Lenders on commercial real estate projects typically require that the general contractor subordinate its mechanics’ lien rights to the lender’s deed of trust and other financing documents in order to assure the lender that its security interests in the project will have priority over any mechanics’ lien rights of the general contractor. While the general contractor is not in privity with the lender under the construction loan documents per se, the typically required subordination, consent and assignment agreement that is a condition from the lender to make the construction loan directly places the general contractor in privity with the lender in enforcing the terms of the subordination, consent, and assignment agreement.

The impacts that subordination agreements have on general contractors are significantly exacerbated in challenging economic times - foreclosures become a reality and contractors are more truly at risk without the protection of their mechanics’ lien rights. Under these circumstances, most often there is little the general contractor can do to protect itself from having its mechanics’ lien rights primed by the lender. There are, however, practical suggestions regarding the subordination agreement in order to place the general contractor in the most advantageous position it can be in the event of an owner’s loan default.

1. Carefully review the progress payment procedures in place as part of the lender’s loan to assure that there will not be delays in receiving progress payments, and that the forms of partial lien waivers and other progress payments documents are clearly identified.
2. Have a clear understanding that the lender’s construction loan budgets are lining up with the general contractor’s budgets and that the owner has sufficient equity at stake in the project to make certain that there are no contemplated shortfalls in the budgets, at least as the budgets are determined at the time of the closing of the construction loan.
3. Try to strike from the subordination agreement any broad grants to the lender of a power of attorney on behalf of the general contractor, especially in dealing with subcontractors.
4. Make sure the change order procedures are understood by all parties and that there is no confusion as to when a change order will be required and what documentation will be a condition to the change order.
5. Clearly define the general contractor’s rights to retainage toward the end of the project, as well as the conditions the lender will require for disbursement of retainage.

California courts have clearly held that subordination agreements are enforceable as long as the agreement to subordinate is clearly laid out, and the general contractor knowingly waived its mechanics’ lien rights.¹ As a result, general contractor challenges to the enforceability of subordination agreements will most likely not be successful absent some unique circumstances. Nevertheless, taking the time to clarify the types of issues described above will at least provide the general contractor with some modicum of protection in waiving its mechanics’ lien rights.

^[1] See Moorefield Constr., Inc. v. Intervest-Mortg. Inv. Co., 230 Cal. App. 4th 146, 178 Cal. Rptr. 3d 709 (2014) (A general contractor’s agreement to subordinate its mechanic’s lien to construction loan deed of trust was a valid exercise of contractor’s right to waive or impair its own mechanic’s lien rights despite California statutory protection against the waiver or impairment of mechanic’s lien rights. The court emphasized, whether or not correctly, that the plain language of the statutory mechanic’s lien protections applied only to subcontractors and suppliers and that general contractors are generally protected by other statutes).