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Court of Appeal, First District, Division 3, California.

STEINY AND COMPANY, INC., Plaintiff and Appellant, v. CITICORP REAL ESTATE, INC., Defendant and Appellant.

No. A075133.

Decided: May 18, 1999

Thelen, Marrin, Johnson & Bridges, Stephen V. O'Neal, Paul W. Berning, San Francisco, for Plaintiff and Appellant. Howard, Rice, Nemerovski, Canady, Falk & Rabkin, Jerome B. Falk, Jr., Therese M. Stewart, Linda Q. Foy, San Francisco, for Defendant and Appellant. California Bankers Association ChristopherE. Chenoweth, San Francisco, Shearman & Sterling, Richard B. Kendall, Los Angeles, for Amici Curiae on behalf of California Bankers Association.

Under California's stop notice laws, must a construction lender make available to a stop notice claimant those amounts the lender has already disbursed to itself for previously accrued interest on the construction loan?   The trial court, following Familian Corp. v. Imperial Bank (1989) 213 Cal.App.3d 681, 262 Cal.Rptr. 101 (Familian ), held that it must.   The court so instructed the jury, which rendered a verdict in favor of the stop notice claimant, respondent Steiny and Company, Inc. (Steiny), and against the lender, appellant Citicorp Real Estate, Inc. (CREI).   We disagree with Familian, and reverse.   In the unpublished portion of the opinion we discuss Steiny's cross-appeal and request for attorney fees.


A. Facts Relevant to the Appeal

In 1987 a consortium of banks, with CREI as lead bank,1 agreed to loan $95 million to Fillmore Center Associates (FCA) for the construction of a residential and commercial development in San Francisco known as the Fillmore Center.   Additional funding for the project came from tax exempt bonds and revenue generated by the project.

The construction loan agreement between CREI and FCA provided for the lender's periodic deposits of the loan proceeds into a construction account “sufficient (i) to pay all of the direct and indirect costs of completing the Work in accordance with the Plans and Specifications, (ii) to satisfy the interest obligations created by and under the Note, and (iii) to pay all costs of operations and maintenance of the Property and the Improvements, including, but not limited to, interest on the Loan, at all times until the Loan is paid in full.”   The loan agreement further provided that funds deposited in the construction account would be disbursed according to a specified order of priority, unless paid by the borrower from other funds.   Disbursement would first pay amounts outstanding under a line of credit loan and related fees and second, would pay monthly interest to the lender as it accrued under the note.2  According to FCA's chief financial officer on the project, provision for the payment of loan interest from the loan proceeds is customary in the construction loan industry.   Each month, FCA would prepare a “draw book” summarizing all of the project costs for the month, including both hard construction costs and soft costs, such as interest.   These draw books served as the basis for CREI's monthly disbursements into the construction fund.

The construction loan closed in 1987 and construction began in 1988.   FCA encountered numerous cost overruns, which ultimately resulted in restructuring of the construction loan in 1989.   Both before and after restructuring, FCA and Steiny, the electrical subcontractor, had disputes regarding the project.   Steiny claimed its costs were higher than originally anticipated because of delays and inefficiencies on the project caused by FCA and the project manager.   Eventually, in December 1990, Steiny served stop notices and mechanic's liens on CREI and FCA claiming it was owed $7.8 million for unpaid amounts under its contract, approved and unapproved change orders, and delay and impact damages.   There is no dispute that at the time Steiny served its stop notice, only $717,000 of the original $95 million remained in the construction loan fund.   As required by the stop notice laws, CREI set aside this remaining amount to satisfy the stop notice.

On December 26, 1990, Steiny, CREI and FCA met to discuss resolution of Steiny's claims.   Further negotiations resulted in a settlement agreement between FCA and Steiny which included the following provision, proposed by counsel for Steiny:  “FCA hereby represents to STEINY ․ that the construction loan from CREI in the approximate amount of $95,000,000 has been fully funded with the exception of approximately $717,000 which has been held by CREI on account of certain stop notices including the stop notice of STEINY.   This representation has been confirmed by letter from CREI to STEINY, attached hereto as Exhibit A.”   The settlement agreement further provided for Steiny to receive $1.3 million for work already completed, for $600,000 to be placed in a separate account to be paid to Steiny for future electrical work on the project and for Steiny to release its stop notice and refrain from filing others until the project was complete.   On January 22, 1991, CREI issued the required certification letter confirming that “in connection with our $95,000,000 construction loan to Fillmore Center Associates, a California limited partnership, the sum of $94,283,000 has been disbursed prior to the date hereof and the sum of $717,000 is being held pursuant to bonded stop notices served on us by Architectural Glass and Steiny and Company, Inc.”   Steiny and FCA complied with the settlement agreement's remaining provisions.

