since," said Richard Zaretsky, a lawyer in West Palm Beach. "Banks came to the conclusion they were throwing away the opportunity to collect funds." Banks are more sophisticated than that, and knew from the inception of the foreclosure boom that they had plenty of time to commence efforts to obtain deficiencies. I am actually surprised that the number of deficiencies cited (270 in Lee County in 2010, a five-fold increase from 2008) is not much higher, as drastically falling real estate prices have led to many residences worth less than the debt against them, with second mortgages likely to be undersecured. Many second mortgagees find themselves without any value in the collateral at all. Wherever collateral is worth less than the balances of loans, judgments on deficiencies will remain the norm.

Liability of Qualifying Agent

As all certified and registered Florida contractors know, every company which engages in the business of contracting (be it general contracting or specialty contracting) must have a designated "qualifying agent," the person who personally holds a contractor's license and who bears the responsibility to supervise, direct, manage, and control the contracting activities of the business organization with which he or she is connected and who has the responsibility to supervise, direct, manage, and control construction activities on a job for which he or she has obtained the building permit. A qualifying agent who does not fulfill these responsibilities is subject to sanctions imposed by the Division of Professional and Business Regulation (DBPR), including fines, suspensions, and license revocations. The responsibilities and sanctions are set forth in Chapter 489, Florida Statutes, and the accompanying regulations.

Recently, a private property owner attempted to use the sanctions in chapter 489 as a basis for a private cause of action (lawsuit) against a qualifying agent. The court held (reaffirming existing law) that the qualifying agent's breach of the duties imposed by chapter 489, providing administrative remedies against a qualifying agent, does not give rise to a private cause of action against the qualifying agent for a building code violation. Scherer v. Villas Del Verde Homeowners Ass'n, Inc., --- So.3d ----, 2011 WL 148801 (Fla.App. 2 Dist.,2011). In other words, only the state agency can use Chapter 489 against a qualifying agent, and a person cannot bring a lawsuit in court based only on an individual's status as a qualifying agent.

Most contractors are honest businesspeople who strive to fulfill responsibilities which come along with their trade and status as qualifying agent. However, when exceptions to this rule arise, despite the court's recent ruling, the threatened or actual consequences of a complaint to the DBPR which may result in a DBPR action for sanctions can often inspire a qualifying agent to act to remedy a situation for which he is ultimately responsible. Therefore, even though the remedies of Chapter 489 belong only to the DBPR, they still can often indirectly address private grievances because anyone can file a complaint asking the DBPR to exercise its powers under Chapter 489.

Code Enforcement Liens - Judicial Restriction on Priority

Municipalities often issue notices of violation to property owners who do not keep their property in compliance with codes and ordinances. If the property owners do not come into compliance within the allowed time, or if they are repeat offenders, fines can be imposed. Chapter 162 of the Florida Statutes provides that a municipality may levy certain fines for noncompliance, and that the fines, until paid, create a lien on the owner's property.

The general rule is that liens, mortgages, and the like, have priority over each other based on when they were recorded. Some cities have passed ordinances providing that their lien rights are superior to the rights of mortgage lenders and other persons with liens on property (even if they were recorded first), meaning that a mortgage lender could be forced to pay off the lien to avoid losing their rights. For example, the city can foreclose its lien rights and, unless someone pays the fines, become the owner of the property free and clear of mortgages.

There has been a case winding through appellate court where a mortgage lender challenged a City’s right to declare its code enforcement liens to be superior to other liens by its ordinances. The 5th DCA has ruled against the City of Palm Bay in that case. City of Palm Bay v. Wells Fargo Bank, N.A., --- So.3d ----, 2011 WL 180363 (Fla.App. 5 Dist.). This decision came out on January 21, 2011.

The gist of the ruling is that a city ordinance purporting to give code enforcement liens “superpriority” goes beyond home rule powers of Art. VIII of the Florida Constitution because such an act directly conflicts with the legislative rule at 695.11, F.S., setting forth that priority is determined by the timing of recording – “first in time, first in right.”

