Daily Development for Thursday, March 23, 2000

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
randolphp@umkc.edu

MECHANICS LIENS; LIABILITY OF LANDLORD'S ESTATE Generally speaking, a mechanic's lien based upon a tenant's failure to pay attaches only to the leasehold estate, but where a landlord knows of tenant's financial instability during construction of leasehold improvements and takes no action to stop construction or to alert subcontractors to the problem is estopped from asserting the termination of the lease as a defense to the subcontractor's claims, since the landlord will retain the benefit from the leasehold improvements at the expense of the mechanic's lienholders.

Franksen v. Crossroads Joint Venture, 599 N.W. 2d 603 (Neb. 1999)

According to the court's analysis of the facts of this case on de novo review, Landlord, owner of a retail mall, desired to have a full service restaurant. It had been in negotiations with Tenant for an ice cream parlor, and asked Tenant to consider instead a more elaborate full scale restaurant. Landlord agreed to various concessions if Tenant would make the improvements for such a restaurant, including rent reduction, allowances, a substantial loan, and a cash payment, all contingent upon Tenant completing the improvements lien free.

The facts are vague as to whether the precise improvements in question were required by the lease, although clearly, if Tenant were to make any improvements, compliance with Landlord's extensive standards was required, and Landlord regularly reviewed and approved the plans and specifications. Although the parties were slow getting the final lease approved, Landlord permitted Tenant to commence construction of the improvements even without a lease.

When the lease was finally ready for signing, Tenant submitted it without the signatures of two anticipated guarantors. Discussion ensued, since it was clear to all that Tenant alone lacked the financial wherewithal to insure completion of the improvements and carrying out the lease obligations. Tenant promised that an SBA loan was in the offing, and Landlord verified that negotiations for such a loan were under way, but failed to ascertain that there were conditions to that loan that Tenant was unlikely to meet. For some period of time, Landlord dithered, and said nothing to the subcontractors, who continued to work on the improvements. Later, Landlord signed the lease despite the fact that the financial strength of Tenant was still in question.

Still later, a confrontation between the subcontractors and Landlord's agent occurred, in which allegedly Landlord's agent implied that the agent would pay for the improvements in Tenant did not, and from this the subcontractors got the impression that Landlord itself would be good for the costs.

Of course, in the end Tenant did not pay the subcontractors, who stopped work, causing a termination of the lease. Subcontractors argued that they were entitled to a lien against the property in the hands of Landlord.

The court speaks of the subcontractor's theory as a form of "equitable merger" because the tenant's estate merges into the greater landlord's estate, the mechanic's lien against the tenant's estate becomes a lien on the fee.

Whatever the technical description of the theory, the basis for the court's conclusion that the mechanic's liens were good against the fee was estoppel based upon Landlord's permitting the construction to proceed at a time when it knew that Tenant likely could not pay the costs, and Landlord ultimately benefitting unjustly from the completion of the improvements.

It appears to be important to the court's theory here that Landlord indeed did derive a benefit from the improvements, even though much of them related to a restaurant that was not defunct, and there is elaborate discussion of the appraisal evidence.

Comment 1 In many jurisdictions, the simple facts that the lease requires the tenant to make the improvements and that the improvements will remain on the premises at lease end are enough to justify the conclusion that the liens attach to the landlord's fee interest. In this case, however, the lease was to be for fifteen years, so perhaps at lease end there would have been little benefit to Landlord, and in addition, as noted, it is unclear whether the lease affirmatively required the exact improvements conducted by Tenant. It may simply be that Nebraska does not permit its mechanic's lien statute to permit landlords to be subjected to liens on these facts alone.

Comment 2 The editor admits to some confusion about calling the doctrine that the court adopts "equitable merger." Normally, if merger were to occur, the (unencumbered) landlord's estate would swallow up the tenant's estate, and any mechanic's liens attached to the tenant's estate would be destroyed. But in Nebraska, the conclusion that merger has occurred appears to result in the liens attaching to the merged estate. Demonstrates again that the concept "merger" doesn't really advance the issue very much, and the editor reiterates that we really ought to call it something else. The editor has suggested that in some instance we call it "Bubba." But here, we could call it simple "unjust enrichment."

Comment 3 Although there is some evidence of estoppel comments by Landlord's agent, these don't appear to be dispositive here, because if they were it would not be necessary to explore whether Landlord benefitted from the subcontractor's work. It would be enough that the subcontractors continued to work in reliance upon the Landlord's assurance of payment.

Comment 4 Thus, we are left with the somewhat amorphous notion that a landlord will be liable for tenant improvements when the landlord lets the tenant arrange for the work to be done with the knowledge that the tenant probably can't pay and the landlord ultimately benefits. Apparently this theory could apply even when the lease does not expressly require that the improvements be carried out.

On the special facts here, there is some reason to conclude that the theory is properly applied, but the editor admits to some uneasiness that landlords can be slugged with the costs of tenant ordered improvements so easily. The appraisal evidence here strikes the editor as shaky, and in reviewing it the court seems to accept the judgment of the trial court, rather than exercise the de novo review that it claims.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

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