In 2006, real estate development seemed like the safest bet in Las Vegas. Developers rushed to fill open lots with projects of unprecedented scope. Manhattan West—a twenty-acre, seven hundred condominium, $350 million development—was such a project. As conceived, Manhattan West would be a new type of development for Las Vegas—a mixed commercial/residential complex far from the Las Vegas Strip. Unfortunately, the economic downturn of the late 2000s halted nearly all of the ambitious projects underway at the time, including Manhattan West.
By October of 2008, construction across Las Vegas had fallen by ninety-two percent. In November of 2008, for instance, Clark County issued only eighty new home building permits, whereas it had averaged five hundred per month throughout 2007. As the value of real estate plummeted, lenders quickly became under-secured, rendering mechanic’s liens of junior priority worthless. In the case of Manhattan West, though, a substantial loan was made after the contractors had started work on the project. In In re Manhattan West Mechanic’s Lien Litigation the Supreme Court of Nevada considered whether a loan made subsequent to the commencement of construction activities can partially subordinate a prior loan, thereby preserving the senior priority to the extent of the amount of the senior loan.
In Re Manhattan West Mechanic’s Lien Litigation
In 2006, Scott Financial Corporation (“SFC”) agreed to make several loans to Gemstone Apache, LLC (“Apache”) to develop Manhattan West. In re Manhattan West Mechanic’s Lien Litigation, 131 Nev. Adv. Op. 70 (2015). Apache recorded the first three loans, which financed the purchase of the property, in 2006 in the aggregate amount of $38 million (the “Mezzanine Loan”). Id. at 1. APCO Construction (“APCO”), Apache’s general contractor, commenced construction activities in April 2007, establishing the accrual date for the contractors’ and subcontractors’ mechanic’s liens pursuant to NRS § 108.225. Id. The following year, Gemstone Development West, LLC (“Gemstone”) purchased Manhattan West from Apache, including Apache’s loan obligations. Gemstone then borrowed $110 million from SFC (the “Construction Loan”) and a corresponding deed of trust was recorded on February 7, 2008. Id. Commensurate with the issuance of the Construction Loan, SFC and Gemstone entered into a subordination agreement whereby SFC intended to subordinate the Mezzanine Loan to the Construction Loan. Id.
Gemstone was not immune from the economic turmoil sweeping across Las Vegas in 2008. The value of Manhattan West had fallen so far and fast that Gemstone lost any realistic chance of earning a profit on the project. As a result, its relationship with APCO rapidly deteriorated, causing APCO to stop work and sue to foreclose on its mechanic’s lien. Id.
The precipitous decline in the real estate market meant that the party with first priority would likely be the only one to realize any recovery from the proceeds of the sale of the property. The project sat fallow for more than five years while APCO and SFC fought over the priority of their claims and the market continued to tumble. Manhattan West was finally sold in 2013 for approximately $20 million—$18 million less than the Mezzanine Loan and $90 million less than the deed of trust recorded for the Construction Loan.
SFC claimed that the subordination agreement between it and Gemstone had preserved the priority position to the extent of the $38 million Mezzanine Loan because it partially subordinated the prior loan. Id. at 2. APCO claimed that the Construction Loan, which was issued after the commencement of construction activities, had fully subordinated the Mezzanine Loan thereby abdicating its priority position and placing the mechanic’s lien holders in the first position. Id.
After multiple battles in district court, the court had ruled in favor of SFC and the matter worked its way to the Supreme Court of Nevada. Id. The court identified two approaches to evaluating the effect of subordination agreements: full subordination (the minority approach) and partial subordination (the majority approach). Id. at 3. With full subordination, the subsequent loan establishes a new and later priority date for the loans, including the first loan, thereby placing liens accruing between the issuance of the two loans in a senior position. Id. Partial subordination preserves the priority date of the original loan to the extent of that loan. Id. The priority of liens is simply rearranged without affecting the priority or validity of intervening liens. Ultimately, the court adopted partial subordination, finding that it “cannot determine any reason SFC would have intended to completely subordinate the [Mezzanine Loan], only for APCO’s mechanic’s liens to then take the first-priority position.” Id. at 4. In doing so, the court gave effect to SFC’s stated intent “that it should be allowed to freely contract the order of payment as between itself.” Id. Further, the court noted that the commonsense majority approach “weighs in favor of partial subordination” because nothing in the subordination agreement mentioned the mechanic’s lien or an intent to fully subordinate the Mezzanine Loan. Id. The mechanic’s liens were thus left in the same priority position as prior to the subordination agreement.
Finally, the court also determined that NRS § 108.225, which gives priority to mechanic’s liens over liens attaching after commencement of construction, did not prohibit negotiations concerning priority between those with liens senior and those with liens junior to mechanic’s lien holders. Id. The court found that such negotiations do not alter the mechanic’s lienholders’ position and are, therefore, not prejudicial to the lienholder or contrary to the intent of the mechanic’s lien statutes. Id.
What Manhattan West Means For Lienholders
The Manhattan West decision is too recent to have yet spawned interpretive precedent or treatment by the courts. Nevertheless, it will likely have some foreseeable impact on lienholders.
In the short-term, Manhattan West likely forecloses the possibility of meaningful recovery on mechanic’s liens that accrued prior to or during the early years of the economic downturn because under-secured lenders will retain first priority absent an express statement of intent to permit mechanic’s lienholders to assume the first position. In this sense, the lienholders’ position remains unchanged—they were junior to the initial lender prior to Manhattan West and remain so now.
Although Manhattan West cuts off one means of payment for mechanic’s lienholders, its effect may be to create additional opportunities for work. The decision offers assurances to lenders that by putting new money into existing projects they will not automatically relinquish the priority position of the initial lenders. This may entice lenders to more aggressively invest into the Las Vegas real estate market again, creating more work for contractors and subcontractors.