DOOR AND MATERIALS COMPANY v. Benjamin Levitt, doing business as Central Valley Sheet Metal Co., E. A. Cornell and Clovis Lumber Co., Cross-defendants and Appellants.

Reset A A Font size: Print

District Court of Appeal, Fifth District, California.

A–1 DOOR AND MATERIALS COMPANY, a corporation, Plaintiff, Cross-defendant and Respondent, v. FRESNO GUARANTEE SAVINGS & LOAN ASS'N, a California corporation, Defendant, Cross-complainant and Appellant, M. Kellner & Son Lumber Co., Walker Insulation Co., and Edward H. Martin and Chester L. Raypholtz, individually and doing business as Fresno Roofing & Lumber Co., Cross-defendants and Respondents, Benjamin Levitt, doing business as Central Valley Sheet Metal Co., E. A. Cornell and Clovis Lumber Co., Cross-defendants and Appellants.

Civ. 263.

Decided: January 27, 1964

Docker, Docker, Perkins & Shelton and John M. Shelton, Fresno, for defendant, cross-complainant and appellant. Burke & LaRue, Clovis, Doty, Quinlan & Kershaw, and William R. Quinlan, Fresno, for cross-defendants and appellants. Clifford R. Lewis, Sacramento, for plaintiff, cross-defendant and respondent. Meux, Gallagher, Baker & Manock and Kendall Manock, Fresno, for cross-defendants and respondents.

This action was submitted to the trial court upon a stipulation and agreed statement of facts reflecting that Fresno Guarantee Savings and Loan Association made three construction loans to James L. Clark and Dolores A. Clark, his wife. Each loan was for the purpose of improving a separate parcel of real property, and each was secured by a deed of trust on the particular parcel. The owners assigned the loans back to Guarantee, with a ‘building loan agreement’ which provided for disbursement of each loan in five equal payments according to progressive stages of completion of the buildings.

After four progress payments had been made, work stopped on all three parcels. There remained in Parcel No. 1 construction fund $4,338.10, and in each of the other two $1,961.28. Unpaid mechanics and materialmen either filed bonded stop notices with Guarantee pursuant to Code of Civil Procedure section 1190.1(h), or recorded mechanics' liens for the following amounts:

Parcel No. 1

Bonded Notices to Withhold

M. Kellner & Son Lumber Co.—filed June 2, 1961

$1,747.26 with interest at 7% from April 20, 1961

A–1 Door and Materials Co.—filed June 19, 1961

$1,721.40 with interest at 7% from June 19, 1961

Walker Insulation Co.—filed July 18, 1961

$936.41 plus interest

Recorded Labor or Material Lien

E. A. Cornell

Recorded June 15, 1961, $695.

Parcel No. 2

Bonded Notices to Withhold

A–1 Door and Materials Co.—filed June 19, 1961

$871.19 with interest at 7% from June 19, 1961

Fresno Roofing & Lumber Co.—filed July 17, 1961

$248.00 with interest at 7% from April 20, 1961

Recorded Labor or Material Liens

Benjamin Levitt (Central Valley Sheet Metal Co.)

Recorded May 24, 1961, $472.18

Clovis Lumber Co.

Recorded June 16, 1961, $895.23.

Parcel No. 3

Bonded Notices to Withhold

A–1 Door and Materials Co.—filed June 19, 1961

$871.18 with interest at 7% from June 19, 1961

Fresno Roofing & Lumber Co.—filed July 17, 1961

$248.00 with interest at 7% from April 20, 1961

Recorded Labor or Material Liens

Benjamin Levitt (Central Valley Sheet Metal Co.)

Recorded May 24, 1961, $472.18

Clovis Lumber Co.

Recorded June 16, 1961, $920.03.

Respondent A–1 Door and Materials Company filed an action against Guarantee to recover the amount claimed by its bonded stop notices. Guarantee then filed a cross-complaint, naming as cross-defendants all unpaid mechanics and materialmen known to it, seeking directions for the disbursement of the fifth progress payment as to each of the three construction funds. Only those mechanics and materialmen whose claims are listed above appeared in the action.

The court found that the bonded stop notice claims were prior liens against the fund, ahead of all other classes of claims, but held that all claimants within the class share the fund pro rata. The court found that the mechanic lienholders acquired an equitable lien against the fund, inferior to bonded stop notice claims; this class of claimants to share pro rata.

The court went a step further and found that Guarantee, as lender and fundholder, had an equitable lien against the building fund, measured by the reasonable cost of completing construction. Although the equitable lien of Guarantee was determined to be subordinate to bonded stop notice claims, it was ordered pro rated with the equitable lien claims of mechanic lienholders.

Interest was allowed on all classes of claims.