Finally, when in December 1990 it became clear that FCA could not meet its loan obligations and was unable to obtain additional financing to complete the project, CREI recorded a notice of default on the project and thereafter initiated foreclosure proceedings.   FCA filed for bankruptcy in November 1991 and under the plan of reorganization CREI acquired the project for $108.5 million.

Steiny, claiming it was owed additional sums for electrical work on the project, filed an action to foreclose on its mechanic's lien.   In subsequent amendments to its complaint, Steiny asserted various fraud theories against CREI.   In its third amended complaint,3 Steiny claimed that CREI's January 22, 1991, letter certifying $717,000 as the amount of funds remaining in the construction account was fraudulent because it failed to disclose that CREI had paid itself $6.9 million in accrued interest out of the construction loan funds prior to the time of Steiny's stop notice.

On the subject of CREI's duty to disclose interest payments made from loan proceeds prior to service of Steiny's stop notice, the trial court instructed the jury before and after trial that “[u]nder California law, when determining the amount to withhold pursuant to a valid bonded stop notice, a lender who receives such stop notice must take into account not only funds remaining in the construction loan account, but also the amount of any fees and interest it has been paid from the construction loan.  [¶] Steiny through its counsel inquired as to the amount of money reached by its stop notice.   The court has ruled that Citicorp Real Estate had an obligation to either advise Steiny that it was withholding an amount that included the interest and fees or advise Steiny that the amount Citicorp Real Estate said it was holding did not include such interest and fees.”   The trial court's instruction was premised upon its conclusion that Familian disposed of the issue.   The jury found that CREI had defrauded Steiny and awarded Steiny $5 million in compensatory damages but declined to award punitive damages.

B. Discussion

1. Stop Notice Law

California's stop notice laws 4 allow subcontractors, laborers and suppliers of materials the right to serve a stop notice on the owner of a project or on the construction lender. (§§ 3158, 3159.)   When served with a bonded stop notice, the lender is required to withhold from the unexpended balance of the loan fund an amount sufficient to pay the stop notice claimant. (§ 3162.)   Thus, by serving a stop notice the claimant acquires, in essence, a lien against the unexpended balance of the loan fund.   Furthermore, the stop notice claimant obtains priority over any assignment of the construction loan funds, whether the assignment is made before or after a stop notice is served. (§ 3166.) 5  In this way, an owner or lender is prevented from circumventing the stop notice claimant's lien rights, because unexpended amounts in the fund will remain available to satisfy the claim.   It is this provision prohibiting assignment of funds in order to avoid responsibility under a stop notice which was of concern to the court in Familian and to the court below.   It now concerns us as well.

2. Familian v. Imperial Bank

In Familian, a construction lender loaned $3.8 million to finance construction of condominium units.  (Familian, supra, 213 Cal.App.3d at p. 683, 262 Cal.Rptr. 101.)   The loan was secured by a deed of trust on the subject property.  (Ibid.)  During the course of construction, the lender paid itself interest, fees and expenses totaling $528,000 out of a segregated “preallocated” reserve account.  (Id. at pp. 683, 686-687, 262 Cal.Rptr. 101.)   With approximately $188,000 remaining in unexpended construction funds, the lender received bonded stop notices for $105,000 and foreclosed on the property.   Thereafter, it received additional stop notices totaling $427,000.   It interpled the unexpended $105,000, contending that the stop notice claimants were entitled to a pro rata recovery of the fund.  (Id. at p. 683, 262 Cal.Rptr. 101.)