Unless the legislature acts to create an exception to the “first in time, first in right” rule for code enforcement liens, or the supreme court overrules the Fifth District (an unlikely outcome, although my understanding is that the City of Palm Bay is seeking review and has solicited support from other municipalites in this regard), then code liens will be subordinate to mortgages recorded earlier, and city foreclosures of code liens will be much less desirable in many occasions.

Protecting leased property against construction liens

Landlords do not want their ownership interest to be subject to construction liens resulting from improvements made by their tenants. However, unless certain steps are taken, a Florida landlord's property WILL be subject to liens, even if they are unaware that the tenant has contracted for improvements. Chapter 713.10(2), Florida Statutes provides two options for the landlord to protect against liens on his interest:

-->First, the landlord may include a provision in the lease expressly prohibiting liens for tenant improvements and record the lease (or a short form of the lease) in the public records to put the world on notice;

-->Second, the landlord (if he leases to multiple tenants) may include an express prohibition of liens for tenant improvements in all of his leases and records a notice in the public records which contains enumerated information and states the specific language in the leases.

A landlord must be very careful when using the second option. A court recently reminded landlords how careful they must be to meet the statutory requirement. (Everglades Elec. Supply, Inc. v. Paraiso Granite, LLC, 28 So.3d 235 (Fla.App. 4 Dist.,2010). In that case, the landlord had included language limiting construction lien liability in all of its leases. However, in one of the leases, the landlord had used slightly different language limiting liability. The court held that since the language was not the same in all of its leases, then the notice which was recorded was defective because it did not include "The specific language contained in the various leases prohibiting such liability." Landlords should take note and consult an attorney to be sure that the notices they record comply with the detailed and technical construction lien law.

Can debts arising from misapplied construction funds be discharged in bankruptcy?

Recently, a case out of the Federal Sixth Circuit Court of Appeals made headlines, holding that a contractor in Michigan receiving funds from the owner on a job could not use bankruptcy to discharge its debts to a subcontractor (or probably a laborer or material supplier) to whom the contractor should have passed along the funds. Patel v. Floorcovering Services, Inc. This holding extended not only to the contractor (a corporation) but to the licensed contractor who guaranteed its debts. The cardinal bankruptcy concept is that the debtor receives a fresh start, with all debts being paid or wiped away by the bankruptcy process. The narrow exceptions to this "discharge" of debts are enumerated in Section 523 of the bankruptcy code. They include certain types of debts (such as student loans, to the chagrin of certain of my law school classmates) and debts resulting from wrongdoing such as "fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny." In Michigan, at least, the misapplication of construction funds received from the owner falls into this category.

A trustee acts in a fiduciary capacity. Under Michigan law, funds paid by an owner for the benefit of subs, laborers or material supplieres are considered trust funds, and the contractor or subcontractor is considered the trustee of the funds. Because the basic rule is that trustees act in a fiduciary capacity, the debts of the contractor (or sub) to his subs, laborers and material suppliers cannot be removed by bankruptcy.

As mentioned in a previous post, bankruptcy courts must make decisions involving both federal and state law. Obviously, the question facing Florida construction professionals is whether Florida law would intersect with federal law in the same way such that Florida contractors would not be able to discharge debts in bankruptcy resulting from the misapplication of funds. In contrast to the recent ruling interpreting Michigan law, when deciding In re Gropp, 153 B.R. 350(Bkrtcy.M.D.Fla.1993), a Florida bankruptcy court reiterated its position that even though Florida law makes misapplication of construction funds a crime, it does not create a "fiduciary" duty such that the debt would be immune to bankruptcy discharge. Although Florida's Section 713.345 (outlawing misapplication of funds) seems to have much in common with Michigan's law at 570.151-153, MCL (outlawing misapplication of funds), the Michigan law can be distinguished because it specifically states that money paid under a construction contract to a contractor (or sub) is considered a trust fund and the contractor or sub receiving the fund "shall be considered the trustee of all funds so paid to him for building construction purposes."