Code of Civil Procedure section 1190.1, subsection (h), permits a mechanic or materialman to serve upon the holder of a construction fund a notice to withhold funds sufficient to pay his claim ‘in any instance in which the funds with which the cost of the work of improvements are, wholly or in part, to be defrayed from the proceeds of a building loan, * * *.’ The notice may be given to the ‘mortgagee, beneficiary under deed of trust, or assignee or successor in interest of either, or to any escrow holder or other party holding any funds furnished or to be furnished by the owner or lender or any other person as a fund from which to pay construction costs or arising out of a construction or building loan, * * *.’ The section further provides that if one who files a notice to withhold also furnishes a bond as prescribed therein, the holder of the fund upon whom the notice is served is under an obligation to withhold funds sufficient to answer such claim.


Guarantee first contends that since no work was done after the fourth progress payment, the fifth payment was not payable under the terms of the agreement and therefore not subject to liens. That is to say, the bonded stop notices ‘caught nothing’ because of the ‘Assignment and Progress Payment Agreements' between the owners and the lender.

Insofar as the argument relates to claims under Code of Civil Procedure section 1190.1(h), precisely this question was determined, adversely to Guarantee's position, in Rossman Mill & Lumber Co., Ltd. v. Fullerton Sav. & Loan Assn., 221 A.C.A. 849, 34 Cal.Rptr. 644. We held in Rossman that Code of Civil Procedure section 1190.1(h) cannot be negated by an owner assigning the building fund back to the lender with a progress payment agreement, even though the agreement may control disbursements from the fund as between them. The rationale of Rossman is likewise applicable to equitable liens which emanate from recorded mechanics' liens. We shall discuss later the right a mechanic lienholder has to assert an equitable lien against a construction fund, a right that originated by a Supreme Court decision which recognized inadequacies in the then existing mechanics' lien laws. Suffice it to say at this point that the decisional doctrine of mechanics' equitable liens is remedial, just as is Code of Civil Procedure section 1190.1, and the reasoning of the Rossman case, supra, as to this issue is applicable to both bonded stop notice claims and mechanics' equitable lien claims. Neither lien can be frustrated by assignment of the fund to the lender with a progress payment agreement of the sort before us.


The contention of some of the claimants that the fundholder incurred personal liability reaching beyond the fund it holds, even though there was no violation of Code of Civil Procedure section 1190.1 (h), is untenable. The question arises since there is insufficient money remaining in the three construction funds to pay the total claims with interest. Liens, whether asserted under section 1190.1(h) or pursuant to the mechanics' equitable lien doctrine, are derivative and directed against the building fund, not the fundholder. Therefore enforcement of such claims is limited to the fund upon which they are a lien, unless the holder by act or by agreement assumes liability, or unless the holder incurs personal liability by violating the provisions of section 1190.1(h). In the Rossman case, supra, and in Calhoun v. Huntington Park First Sav. & Loan Assn., 186 Cal.App.2d 451, 9 Cal.Rptr. 479, the fundholders incurred personal liability because they failed to withhold funds after being served with stop notices and bonds. Since Guarantee here complied with Code of Civil Procedure section 1190.1(h) and since there is nothing in the record disclosing assumption of personal liability, the trial court correctly determined that Guarantee is not personally liable for any of the claims asserted.


The allowance of interest on all claims, whether based on bonded stop notices or recorded mechanics' liens, is challenged, but we find no error, except as to proration of interest. The law of contracts provides for interest from the date an obligation becomes due. (Civ.Code §§ 3287, 3302.) This general rule has been followed in mechanics' lien foreclosures (32 Cal.Jur.2d § 173, p. 808), and interest prior to judgment has been awarded in such actions. (Meda v. Lawton, 217 Cal. 282, 285–286, 18 P.2d 665.) In the case of Calhoun v. Huntington Park First Sav. & Loan Assn., supra, interest was allowed in an action founded on a fundholder's personal liability for failing to honor a bonded stop notice claim.

The trial court in the case before us properly applied the rules relating to interest in contract and mechanic's lien actions. However, in those instances where the fund is insufficient and there must be proration of claims, interest up to the time of judgment is to be included in the total amount of each claim to be prorated. Absent personal liability for the principal amount of the claim, it follows that the fundholder incurs no personal liability for interest.


Appellants whose claims stem from recorded mechanics' liens argue that those respondents whose claims rest on bonded stop notices are precluded from any recovery by their failure to either record a mechanic's lien and pursue it to judgment, or to file an action on their verified stop notice claims. Apparently this argument is based on certain language found in Code of Civil Procedure section 1190.1(h) that relates to the stop notice bond or undertaking. It is provided that if the defendant ‘recovers judgment in an action brought on said verified claim or on the lien filed by the claimant’ the bond assures payment of all damages as specified by the statute. The language, taken out of context as it is, refers to nothing other than an undertaking for the protection of the fundholder, and in no way prescribes the manner in which a claimant must proceed to enforce a claim after filing a bonded stop notice. But even assuming, without deciding, that appellants are correct, the rights of all claimants here were determined by a declaratory relief action. The suggestion that such a proceeding is not an ‘action’ establishing a claim within the sense of Code of Civil Procedure section 1190.1(h) is without substance.


