Surety Case Law Note: Attorney Lien Priority Issue
November 28, 2023
In this Surety Today Blog post we consider a Case Law Note addressing an issue that a California appellate court described as the messy intersection of public construction law, surety law, and the law governing the priority of attorney liens. The case is:
Nichols v. North American Specialty Ins. Co., B329206, 2023 WL 7980742 (Cal. Ct. App., Nov. 17, 2023)
In this matter, between 2013 and 2014, Pickard & Butters Construction, Inc. (“PBC”), as the general contractor, was involved in five construction projects in California. North American issued payment and performance bonds for each of the projects. After not being paid what they were owed by PBC, various subcontractors on the five projects either brought claims against the payment bonds, or sent “stop payment notices,” which informed the project owner that the subcontractors had not been paid and which statutorily prohibit the project owner from paying the general contractor until those amounts are paid. Pursuant to the terms of the payment bonds, North American paid the subcontractors on the five projects at issue. Once North American paid the subcontractors, their claims against the payment bond were resolved and their stop payment notices were dissolved. Thereafter, the projects were completed and PBC moved forward with collecting the proceeds it was owed for the projects.
PBC hired attorney F. Glenn Nichols (Nichols) to represent it in the collections actions. In its agreement with Nichols, PBC consented to Nichols “having a lien on any cause of action …, and on the proceeds thereof, including … on any recovery, monies or property, obtained by settlement, judgment or otherwise, in satisfaction … of any claim [PBC] may have against others, in any matter in which [PBC has] retained [Nichols], for purposes of satisfying” any fees or costs PBC owes Nichols. PBC, through Nichols, sued all five project owners for breach of contract and to recover unpaid project proceeds.
North American learned of three of the lawsuits then exercised its rights under the indemnity agreement to act as PBC’s attorney-in-fact and control each lawsuit on PBC’s behalf. North American invited PBC to continue as a direct participant in settling at least some of the lawsuits, but PBC declined. Ultimately, North American “as PBC” settled the three lawsuits. PBC prosecuted the remaining two lawsuits without North American’s intervention, because, North American did not know that PBC had filed those suits until two years after judgment was entered for PBC.
Nichols contended that he was owed $1,499,661.58 by PBC in attorney fees. Nichols collected $69,152.45 in fees from the proceeds of the two lawsuits that PBC itself prosecuted to completion. Nichols then sued PBC and North American seeking a declaration that he was entitled to place his attorney lien on the proceeds of the three lawsuits North American had settled against the project owners on PBC’s behalf, asserting that his attorney lien had priority over North American’s entitlement to recoupment of what it paid to the subcontractors pursuant to the payment bonds. North American filed a reciprocal counterclaim asserting that its claims had priority over Nichols’s attorney lien and that Nichols had wrongfully converted the $69,152.45 he collected from the two matters PBC prosecuted.
The matter proceeded to a six-day bench trial at the conclusion of which the court denied all relief sought by Nichols and issued declarations recognizing North American’s rights to the proceeds. Nichols appealed.
The appellate court stated that the issues boiled down to “whether Nichols is entitled to enforce his lien for attorney fees on the full amount of proceeds recovered in the lawsuits against the project owners, or instead is limited to the amount left over after North American deducted what PBC owes it for resolving the claims of PBC’s subcontractors.” At bottom, the case turned on the priority of a surety’s claims vis-à-vis the priority of an attorney lien.
Under California law an attorney lien (or “charging lien”) is a lien that empowers an attorney to collect his unpaid fees and costs from the “proceeds of a prospective judgment” in his client’s favor. Such a lien may be created expressly through a contract like a retainer agreement, in which case the language of the contact governs its scope. In California, as a general rule, an express attorney lien takes effect on the date it is created by contract and has priority over any later-created encumbrances on the proceeds of any prospective judgment to which the lien attaches. This general rule applies whether or not the later created encumbrancers had notice of the earlier attorney lien. However, the court observed that “[a]n attorney lien does not always have priority over other liens” and noted two exceptions to the general “first-in-time” rule. First, an earlier-created attorney lien is subordinate to the rights of an adverse party to offset judgments in the same action or in actions based upon the same transaction. Second, an earlier-created attorney lien may be subordinated to later-created encumbrances if “[e]quitable considerations and public policy” favor a different priority.