Despite the subtle differences in various state statutes, the Sixth Circuit will have some persuasive authority nationwide. It will be interesting to see if attorneys in jurisdictions outside Michigan (including Florida) attempt to use the Patel v. Floorcovering Services, Inc. decision to expand the scope of debts resulting from wrongdoing that cannot be wiped clean by bankruptcy.

Loss of Construction Jobs in Florida

The Associated General Contractors (AGC) of America has published an analysis of federal construction employment figures and determined that employment has declined in 276 of 337 metropolitan areas in the year ending July, 2010. According to the September 1, 2010 issue of the Orlando Business Journal, this decline was felt at the rate of 8% in the Orlando metro area and 7% throughout the areas analyzed within Florida.

Judge bombs Vista Lakes case

My local news made much of the revelation that the "Vista Lakes" subdivision and surrounding developments were built adjacent to a WWII-era bombing range and that the purchasers of homes in those developments did not learn about the range until it was too late. Property values fell (probably in part due to self-fulfilling media reports of potentially falling property values), and one resident sued several entities including Ryland Homes and the original developer of Vista Lakes.

The Honorable Judge Presnell of the US Distric Court for the Middle District of Florida has held that the plaintiffs case does not create liability under common law negligence. The court recognized that Florida law allows for novel negligence claims, but did not find one in this case. Virgilio v. Ryland Group, Inc., --- F.Supp.2d ----, 2010 WL 503023.

Specifically, the court held found no "affirmative duty on a developer, or on an entity that promotes a residential development, to publicly disclose material facts that may negatively affect the economic value of a home that the developer did not build, own or sell." Furthermore, a party that markets but does not directly sell the property to the purchaser does not have a duty to disclose facts materially affecting value of property which are not readily observable and are not known to purchaser but result only in loss in market value.

If someone drives over an unexploded shell and it explodes, then she might have a negligence cause of action.

Construction Liens in the News

The Orlando Sentinel recently ran an op-ed column written by Greg Dawson bashing Florida's existing Construction Lien Law, focusing on the potential horror stories where homeowners have to pay twice for subcontractor services. This can occur where an owner pays their contractor but the contractor has not paid its subcontractors or material suppliers, and then the unpaid subcontractor places a lien on the property. The column makes some points about problems faced by owners who do not understand the lien law. But first:

The column does not mention that this problem is completely avoidable if the owner obtains lien waivers from the contractor at the time of payment, and that the owner should never be surprised that the subcontractor or material supplier was furnishing labor or materials to the project if the subcontractor or material supplier provides a "Notice to Owner." If no Notice to Owner is provided, before or soon after work is started, then the subcontractor or material supplier has absolutely no lien rights, and the problems Mr. Dawson describes cannot occur. The Notice to Owner is required to say, in big letters, right at the top,

WARNING! FLORIDA'S CONSTRUCTION LIEN LAW ALLOWS SOME UNPAID CONTRACTORS, SUBCONTRACTORS, AND MATERIAL SUPPLIERS TO FILE LIENS AGAINST YOUR PROPERTY EVEN IF YOU HAVE MADE PAYMENT IN FULL.UNDER FLORIDA LAW, YOUR FAILURE TO MAKE SURE THAT WE ARE PAID MAY RESULT IN A LIEN AGAINST YOUR PROPERTY AND YOUR PAYING TWICE. TO AVOID A LIEN AND PAYING TWICE, YOU MUST OBTAIN A WRITTEN RELEASE FROM US EVERY TIME YOU PAY YOUR CONTRACTOR.

If the homeowner reads this notice, they should get an idea of the risks and steps to be taken to protect himself. If he doesn't receive this notice, than there can be no lien on the property. By omitting this information, Mr. Dawson's column presents an unfairly biased perspective.