It is contended that the mechanic lienholders who did nothing more than record notices of mechanics' liens are not entitled to share in the construction fund because they failed to serve a stop notice on the fundholder in compliance with Code of Civil Procedure section 1190.1(h). The argument misconceives the nature of the ‘equitable lien’ remedy pursued bythe mechanics' lien claimants in this action for declaratory relief. The right to this kind of equitable lien against a construction fund is not predicated upon section 1190.1(h), nor any other statute; rather, the right is a creation of judicial construction.

The case of Smith v. Anglo-California Trust Co., 205 Cal. 496, 271 P. 898, gave birth to the mechanic lienholder's decisional ‘equitable lien’ against a construction fund, a result the Supreme Court reached by a two-step ratiocination. The court first pointed out that the case of Fickling v. Jackman, 203 Cal. 657, 265 P. 810, held that a construction loan lien recorded before material or labor goes into the property, is prior to any subsequently recorded mechanic's lien. From this premise, reasoned the Supreme Court:

‘* * * it seems but reasonable to conclude that the mechanics' lien claimants, knowing or being charged with knowledge of the encumbrances of record against the real property, must have relied upon, excluding the possibility of the security ordinarily afforded by the filing of mechanics' liens, the agreement between Smith and the defendant Securities Company as to the amount to be advanced for building purposes.’ (P. 501, 271 P. p. 900) (Emphasis added.)

Prerequisites to a mechanic's equitable lien against a building fund are, first, a lender's prior lien equal or nearly equal to the value of the property when the improvements are completed, and, second, a mechanic's reliance on the construction loan fund because of the prior lien. Clearly, the first requirement is met in our case, but there is some question as to the second, reliance on the fund. The pretrial order and the stipulation and agreed statement of facts, as well as the findings of fact and conclusions of law are, to say the least, sketchy on the issue of mechanic lienholders' reliance on the construction fund. However, it is apparent from the Smith case that the Supreme Court there had little more to go on than we have here; the court nevertheless concluded that the mechanics' lien claimants ‘must have relied upon’ the building fund. Approaching our case in the liberal spirit manifested by the Supreme Court in Smith, we conclude that the issue was properly raised and the finding that mechanic lienholders have an equitable lien against the building fund is supported by the stipulation and agreed statement of facts.

Before concluding our discussion of a mechanic lienholder's equitable lien against a construction fund, we point out that the doctrine was not repealed expressly or impliedly by the enactment of Code of Civil Procedure section 1190.1(h) and, further, that this judicially-created doctrine has not been overruled or modified by decisions subsequent to the Smith case. (See Pacific Ready Cut Homes v. Title I. & T. Co., 216 Cal. 447, 451, 14 P.2d 510; Hayward L. & I. Co. v. Coast etc. Assn., 47 Cal.App.2d 211, 117 P.2d 682.)


Our determination that the mechanic lienholders have equitable liens against the construction fund brings us to the contention of the bonded stop notice claimants that they are entitled to priority over the mechanics' lien claimants. Mechanic lienholders, arguing for pro rata distribution among claimants of all classes, assert that Code of Civil Procedure section 1190.1(h) gives a mechanic or materialman nothing more than an opportunity to file a stop notice with the fundholder. Thus, it is argued, priority is predicated upon an action to establish the claim, rather than the notice to withhold. Further, they argue that the Legislature was aware of the Smith decision when the statute was enacted and since no mention is made of priorities as between claimants who record mechanics' liens and those who comply with section 1190.1(h), no priority accrues from compliance with the statute.

We agree that the Legislature was aware of the import of the Smith case when it enacted Code of Civil Procedure section 1190.1 since the statute was designed to remedy the patently inadequate protection afforded by a mechanic's equitable lien. That defect, of course, is that recording a mechanic's lien, ipso facto, does not constitute notice to the fundholder. Although recording is a first step which may result in an equitable lien through court decree, the fund is not affected by the recording. To express the critical fact in another way, until the mechanic commences an action in equity the fundholder may ignore the recorded notice of lien and disburse the fund with impunity. The Legislature enacted section 1190.1(h) to protect a mechanic or materialman who must rely on the construction fund. This the statute does by providing that a claimant may file a stop notice and bond with the fundholder, which requires him to withhold an amount sufficient to satisfy the claim. Furthermore, the duty upon the fundholder to withhold pursuant to the bonded stop notice is on pain of personal liability.

