5/1/2008 Newsletter and Legal Memorandum (print version)

The North Carolina Supreme Court has expanded the right of a subcontractor to contest the default of the general contractor in an action by the owner. On discretionary review of the unanimous, unpublished decision of the Court of Appeals affirming the trial court in Carolina Building Services' Windows & Doors, INC. v. Boardwalk, LLC, No. 444PA06, filed on April 11, 2008, the Supreme Court overturned those decisions holding that the choice of the general contractor not to defend the owners claims for breach of contract and damages constituted an “action” which prejudiced the rights of the subcontractor as limited in N.C.G.S. § 44A-23 and that the subcontractor should have an opportunity to present its evidence concerning the merits of recovery under its lien on real property as against the owner.

In 2001, the defendant owner entered into a contract where Miller Building Corporation (“Miller”) agreed to serve as the general contractor for the owner’s over $3,000,000 condominium project. Miller abandoned the job in 2002 before completion of the project and did not fully pay the plaintiff subcontractor. The plaintiff gave notice of its lien on funds and timely filed and properly perfected its subrogation lien by filing suit against the owner and Miller. There is no dispute concerning the plaintiffs furnishing $189,704.41 worth of unpaid materials to Miller, which were used on the owner's property. Miller never answered nor appeared, and the plaintiff obtained a default judgment on its claims against Miller in December of 2002.

The owner filed a crossclaim in the action against Miller two years later alleging negligence and breach of contract and as before, Miller defaulted. The owner obtained an entry of default against Miller in January of 2005 and sought default judgment in the amount of $185,420.38, to which the plaintiff objected. At the hearings on the issues between the plaintiff and the owner, the owner asserted that it incurred costs in excess of the contract amounts to complete the project which precluded the plaintiff from any recovery against the owner under the lien statutes. The plaintiff asserted that the owner completed the project for less than the contract price, the difference of which apparently was supposed to provide a fund for recovery.

The trial court ruled that the plaintiff lacked standing to contest a default judgment in an action between the owner and the contractor and entered the requested default judgment against Miller in favor of the owner in the amount of the asserted difference totaling $172,265.63. The trial court also granted summary judgment for the owner as to the plaintiff’s claims predicated on the default judgment against Miller.

A unanimous panel of the Court of Appeals agreed with the trial court in an unpublished opinion filed in 2006 holding that the plaintiff did indeed lack standing and that summary judgment for the owner was appropriate because there was no dispute that it did not owe Miller any money on the date it received notice of the lien on funds and that it paid nothing afterward. The Court of Appeals also held that the trial court’s grant of summary judgment against the plaintiff on its lien claim was appropriate because the lien was subrogated to Miller's rights and that the default judgment against Miller in favor of the owner meant that Miller had no right to a lien against the owner’s real property. In January of 2007, the North Carolina Supreme Court allowed the plaintiff’s petition for discretionary review as to the sole issue addressed by the Court of Appeals of whether a default judgment for an owner against a general contractor who does not appear may be the basis for extinguishing a subcontractor's lien on the owner's real property.

The court observes that Chapter 44A “is remedial in that it seeks to protect the interests of those who supply labor and materials that improve the value of the owner's property.” Quoting its recent opinion in O & M Indus. v. Smith Eng'g Co., 360 N.C. 263, 268, 624 S.E.2d 345, 348 (2006) the Court notes that a “remedial statute must be construed broadly ‘in the light of the evils sought to be eliminated, the remedies intended to be applied, and the objective to be attained.’ (citations omitted)” and it concluded that N.C.G.S. Section 44A-23 is a remedial statute that must be construed broadly as well. The majority analyzes the Chapter’s provisions as follows:

“When certain notice and perfection requirements are met, a first tier subcontractor is subrogated to the claim of lien on real property of the contractor. N.C.G.S. § 44A-23(a) (1999). This is “a separate right of subrogation to the lien of the contractor who deals with the owner, distinct from the rights contained in N.C.G.S. § 44A-18,” Elec. Supply Co. of Durham, Inc. v. Swain Elec. Co., 328 N.C. 651, 660, 403 S.E.2d 291, 297 (1991), meaning “the subcontractor may assert whatever lien that the contractor who dealt with the owner has against the owner's real property relating to the project,” id. at 661, 403 S.E.2d at 297 (citing Powell & Powell v. King Lumber Co., 168 N.C. 723, 729, 168 N.C. 632, 638, 84 S.E. 1032, 1035 (1915)).”

“In pertinent part, N.C.G.S. § 44A-23 states: ‘Upon the filing of the notice and claim of lien and the commencement of the action, no action of the contractor shall be effective to prejudice the rights of the subcontractor without his written consent.’ N.C.G.S. § 44A-23(a). The parties agree that Carolina Building properly filed a notice and claim of lien and properly commenced the action. It is also uncontested that Miller defaulted after Carolina Building commenced its action and that Carolina Building did not provide written consent allowing Miller's actions to prejudice its rights. However, the parties disagree whether Miller's default constituted an ‘action’.”