Mr. Dawson in a subsequent comment published a portion of a letter from a reader who said "I ask for a lien waiver from contractors that do larger jobs for us. I think I've only gotten it once. Either they act like they don't know what I'm talking about, or they flat out don't send it. I guess I could hold out on the final payment until I get the waiver, but this is hard to do when they've done a good job." Rather than upholding this as the popular viewpoint, Mr. Dawson should be enlightening his readers to the idea that paying a contractor without obtaining a lien waiver, particularly when the owner knows to ask for one, is like paying cash for a car and driving away without the title.

It should also be noted that if a contractor is paid and does not pay the subcontractors or material suppliers, he may be subject to sanctions including fines and loss of a license, or in many cases, could be charged with a crime up to a felony. In other words, the contractor can't just keep the money paid by the homeowner and walk away with impunity.

If owners are unwilling to follow the instructions in the Notice to Owner, they can get help from an attorney, or as is more often the case, from their lender. In any construction project that is financed with a construction loan from the bank, the bank will generally ensure that the proper waivers are obtained prior to disbursing funds to the contractor. On a big project, it always helps to have a lender involved for this purpose.

Despite these points that Mr. Dawson does not consider, his views are not without some academic support. Last year, I was excited to see a rare law review article dealing with Florida Construction Lien law. In her note, Didn’t My General Contractor Pay You? Subcontractor Construction Liens in Residential Construction Projects,61 Fla. L. Rev. 151, Heather Howshedell made arguments for changes to the lien law which, although much expanded and well researched, boiled down to those in Mr. Dawson's editorial. Although I understand the difficulties that owners sometimes face, I cannot agree that the teeth of the lien law should be removed in all residential projects.

In my practice, I come into contact with many subcontractors who are not lawyers and have just as much trouble understanding and enforcing lien rights as the owners have in avoiding liens. The lien law is technical. The subcontractors often put substantial cash into projects, up front, to pay for materials and workers before they are paid by the contractor. If the contractor does not pay, the lien law is critical in obtaining payment. In many cases, the owner has NOT paid the contractor due to some dispute that has nothing to do with the labor, material, or services provided by the subcontractor, and the liens are an important tool in avoiding unfairness to the subcontractor resulting from some dispute between the owner and a contractor that is not his fault.

The solution, in my opinion, is not to have the legislature remove or even substantially change the lien law. Relatively simple steps can be taken by the owner to prevent problem liens. However, owners are not educated about these steps and apparently do not read or understand the warnings in the Notice to Owner. Accordingly, I would support changes in the law to educate owners about their rights and responsibilities without hurting the small businesses that rely on the lien law to ensure payment.

Construction Liens and Bankrupt Owners

A construction lien is a lien on title to property in favor of someone who has supplied labor or materials that improve the property. In easier terms, if a plumber installs pipe, he may have a lien on the property for the price of the pipe and labor, so that if he is not paid, he can file a lawsuit asking a judge to order the sale of the property to pay the plumber out of the sale price. It is difficult enough for a contractor, such as our plumber, to follow the technical rules which must be observed under Florida law in order to be able to enforce the lien rights. Many contractors will give up on lien rights altogether if the owner of the property files bankruptcy. Representing contractors, subcontractors, and material suppliers, I encounter frustration and confusion in situations where a contractor has carefully protected its construction lien (or rights to record a claim of lien) and the owner files bankruptcy.

Except on federally funded projects where the Miller Act kicks in (a situation quite beyond the scope of this post), my experience is that most construction lien and bond litigation generally involves the application of state law. However, if an owner files bankruptcy (an unfortunately common occurrence in recent Florida history), a contractor or other construction lienor has to deal with the intersection of state law and the Federal Bankruptcy Code. Even though bankruptcy is a federal law, the bankruptcy courts must often apply state laws to determine the debtors rights and the rights of various creditors.

Ideally, the claim of lien was recorded prior to the filing of the bankruptcy. In this event, the lienor (e.g., our plumber) is a secured creditor in the bankruptcy, and the lien may be enforced if the bankruptcy is dismissed.