Thus the effect of the bonded stop notice, to use the language of the code section, is to immediately create an ‘equitable garnishment’ of the fund. This clothes the bonded stop notice claim with a legal status which does not inure to a mechanic's lien notice upon recording. This impels us to conclude that in a circumstance where a bonded stop notice claim conflicts with a mechanic's equitable lien because both claim the same fund, as here, the claimant who has effected an equitable garnishment of the fund by following the procedure provided by Code of Civil Procedure section 1190.1(h), establishes a prior claim.

An additional and most persuasive reason supporting this conclusion is readily apparent if we apply appellants' argument to a situation wherein a single mechanic or materialman files a stop notice and bond with the fundholder. It is to be anticipated that only an amount equal to the one bonded stop notice will be withheld by the fundholder, since he is under no legal duty to withhold paymants from the fund unless a bond is filed, and absent a bond he suffers no personal liability. Under appellants' theory the amount of the one claim withheld by the fundholder would be shared pro rata by all mechanic lienholders who asserted equitable liens, and they would share despite their failure to file under section 1190.1(h) and prevent depletion of the building fund. Since this result would be neither equitable nor logical, we reject the argument that whatever remains in the building fund is shared pro rata by all classes of claimants.


Respondent A–1 Door and Materials Co. argues that although the court properly held that bonded stop notice claimants enjoy a priority as a class, nonetheless the court erred in holding that all bonded stop notice claimants share their class priority among themselves pro rata. It is argued that subsection (h) of section 1190.1 is silent as to priorities and therefore Civil Code section 3525, which provides that ‘Between rights otherwise equal, the earliest is preferred,’ must prevail. Under this theory bonded stop notice claimants would hold priorities among themselves according to the date each filed his bonded stop notice. The argument does not stand up for two reasons. First, it is contrary to the legislative intent to be gleaned from the other subsections of Code of Civil Procedure section 1190.1, particularly subsection (d) which, like subsection (h), is an implementation of the statutory right to file stop notices against construction funds. Subsection (d) provides for pro rata distribution under circumstances similar to those prevailing under subsection (h), and clearly expresses the tenor of section 1190.1 when viewed in its entirety. Second, to create priorities by date of filing as among members of the same class of claimants would violate the spirit of the mechanics' lien laws in that it would set up a system of priorities according to the nature of the work performed. For instance, a mechanic clearing the lot could establish the first priority, the excavator the second, the mechanics and materialmen who lay the foundation the third, and so on. Mechanics' lien statutes are both remedial and ameliorative and they must be construed with a view to providing relief to the greatest number of persons within the class for whose benefit the statute is designed. (Hendrickson v. Bertelson, 1 Cal.2d 430, 432, 35 P.2d 318.)


Finally, we come to the court's finding and judgment that Guarantee, as lender and fundholder, has an equitable lien against the construction fund, to be shared pro rata with the mechanic lienholders who failed to serve bonded stop notices. The trial court observed that the lender relied on the construction fund to complete the improvements to be placed on the property, just as the mechanics and materialmen relied on the fund to pay for the improvements made by them. But the position occupied by the mechanic lienholders and that occupied by the lender are not apposite, and the result here reached by the trial court cannot be justified by parallel reasoning.

As we have pointed out, Fickling v. Jackman, supra, established the lender's deed of trust as a lien prior to subsequently-filed mechanics' liens. This rule of law motivated the Supreme Court to determine in the later case, Smith v. Anglo-California Trust Co., supra, that a mechanic whoselien is impotent in the face of a prior construction loan deed of trust, is entitled to an equitable lien against a construction loan fund upon which he relies. The doctrine of the case was limited to mechanics and materialmen who relied on the building fund. Our attention has not been directed to any decision extending the doctrine to the lender. This is not surprising for in view of the lender's prior lien on the property that gave rise to the decisional doctrine of mechanics' equitable liens, it would be at least anomalous to hold that the lender also has an equitable lien against the building fund.

Additionally, we see no reason for extending the equitable lien doctrine to a lender who, by agreement with the owner, controls payments from the building fund. As pointed out in Rossman, supra, a lender who controls progress payments can protect mechanics and materialmen who contribute to the construction project. That is to say, he can prevent diversion of the fund to the owner's personal use, thereby protecting the security for his loan while at the same time protecting mechanics and materialmen who rely on the fund. Thus there appears to be no equitable basis for giving a fundholder who has failed to protect his prior lien on the property an equitable lien against the building fund, to be shared with the mechanic lienholders he has failed to protect.

That part of the judgment giving Fresno Guarantee Savings and Loan Association, the lender and fundholder, an equitable lien against the building funds is reversed; that part of the judgment allowing interest on prorated claims is modified to provide that interest to time of judgment shall be included in such prorated claim; in all other respects the judgment is affirmed.

STONE, Acting Presiding Justice.

R. M. BROWN, J., concurs. CONLEY, P. J., deeming himself disqualified, did not participate.