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When a subcontractor or supplier doesn鈥檛 receive pay for a private project, one possible remedy is for it to file a lien against the land or improvements. The lien remedy has limits, however. If the subcontractor starts work after the project is under way (common unless it performs demolition, clearing or grading), the construction lender likely has a prior claim to the property based on a recorded mortgage or deed of trust.

If the loan amount is close to the property value, a subsequent lien has limited value. When that happens, another remedy can be considered in Washington or Alaska (but not in Oregon). It鈥檚 called a stop notice.

The stop notice remedy comes via statute (see RCW 60.04.221 and AS 34.35.062) and can apply in a scenario where the owner鈥檚 construction lender advances money to fund the work as it proceeds, with each advance secured by the original mortgage or deed of trust.

The general idea behind a stop notice is that an unpaid claimant gives notice to the lender. If the statutory requirements are satisfied, then the lender may not continue to advance money to fund the project until it has taken steps to secure payment to the claimant.

Some potential issues of the stop notice remedy were illustrated in Pacific Continental Bank v. Soundview 90 LLC, a March 2012 case from the Washington Court of Appeals. In that case, the bank promised to lend the developer a sum of money to purchase property and construct apartments on it.

The bank鈥檚 loan, including all future advances, was secured by a deed of trust on the land and the improvements. After the deed of trust was recorded, the general contractor hired a wood framing subcontractor, VFC. When the general contractor failed to pay, VFC filed a lien against the property and sent a stop notice to the bank using the form provided in the statute.

The bank may have been unfamiliar with the stop notice remedy. In any case, it did not interrupt its payments to the developer. It made an accounting entry allocating a portion of the total loan amount to VFC鈥檚 claim. The effect of this action was to limit the total amount it would disburse to the developer. As the court noted, this could theoretically prevent the developer from drawing on the last portion of its total loan, but it had no practical effect on the bank鈥檚 payments in the short term.

Later, the developer became insolvent and the bank foreclosed on its deed of trust. The property was sold and the bank recovered less than its loan amount. The bank claimed that it had complied with the stop notice statute and that it owed nothing to VFC. The trial court agreed.

The Court of Appeals reversed, noting that the Washington stop notice statute required the bank to withhold from the 鈥渘ext and subsequent draws鈥� the amount claimed to be due as stated in the notice or else to obtain from the owner or general contractor a bond securing payment of VFC鈥檚 claim. Alternatively, the bank could have stopped advancing money and moved to foreclose its mortgage and deed of trust.

But the bank did none of these things. It continued making advances to the owner and general contractor. Because the bank failed to do what the statute required, it had to accept a statutory 鈥減enalty鈥�: its own deed of trust was subordinated to VFC鈥檚 lien. This outcome created a procedural puzzle because VFC had abandoned its lien claim at trial, relying instead on the stop notice alone. But the intent of the Court of Appeals鈥� decision was clear: The bank was going to have to pay VFC.

The stop notice remedy is not available in most states, and in those it is it has value only when a construction lender is holding funds for future payments under a construction loan. The stop notice remedy loses value as the project continues, because as loan proceeds are advanced they become immune to any later stop notice.

However, if a subcontractor or supplier is encountering payment problems at a time when loan proceeds remain unpaid, and if its lien is subject to prior interests in the land and improvements, the stop notice remedy is worth a look. Like the lien statute, the stop notice statute contains technical requirements that must be complied with for the notice to be effective, so pay careful attention to the statute.

Karl Oles is an attorney in the construction and design practice group of Stoel Rives LLP. Contact him at 206-386-7535 or at [email protected].