Pacific Continental Bank v. Soundview 90, LLC (Division 1, March 26, 2012), involves the determination of priority for recorded secured obligations that permit draws over some period of time after the recordation. (If that lede doesn’t grab you, I don’t know what to say.) Specifically, when a lender records an obligation that permits periodic draws, and then a second lender records a second obligation, what is the priority for claims by the first lender based on draws the borrower makes after the recording of the second obligation? Well, it turns out Washington has an interesting statutory scheme to answer that question.
Under RCW 60.04.221, et seq., the first lender gets priority on its recorded obligation for “all sums secured by the mortgage or deed of trust regardless of when the same are disbursed or whether the disbursements are obligatory.” RCW 60.04.226. So under the statute, the first lender gets priority even though much of its loan might have been actually disbursed after the recordation of other obligations. But the statute also builds in some protection for subsequent lenders. Under RCW 60.04.221, a second lender can provide the first lender with a statutorily prescribed notice, which informs the first lender of the second lender’s claim. After receiving the notice, the first lender is essentially required to “withhold from the next and subsequent draws the amount claimed to be due as stated in the notice.” RCW 60.04.221(5). And if the first lender fails to withhold the amount? Well, then the second lender (if it provided the notice of claim!) gets priority over the first lender.
Here’s how that played out in this case (with all numbers approximate):
Pacific Continental Bank (“Bank”) lent $10M to Soundview to build an apartment complex. The loan was secured by a deed of trust and permitted Soundview to make periodic draws against the $10M. After the Bank filed its security interest, Soundview entered into a subcontract with Village Framers Corp (“VFC”) to do some work on the project. As you can imagine, Soundview didn’t pay the full amount owed to VFC, so VFC recorded a $380K mechanic’s lien against Soundview’s project. And like a good lender, VFC provided the statutory notice to the Bank.
For some reason, the Bank responded to VFC’s notice by… well, by not really doing much of anything except changing its bookkeeping on the loan in a manner that purported to set aside the “last” $380K from the $10M loan. But the Bank kept making full payments on Soundview’s draws, assuming that its $380K “reserve” was sufficient to satisfy the statute’s requirements.
The Court of Appeals disagreed, reasoning that if a statue says that you have to “withhold from the next and subsequent draws the amount claimed to be due,” then to comply with the statute you actually have to withhold from the next and subsequent draws the amount claimed to be due. The Bank didn’t do that, so the Bank lost its priority.
What could the Bank have done to maintain its priority after receiving the notice? The Court of Appeals answers that question: “The Bank could have maintained its priority by (1) withholding the amount in arrears—$385,465.48—from the next and subsequent draws it issued, (2) requiring Soundview to post a bond for the amount of VFC’s claim, or (3) suspending all further draws to Soundview and immediately foreclosing on its deed of trust.”