Familian had supplied plumbing materials on the project and was one of the bonded stop notice claimants.   It moved for summary judgment contending that it was improper for the construction lender to maintain a preallocation reserve to pay the costs of the construction loan, to disburse payment to itself from the loan proceeds, to obtain through foreclosure property rendered more valuable because of Familian's supplies, and to then assert it could not pay for the work and materials because the construction funds had already been spent.   The trial court granted summary judgment for Familian.  (Familian, supra, 213 Cal.App.3d at p. 683, 262 Cal.Rptr. 101.)   In affirming on appeal the entry of judgment for Familian, the court made, essentially, two holdings, one with which we agree, and the other with which we do not.   It is this second holding upon which the trial court's jury instruction rested here and which, in our view, requires reversal of the judgment entered for Steiny.

Based upon section 3166 (see fn. 5, ante ), the court in Familian held that the lender's attempt to preallocate a portion of the construction loan fund for the payment of loan interest and fees was ineffective as against the stop notice.  (Familian, supra, 213 Cal.App.3d at pp. 685-688, 262 Cal.Rptr. 101.)   It held, and with this we agree, that the preallocation and segregation of funds to pay unearned loan fees, interest and other “soft” costs constituted an assignment of funds and could not take priority over a stop notice claim.   The court went on, however, to a second unsupportable conclusion.   It held further that disbursements already paid to the lender for loan fees, points and interest already earned also constituted an assignment within the meaning of section 3166 and could be recaptured to pay stop notice claimants.  (Id. at p. 688, 262 Cal.Rptr. 101 [“We hold that ․ periodic disbursements to the lender are assignments within the meaning of section 3166.”].)

 To state that an amount already disbursed to pay an accrued debt can be characterized as an “assignment” goes contrary to the meaning ordinarily given that word, that is, a transfer of a right to something that has not yet become property in possession.  (See 7 Cal.Jur.3d, Assignments, § 1 (1989) p. 7;  Estate of Beffa (1921) 54 Cal.App. 186, 189-190, 201 P. 616.)   Yet Familian offers no explanation for its extension of the definition;  it simply fails to explain how payment of amounts due and owing can constitute an assignment.6

 The only assignment at issue in the case before us also does not assist respondent.   Immediately preceding the provision in the construction loan agreement specifying the manner and priority of funds disbursement, the agreement contains the following provision:  “The Borrower irrevocably assigns to the Lender as security for the due performance of this Agreement all of its right, title and interest in and to the Construction Account and the monies placed therein to be held pursuant to the terms hereof.”  (Italics added.)   This omnibus assignment provision does nothing to bring the construction fund within Familian 's holding.   The assignment of the entire construction account provided additional security for FCA's performance under the loan agreement.   It did not supply the legal basis for CREI's periodic disbursement of money into the construction fund to cover all expenses, including interest payments and direct costs of construction.   Rather, such payments were made on a regular basis pursuant to the terms of the loan agreement and in response to the monthly draw books submitted by FCA to CREI which specified the current amount of FCA's debt.   Thereafter, also pursuant to the provisions of the loan agreement, FCA was under a contractual obligation to pay its construction related debts out of the available loan proceeds.   Once funds were paid pursuant to the loan terms, they were no longer a part of the construction account, and were, therefore, not subject to the assignment.   If Familian were carried to its [il]logical conclusion then all amounts paid out of this account, allegedly created by virtue of the assignment in the construction loan agreement, would be subject to recapture and made available to pay the stop notice claimant, including those amounts already paid to the claimant from periodic disbursement of the fund.

 As a reason for its decision the court in Familian stated:  “A construction lender would need only to deduct its profits at the inception of the loan to assure a double recovery at the expense of those who enhance the value of the property by supplying labor and materials.”  (Familian, supra, 213 Cal.App.3d at p. 687, 262 Cal.Rptr. 101.)   This comment suggests to us that the Familian court failed to draw a crucial distinction between funds actually paid on accrued debt and funds made the subject of an assignment for purposes of securing the debt.   If the deducted profits referred to are amounts actually paid out to the lender, that is, if they are in fact placed in the lender's possession and control, then they cannot also be the subject of an assignment, which implies a future, anticipated right to possession.   Therein lies the essential flaw in Familian 's reasoning:  an amount paid is not an amount assigned.

