On March 29, 2013, the Court of Appeals for the 10th Appellate District in Columbus issued a decision of significance for mortgage lenders that rely on contractual subordination and flow down provisions in construction contracts. 

In KeyBank Natl. Assn. v. Southwest Greens of Ohio, L.L.C., 10th Dist. No. 11AP-920, 2013-Ohio-1243, the 10th District Court of Appeals upheld the September 14, 2011 decision by Judge John Bessey of the Franklin County, Ohio Common Pleas Court that the plaintiff lenders (the "Lenders") had priority over the subcontractors/ mechanic’s lien claimants even though the lenders recorded their mortgage subsequent to the notice of commencement’s recording.  The decision is significant because during this period fraught with contested foreclosures and inter-creditor disputes over priorities in real estate, the 10th District has affirmed Ohio’s broad construction and consistent enforcement of flow down provisions in construction documents.

In the spring of 2008, defendant Columbus Campus, LLC ("Campus") contracted with a general contractor to construct a continuing care retirement community on 88 acres in Hilliard, Ohio.  On March 10, 2008, Campus filed a notice of commencement; on April 16, 2008, the Lenders executed a $90 million construction loan agreement with Campus secured by a mortgage on the 88-acre property; the Lenders recorded their mortgage on April 22, 2008.  By March, 2009, the Lenders had disbursed approximately $45 million of the loan proceeds pursuant to various draw requests, $27 million of which was paid to the general contractor and various subcontractors.

In the spring of 2009, Campus defaulted on its loan from the Lenders, and in July, 2009, the Lenders filed suit in Franklin County Common Pleas Court (Case No. 09 CV 9921) seeking money judgment, a judgment decree in foreclosure and the appointment of a receiver.  Campus consented to all three in July, 2009.  As the mechanic’s lien claimants (subcontractors and the general contractor) filed their answers, it quickly became apparent that there was a priority dispute between the mechanic’s lien claimants and the Lenders.  By October of 2009, Campus and its owner/ guarantor, Erickson Retirement Communities, LLC ("Erickson") had filed for bankruptcy protection in Texas.

The parties briefed their priority dispute on cross-motions for summary judgment in early 2011, and on September 14, 2011, Judge Bessey ruled in favor of the Lenders vis-à-vis the subcontractors, finding that (1) the subcontractors had contractually agreed to subordinate their lien claims to the Lenders’ mortgage and (2) R.C. §1311.14, also known as the construction mortgage statute, provided the Lenders’ mortgage priority over the subcontractors’ mechanic’s liens.  Judge Bessey journalized his decision in an entry filed on October 4, 2011; the cross motions for summary judgment between the Lenders and the general contractor remain pending with the trial court.

The 10th District Court of Appeals reviewed the trial court’s ruling de novo, and affirmed its decision.  The 10th District found that the subcontractors had agreed to be bound by the subordination provisions of the prime contract between the general contractor and Campus by virtue of the "flow down" provisions in the subcontracts that, the court found, sufficiently incorporated the prime contact into the subcontracts.  The 10th District also specifically rejected the subcontractors’ narrow reading of the flow down provision to limit its application to only those provisions of the prime contract that related to the scope, quality, character and manner of the subcontractors’ work, finding that the subcontracts incorporated the entire prime contract, including its subordination provision, noting that "Ohio courts have broadly construed subcontract flow down provisions." KeyBank Natl. Assn. v. Southwest Greens of Ohio, L.L.C., 2013-Ohio-1243, ¶35.

Having affirmed the trial court’s ruling on the contractual subordination claim, the 10th District found the Lenders’ statutory claim to lien priority under R.C. §1311.14 was moot.  Finally, the 10th District affirmed the trial court’s order granting the Lenders’ unopposed motion to strike an attempt by the subcontractors to, after briefing on summary judgment had closed, introduce evidence that the Lenders had obtained a title insurance policy.  The 10th District found no abuse of discretion in the trial court’s reliance on Evidence Rule 411, which provides that evidence of insurance is not relevant on the issue of whether the insured acted negligently or otherwise wrongfully.

The Lenders are represented by the Columbus, Ohio office of Porter Wright Morris & Arthur LLP, including Jack Pigman, Polly Harris, Craig Carlson, Bradford Hughes, Andrew Nicoll, Ryan Sherman, Christen Blend and Gale Heaney.  Please contact Polly Harris at 614.227.1962 or pharris@porterwright.com with questions.