Contractor Can Sue Bank Directly When Borrower

A general contractor who built a restaurant but never got fully paid by the owner can sue the bank that financed the project, the North Carolina Supreme Court ruled Jan. 10.

The contractor may assert an equitable lien against the balance of construction funds held by the lender, the court said.

Lawyers say the ruling opens a new remedy for contractors who are stiffed by property owners.

“It definitely increases the risk to North Carolina banks that make construction loans,’ said Winston-Salem lawyer Jackson Steele, who represented the bank. ‘This ruling allowed the general contractor to make a claim against the bank without any privity of contract at all.”

Steele said this is the first time a North Carolina court has recognized a contractor’s equitable lien against undisbursed construction loans funds. He said other states are split on the issue.

In a second holding, the court said the directors of the corporation that owned the restaurant might be personally liable for thwarting final payment to the contractor. Charlotte lawyer Marc Gordon, who represented the owners, said this ruling could spur actions by creditors against corporate insiders.

The case is Embree Construction Group, Inc. v. Rafcor, Inc. (North Carolina Lawyers Weekly No. NS0054 – 20 pages).

In 1987, Embree Construction agreed to build a restaurant in Mecklenburg County for Rafcor, a closely held corporation owned by three men. United Carolina Bank loaned Rafcor $942,500 for the project and held the money in a construction loan account. As security, UCB received a deed of trust for the property, and the corporate owners also signed personal guarantees with the bank.

During construction, Embree submitted periodic applications for progress payments to Rafcor, which in turn authorized UCB to disburse the funds to the contractor. When Embree completed the project, it submitted a final bill for $110,000 but discovered that Rafcor was insolvent. At the time, $70,000 remained in the UCB account. Embree asked the bank for this money as a partial payment of its bill, but the corporate owners refused to authorize disbursement and UCB would not release the funds.

Embree brought suit against UCB in Mecklenburg Superior Court alleging an equitable lien over the disputed account. It also sued the corporate owners for tortious interference with its contract with Rafcor.

A trial judge dismissed both claims under Rule 12(b)(6). A divided Court of Appeals reversed (Lawyers Weekly No. NA0212 – 10 pages).

In affirming, the Supreme Court said both claims were valid. The opinion was written by Chief Justice James G. Exum Jr.

Unjust Enrichment

UCB contended that the contractor’s only remedy was to file a lien against the property pursuant to Chapter 44A of the General Statutes. But the Supreme Court said a contractor’s lien was an inadequate remedy under the circumstances.

“When a contractor’s lien is subordinate to a construction loan mortgage, as here, or to prior encumbrances such as a purchase money mortgage, any lien on the owner’s property or its improvements is worthless when the owner is insolvent,’ Chief Justice Exum wrote.

In the absence of a legal remedy, the court said equitable relief was appropriate because UCB had been unjustly enriched at the contractor’s expense.

‘Plaintiff avers that by UCB’s refusal to disburse the monies remaining in the construction loan fund, coupled with its receipt of all the security for which it bargained in the form of a completed building, UCB was unjustly enriched,’ the court said. ‘We agree.”

In such situations, one remedy is to impose an equitable lien on the property of the party that has been unjustly enriched, the court said.

“In other jurisdictions, attempts made to reach construction funds remaining with the lender under equitable assignment, third party beneficiary, and trust fund theories have been generally unsuccessful,’ according to the opinion. ‘Attempts to obtain relief in the form of an equitable lien based on a theory of detrimental reliance or unjust enrichment have been more fruitful, most notably in California and Florida.”

Steele said he was disappointed that the court chose to follow California’s lead on the lien issue. He said the full scope of the ruling is uncertain.

“The court did not say what would happen if the building had not been finished when the lien was asserted,’ he said. ‘It is uncertain how far toward completion you have to go before you can tap into this equitable lien theory. If the structure has to be completed, as was the case here, you may not see very many equitable liens, because usually the owner goes belly up before the building is completed.

Tortious Interference

The court also said Rafcor’s owners might be individually liable for wrongfully interfering with the corporation’s contract with Embree. This claim was based on the following allegations:

Embree had a valid contract with Rafcor.

Rafcor’s owners knew that the contract called for Rafcor to pay Embree for work performed.

The owners intentionally induced the corporation not to authorize payment to Embree.

The owners did so because they had signed personal loan guarantees with UCB. Embree said that because the insiders were personally liable on the loan, they had an ulterior motive in seeing that the $70,000 remained untouched in the account.

Embree suffered actual damage as a result.

The court acknowledged that the insiders had a qualified privilege to interfere with the corporation’s contracts. But Chief Justice Exum said this privilege extends only to actions that are in “good faith and for the best interests of the corporation.

Owners Liable

Gordon said the decision might increase the individual liability of corporate officers and directors.

“I’m afraid this could open the door to more lawsuits against the principals of a corporation when there has been some individual involvement by the insider in the corporate affairs,’ he said. ‘The significant thing about this case is that we’re not talking about outsiders. We’re talking about insiders, who are always going to be involved in corporate affairs.”

Gordon said the insiders had no contractual obligation to the plaintiff.

“There was no contract or guarantee whatsoever,’ he said. ‘The plaintiff had a contract with the corporation only. The plaintiff hung its hat on the fact that the owners personally guaranteed the loan to the bank. It alleged that this created a conflict between the insiders and the corporation. But it’s very common for principals to guarantee the debts of the corporation. A closely held corporation is not going to be able to get a million-dollar bank loan on its own strength.

‘I see this ruling as just another way to get around the corporation to the individuals behind it,’ he said.