 In conclusion, we hold that Familian does not withstand careful scrutiny.   Payments for interest and loan fees legitimately incurred and disbursed prior to service of a stop notice do not constitute an assignment within the meaning of section 3166.   Because we disagree with the holding in Familian, we hold that the trial court erred in concluding that under Familian CREI had a duty to disclose to Steiny that it had previously paid itself earned interest in the amount of $6.9 million.7  We therefore reverse the judgment entered in favor of Steiny which was premised on the jury's finding that CREI acted fraudulently in concealing that fact from Steiny.   Given our holding regarding Familian 's inapplicability and resulting reversal, we do not reach CREI's remaining grounds for appeal.



On CREI's appeal we reverse the judgment entered for Steiny.   On Steiny's cross-appeal we affirm in all respects.   CREI shall recover its costs on the appeal and cross-appeal.   As to Steiny's appeal from the trial court's denial of attorney fees, we reverse as to request for admission No. 57 and affirm in all other respects.   The matter is remanded to the trial court for a determination of the amount of attorney fees to be awarded Steiny under Code of Civil Procedure section 2033, subdivision (o).   On this last appeal, each side shall bear its own costs.


1.   The other banks included Bank of Nova Scotia, Sumitomo Trust and Banking Company, Limited, Dai-Ichi Kangyo Bank, Limited, and Sanwa Bank, Ltd.

2.   The sixth disbursement priority was to pay appropriately documented direct costs on the project.

3.   At the time of trial a fourth amended complaint had been filed containing essentially the same allegations.

4.   California's stop notice laws are contained in Civil Code sections 3156-3267.   Unless otherwise specified, all further statutory references will be to the Civil Code.

5.   Section 3166 states:  “No assignment by the owner or contractor of construction loan funds, whether made before or after a stop notice or bonded stop notice is given to a construction lender, shall be held to take priority over the stop notice or bonded stop notice, and such assignment shall have no effect insofar as the rights of claimants who give the stop notice or bonded stop notice are concerned.”

6.   None of the cases relied upon by the Familian court and cited by respondent here considered the issue now before us.  Calhoun v. Huntington Park First Sav. & Loan Assn. (1960) 186 Cal.App.2d 451, 9 Cal.Rptr. 479 held that a construction lender may not invalidate the effect of service of a stop notice by thereafter transferring construction loan funds to other creditors or using them to advance their own interests.   (Id. at pp. 459-460, 9 Cal.Rptr. 479.)   The case did not involve or discuss the effect of a stop notice on funds disbursed prior to its service.  Rossman Mill & Lbr. Co. v. Fullerton S. & L. Assn. (1963) 221 Cal.App.2d 705, 34 Cal.Rptr. 644 also did not discuss the propriety of pre-stop notice disbursements.   It held that the lender and borrower could not set up a building fund to control disbursements according to their private agreement, thereby nullifying the stop notice provisions.  (Id. at pp. 709-710, 34 Cal.Rptr. 644.)   Similarly, Miller v. Mountain View Sav. & L. Assn. (1965) 238 Cal.App.2d 644, 48 Cal.Rptr. 278 and A-1 Door & Materials Co. v. Fresno Guar. Sav. & Loan Assn. (1964) 61 Cal.2d 728, 40 Cal.Rptr. 85, 394 P.2d 829 (A-1 Door ) did not hold that pre-stop notice disbursements could be recaptured to pay stop notice claimants.   In A-1 Door the owners had assigned the loan fund to the lender, who agreed to use the fund to make periodic payments.   After a substantial portion of the fund had been disbursed construction ceased.  (Id. at p. 731, 40 Cal.Rptr. 85, 394 P.2d 829.)   The lender retained the unexpended funds and contended it had the right to apply those undisbursed funds to reduce the owner's debt or complete construction without regard to stop notice claims.  (Id. at pp. 731-732, 40 Cal.Rptr. 85, 394 P.2d 829.)   The court held that once the stop notice claims were filed the lender was required to withhold from the undisbursed funds amounts sufficient to pay the claims.  (Id. at p. 734, 40 Cal.Rptr. 85, 394 P.2d 829.)

7.   We do not fault the trial judge for his ruling.   He was, of course, bound to follow the law as it existed at the time the issue was presented to him.   We, however, are not constrained to follow an appellate decision which we consider to be poorly reasoned.  (McCallum v. McCallum (1987) 190 Cal.App.3d 308, 315-316, fn. 4, 235 Cal.Rptr. 396.)

FOOTNOTE.   See footnote *, ante.


CORRIGAN, Acting P.J., and PARRILLI, J., concur.

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