The majority states that the plaintiff’s affidavit raised a genuine issue of material fact concerning the owner’s liability to Miller based on a lien against Boardwalk's real property. Yet we are not aware of any law that would impart a right or remedy to defaulting contactor against an owner for successfully mitigating damages. When the owner completed the project in an economical fashion, it mitigated damages. If the plaintiff’s contentions were true, the owner still would not owe anything to the defaulting contractor nor, by subrogation, to the subcontractor.

The majority goes on to say that “ Miller's choice not to defend Boardwalk's claims constituted an “action” which prejudiced the rights of Carolina Building contrary to the statutory mandate of N.C.G.S. § 44A-23. Carolina Building should have an opportunity to present its evidence concerning the merits of recovery under its lien on real property.” Inexplicably the opinion then dictates that the “decision of the Court of Appeals is reversed as to the issue before this Court on discretionary review. The remaining issues addressed by the Court of Appeals are not before this Court, and its decision as to those issues remains undisturbed. This case is remanded to the Court of Appeals for further remand to the trial court for proceedings not inconsistent with this opinion.”

Taken literally, we can speculate that this means that the 2006 holding by the Court of Appeals that the plaintiff did indeed lack standing and that summary judgment for the owner was appropriate because there was no dispute that it did not owe Miller any money on the date it received notice of the lien on funds and that it paid nothing afterward stand. Thus, upon remand the, Court of Appeals will rule that if such were not the case then the plaintiff would otherwise “have an opportunity to present its evidence concerning the merits of recovery under its lien on real property.” We say ‘speculate’ since the remand order is anything but clear in its mandate.

Justice TIMMONS-GOODSON authored the dissenting opinion with Justice Brady joining in the dissent. The opinion is well reasoned and articulated. We publish it in its entirety as editing and commentary would likely only diminish its clarity.

Notwithstanding the default judgment in favor of Boardwalk, the majority declares that the trial court erred in relying upon the default judgment against Miller in granting summary judgment to Boardwalk, and that Carolina Building may pursue its claim to recovery on its lien on real property owned by Boardwalk. In so holding, the majority sub silentio overrules the settled law of default judgments in North Carolina . The majority moreover contravenes the lien law hierarchy created by N.C.G.S. §§ 44A-7 to -23. I therefore respectfully dissent.

I must first note that the majority's decision strays beyond the boundaries set by this Court when it agreed to entertain the case. The majority acknowledges that in allowing discretionary review, we limited the scope of our review to the second issue only, which is “whether a default judgment for an owner against a general contractor who does not appear may be the basis for extinguishing a subcontractor's lien on the owner's real property.” We did not grant discretionary review to the first issue, which was that Carolina Building “lacked standing to object to Boardwalk's motion for default judgment against Miller.” Thus, under the law of this case, Carolina Building has no standing to argue the merits of any defense Miller may have had to Boardwalk's claim against it. Yet the majority's resolution of the case contradicts itself and expressly allows Carolina Building to argue the merits of Miller's right to a lien against Boardwalk's real property. The majority thereby improperly reverses the opinion of the Court of Appeals not only as to the second issue, but as to the first issue as well.

Under our lien statutes, there are only two methods by which a subcontractor may assert lien rights against the owner's real property: (1) a direct liability lien pursuant to N.C.G.S. §44A-20(d); and (2) a subrogation lien pursuant to N.C.G.S. §44A-23, as we have here. Under N.C.G.S. § 44A-23, a subcontractor seeking a claim of lien on real property must first give notice of claim of lien upon funds pursuant to N.C.G.S. §§ 44A18-19. See N.C.G.S. § 44A-23(a). The notice of claim of lien upon funds statute creates a risk shifting mechanism for subcontractors. Prior to notice to the obligor, the subcontractor bears the risk of loss or nonpayment by the general contractor. When notice is served, the risk shifts to the obligor to the extent that the obligor is holding funds. With this notice the burden of assuring payment of the subcontractor's lien shifts to the obligor who owns the project, is receiving construction funds, and receives the benefit of the subcontractor's labor and materials. The owner is, thus, put on notice of a general contractor's potential breach and is apprised of the need to take precautions necessary to protect the project and to ensure that subcontractors remain on the job. O & M Indus. v. Smith Eng'r Co., 360 N.C. 263, 269, 624 S.E.2d 345, 349 (2006). Once notice of claim of lien upon funds is given, the subcontractor, “may, to the extent of this claim, enforce the claim of lien on real property of the contractor.” N.C.G.S. § 44A-23(a). A subcontractor's claim of lien on real property is subrogated to the contractor's claim of lien on real property, and the lien is therefore necessarily limited to the amount of money the owner owes the contractor. N.C.G.S. § 44A- 23(a); Electric Supply Co. of Durham v. Swain Electrical Co., 328 N.C. 651, 661, 403 S.E.2d 291, 297 (1991). If the general contractor has no right to a lien, the first tier subcontractor likewise has no such right. See N.C.G.S. § 44A-23(a); Watson Elec. Constr. Co. v. Summit Cos., 160 N.C. App. 647, 650-51, 587 S.E.2d 87, 91 (2003).