However, in many cases, a lienor is taken by surprise when the owner files bankruptcy, and while the lienor hasn't been paid yet, he hasn't recorded his claim of lien either. Most creditors are familiar with the idea that a bankruptcy filing immediately prevents any collection action. This is because of the "automatic stay" provision of the bankruptcy code (§ 362), which creates penalties from any person who attempts to collect from the debtor, sue the debtor, or create liens against the debtor. However, there is a limited exception which allows a lien to be perfected (to "perfect" a lien means to take steps, such as recording a claim of lien, to make the lien effective against third parties and the debtor) even after the bankruptcy filing if the lien would relate back to some time prior to the bankruptcy filing. A construction lien relates back to (in other words, is effective as of the time of) the notice of commencement. Therefore, in some situations, a lienor may record his claim of lien after the bankruptcy filing if there is a notice of commencement on the project recording prior to the bankruptcy filing.

Even so, a lienor in this situation should talk to his lawyer to be sure that the technical bankruptcy (and state law) rules are being carefully followed. Consequences for fraudulent liens and violations of the stay are severe. (Never ever rely on this blog to make legal decisions -- these posts are not legal advice).

A sophisticated reader of this post might think that I've missed the forest for the trees. Even if a lienor goes to the expense of recording the claim of lien, no action can be commenced to enforce the lien while the bankruptcy is pending, and the lien will expire after a year, even if the bankruptcy is still going. Nevertheless, the right to record a claim of lien will be lost if it is not done within 90 days of final furnishing (under Florida law), and it would be doubly annoying if the time for recording expired and the bankruptcy was abandoned by the debtor or dismissed by the court for some reason. Further, a perfected lien may put the lienor, such as our plumber, in a better position compared to other unsecured creditors in the bankruptcy. In some cases, the bankruptcy court could allow a lienor "relief from stay," and by doing so let a lienor enforce the lien in court despite a bankruptcy (this is admittedly in limited situations).

In sum, a construction lienor who faces the loss of substantial lien rights may wish to consider consulting an attorney about the possibility of recording a claim of lien even after the owner files bankruptcy.

Condo Association allowed to pursue construction bond

In an interesting split decision, the 1st District Court of Appeal has decided that, under Florida law, a condominium association may sue under a performance bond issued by a surety in favor of a developer and enforcable only by the 'owner and its ... successors'.

In a decision yet to be published (Marseilles Condominium Owners Ass'n, Inc. v. Travelers Cas. and Sur. Co. of America --- So.3d ----, 2009, App. 1 Dist., October 30, 2009), the majority held that the condo association is a "successor" to the owner (the developer) who may enforce the bond. This is interesting; as the dissent points out, the association does not typically step into the shoes of the developer except insofar as it ultimately manitains and controls the common elements of the condo -- the association is not a successor in ownership (it never owns the units or the common areas). Therefore, doesn't it seem like a stretch to deem an association which is not a successor in ownership to be a party able to enforce a bond which expressly limits its protection to the owner and its successors?

The Wall Street Journal reported today that 1 in 7 households with mortgages are either in the foreclosure process or delinquent in payment on their first mortgage. Based on data from the Mortgage Bankers Association, this report suggests that delinquencies are at a new highest rate since the beginning of the present 'crisis.' As existing home sales and the broader economy recover, a solution for homeowners without the ability to pay for their homes has yet to arrive.

Kelo, 4 years on

Goverment Attorneys and libertarians alike recall that four years ago, the Supreme Court upheld the condemnation of property for economic development in Kelo v. City of New London. The leaders of New London, CT, envisioned the replacement of a residential neighborhood with new condos and offices to enhance and support a nearby Pfizer facility. The court held that the city of New London was not prohibited from taking land from one private owner to turn it over to another in the name of this redevelopment project. This was a landmark eminent domain opinion which offended many Americans and touched off a wave of state-level legislation across the nation limiting the scope of condemnation powers. (In Florida, we amended the constitution to say that "private property taken by eminent domain ... after January 2, 2007, may not be conveyed to a natural person or private entity except as provided by general law passed by a three-fifths vote of the membership of each house of the Legislature.")

It was pointed out Wednesday, in a Wall Street Journal opinion piece (which called the Kelo decision "one of the worst in recent years"), that Pfizer has decided to shut down its R&D headquarters in New London, CT, and the condemned neighborhood stands bulldozed and vacant.

While it sparked outrage, the Court's opinion may very well have been constitutionally sound, and, ultimately, the political process worked; the Kelo story helped to raise awareness and spur the legislative shift toward restricting condemnation powers. But that doesn't help Ms. Kelo.

Proposed Change to Fla. RCP 1.110(b)

The Florida Supreme Court's Task Force on Residential Mortgage Foreclosure Cases made oral arguments to the Florida Supreme Court last week and requested, among other things, a change to the rules of procedure to require residential foreclosures to be instituted by a 'verified' complaint -- in other words, requiring the Plaintiff to swear to the contents of the initial pleading. The court seems to be perceiving that many high-volume foreclosure firms bring suits in a loose and disorganized manner, and the testimony pointed to the "lost note" count that is almost invariably included in foreclosure complaints despite the fact that the plaintiff is usually able to 'locate' the note at the last minute. As any attorney who practices in the foreclosure field knows, this perception is accurate in many cases, and some foreclosure matters are handled without the professionalism that should be expected from attorneys. Nevertheless, it is not clear why foreclosures ought to be subject to standards different from those imposed on the parties when commencing any civil matter. Don't the rules of professionalism, 57.105, and other standards already in place and applicable to ALL civil actions provide the necessary incentives to ensure accurate pleading?

FHA lending to more condo purchasers?

The FHA has decided to relax underwriting criteria for loans secured by residential condominiums, the Miami Herald reports. Every little bit helps... Perhaps traditional bank lenders will one day follow suit, even for loans that are not federally insured.

Changes to Construction Defects statute

Last week, changes to Chapter 558, Florida Statutes, became effective. Chapter 558 was enacted in 2003 to provide an alternative dispute resolution process to supposedly reduce the need for litigation by requiring a person who is making a damage claim for construction defects to follow certain procedures before initiating litigation. In short, before a property owner may sue a contractor, the property owner is required to notify the contractor of the defect and give the contractor an opportunity to examine the defect (including examination requiring destructive testing). If the contractor agrees that there is a defect, he is given an opportunity to repair it or offer to settle the matter. If the parties still disagree, the property owner may file his lawsuit. These procedures apparently applied to all construction contracts irrespective of the desire of the owner and contractor, though there was some ambiguity as to whether the legislature intended it that way. The recent bill changes Chapter 558 while preserving the basic concept.

The most important change, as far as my clients tend to be concerned, is that the notice that previously was mandated for all contracts for improvement is now optional if the parties agree in writing to opt out, and that in the event that the parties do opt out, the notice provisions do not apply to the contract. The bill also clarifies that Chapter 558 is generally inapplicable to projects prior to completion (C/O). Finally the bill prohibits Chapter 713 liens for persons who do destructive testing or for restoration work, raising interesting questions but having little practical significance. (I can think of instances where a contractor or materialman would be hired to do restorative work or furnish materials after destructive testing, unaware that the project is restorative in nature and provides no lien rights).

The changes to the law are an improvement insofar as ambiguity has been removed and the parties may contract around its provisions.

News to no one: Record Foreclosures in Lake

The Orlando Sentinel yesterday confirmed what I suppose we all knew: Lake foreclosures shatter record-bad mark again. 878 foreclosures set the record for volume in 2006; incredibly, there have been 4,965 foreclosures this year (2009) in Lake County (through the end of October). The article suggests that the rate of increase is slowing -- nice news, but one wonders how much of the change in change is a temporary result of the drastically increased foreclosure filing fees instituted earlier this year. Here's hoping the trend continues and that the constructions and real property markets can be extracted from flux...