In the present case, it is undisputed that any claim by Carolina Building on Boardwalk's real property is subrogated to Miller's claim. Both parties also agree that after receiving Carolina Building's notice, Boardwalk paid no funds to Miller. Carolina Building's claim on Boardwalk's real property is therefore limited to the amount of money owed by Boardwalk to Miller. The entry of default and default judgment entered against Miller conclusively established that Boardwalk owed no money to Miller and Miller had no claim of lien upon Boardwalk's real property. “'Once the default is established defendant has no further standing to contest the factual allegations of plaintiff's claim for relief. If he wishes an opportunity to challenge plaintiff's right to recover, his only recourse is to show good cause for setting aside the default . . . and, failing that, to contest the amount of recovery.'” Bell v. Martin, 299 N.C. 715, 721, 264 S.E.2d 101, 105 (1980) (citation omitted) (quoting Charles Alan Wright & Arthur R. Miller, Federal Practice and Procedure § 2688 (alteration in original) (footnote omitted)). The default judgment entered here has not been set aside. As it is judicially established that Miller has no right to claim of lien on Boardwalk's property, it follows that, as the subcontractor, Carolina Building can have no claim of lien on Boardwalk's property. As such, Boardwalk was entitled to judgment as a matter of law, and the trial court did not err in granting summary judgment in favor of Boardwalk.

The majority does not expressly address the interplay between N.C.G.S. § 44A-23 and the law of default judgments, but determines that Carolina Building is entitled to “an opportunity to present its evidence concerning the merits of recovery under its lien on real property.” The majority thereby necessarily concludes that the default judgment entered here has no effect and may be regarded as a nullity in the face of N.C.G.S. § 44A- 23(a)'s provision that “no action of the contractor shall be effective to prejudice the rights of the subcontractor.” The majority offers no authority in support of its holding beyond a mere definition of the word “action.” This holding fundamentally contradicts the settled law of default judgments in this State and ignores the lien law hierarchy created by N.C.G.S. §§ 44A-7 to -23. Notably, the majority makes no attempt to limit its holding to situations involving contractors and subcontractors, which throws into question the continued validity of default judgments in this State. If a validly-entered default judgment may no longer be relied upon by a property owner against a lien claim by a subcontractor, it begs the question to what other statutorily-based, judicially-created exceptions Rule 55 might be vulnerable. Ironically, the basis of Carolina Building's established claim to monies owed it by Miller -- a default judgment entered against Miller in the same action -- is the very same type of judgment Carolina Building and the majority deem ineffectual in the present case.

The factual scenario of the instant case is an all too common one, which is why the General Assembly established the lien protections of Chapter 44A. In a case between two innocent parties, as we have here, the risk must fall on the party better placed to protect its interest. Compare O & M Indus. v. Smith Eng'r Co., 360 N.C. at 269, 624 S.E.2d at 349 (noting that, with a claim of lien on funds, “[p]rior to notice to the obligor, the subcontractor bears the risk of loss or nonpayment by the general contractor.”). Carolina Building could have earlier filed for a lien and thus better protected itself from potential loss. See, e.g., N.C.G.S. § 44A-18(5) (providing that a lien on funds will secure amounts earned by the claimant, even before amounts are due or performance is complete). I fear that the majority's broad holding may have many unanticipated consequences for our State's jurisprudence.

As noted above, we believe that the dissenting opinion needs little in the way of commentary, but we do think that the practical application of this opinion begs a few conclusory remarks. It is important to note that in this context the supplier is extending credit to the builder and the court is attempting to give them the hammer of litigation to enforce that extension of credit against the landowner. We anticipate that large, well-financed suppliers are gleefully anticipating using this tool with which they will assuredly attempt to beat owners into submission regardless of whether there is any merit in their contentions. In most instances under similar facts, all the subcontractor has to do is file its lien, perfect it by filing a complaint and sit back and wait until the landowner is forced to pay twice because it will most likely not be economically feasible to litigate even the most egregious of builders defaults. But for the magnitude of this project, it is unlikely that this case would have been appealed.

It is important to restate that the subcontractor in this case was apparently not alleging that the owner actually owed the general contractor money. Their argument was that the owner finished the project for less total money than the original contract. Even if this were true, it would not mean that as between the owner and the contractor that the contractor was owed any money. The contractor cannot claim any benefit from the owner’s legal requirement to mitigate its damages caused by the breach of contract. If the contractor is not owed any money as result of mitigation, what subrogation right can the subcontractor assert in this difference? We are unaware of any North Carolina cases suggesting that the subcontractor can call for payment out of mitigation. In fairness to the majority, it appears as if the Court of Appeals missed this point as well. The majority has said that the subcontractor has a right to contest and be heard on whether it exists, but has not suggested what remedy it is that could be granted by the courts. If the facts as presented by the Supreme Court suggested that there was any likelihood of prevailing in a hearing on whether money was actually owed to the contractor, this case would make more sense, unfortunately, the Majority missed its opportunity to recognize that as to summary judgment the plaintiff here was required to show that they had a right to relief not just a mere dispute about non-essential facts.

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