The court analyzed the surety’s priority rights under the two exceptions noting that the surety through its right of equitable subrogation stood in the shoes of the subcontractors it has satisfied. In the court’s analysis it seems to have assumed that the attorney’s lien was first in time, but there was no discussion of the relation back to the date of the issuance of the bonds aspect of the surety’s rights. The court made a point of noting that the briefing by both parties was terrible, so it may have been overlooked. Looking at the first exception, which subordinates an earlier-created attorney lien to the rights of an adverse party who is seeking to offset amounts it is owed “in the same action” or “in actions based upon the same transaction,” the court noted that the surety, as a now-subrogated proxy for the subcontractors, was an “adverse party” who was seeking to offset the amount it was owed in “the same action,” and that also happened to arise from the same general transaction. Thus, the court held that the surety’s rights fell within the first exception and had priority. The court noted that the amount of money the general contractor owes to the subcontractors reduces the amount of money the general contractor would be permitted to keep from the project owner in the lawsuit. In other words, the amount due to the subcontractors will offset the amount the general contractor receives from the project owner, thereby reducing the net “proceeds” the general contractor will receive in the litigation. The court stated “because the pot of money the general contractor obtains from litigation is what constitutes the ‘proceeds’ from that litigation, and because the attorney lien attaches only to the client’s ‘proceeds,’ the attorney lien does not attach to the amount the general contractor owes the surety.”
Looking at the second exception regarding equity and public policy, the court observed that “when it comes to equitable considerations, the priority accorded to attorney liens in the proceeds of litigation rests chiefly on the notion that the attorney has helped bring those proceeds into being, such that the attorney—in all fairness and equity—deserves to get a piece of the pie he helped bake.” However, the court also noted that in this case “it is the surety—not the attorney—who is most responsible for bringing the ‘pie’ into being: If the surety had not paid off the outstanding claims of the subcontractors, the project may well never have been completed, and the general contractor would not be entitled to the proceeds it is seeking from the project owner.” The court further noted that “[p]rioritizing the surety’s right to recover the outstanding claims it paid to the subcontractors on behalf of the general contractor serves the public policy of ensuring that sureties will be willing to issue payment bonds. If there is no protection for sureties to collect what they have paid out pursuant to a payment bond, there will be no payment bonds, no public works projects . . . and hence no proceeds to a general contractor against which an attorney can assert a lien.” The court concluded stating “as between those competing public policies of ensuring a supply of attorneys or a supply of sureties willing to issue payment bonds, protecting the latter seems to be the more compelling public policy—and one that justifies according priority to the debts owed to subrogated sureties.”
The court was not persuaded by Nichols’ argument that North American exercised its power under the indemnity agreement as an attorney-in-fact for PBC to step into PBC’s shoes in three of PBC’s lawsuits against the project owners and thus settled all three lawsuits “as PBC.” The court held that the equities and public policy considerations dictating priority to the surety still applied with equal force. The court also brushed aside a number of other procedural arguments put forth by Nichols and ultimately affirmed the lower court ruling in favor of North American.
Attorney lien rights will vary from jurisdiction to jurisdiction and can arise at common law, by statute or rule. The lien rights also vary in scope. In some jurisdictions, a lien only exists as to papers and other items in the attorney’s possession – a so-called “retaining lien.” A retaining lien is a passive lien and cannot be actively enforced either at law or in equity. Other attorney liens, as in this case, are known as a “charging lien” which binds a judgment recovered through the attorney’s efforts. This type of lien is based upon the broad principle of justice that an attorney, as a recognized officer of the court, should be paid his fees and expenses out of any judgment obtained as the result of his labor and skill. In some jurisdictions, the lien may apply automatically, but may require service of written notice upon competing parties to gain priority from the point of the notice. Attorney liens may also be impacted by applicable ethical rules binding attorneys. As with so many legal issues, a surety will need to consult the law in the jurisdiction where the dispute arises. Of course, the best policy is always to pay one’s legal fees!
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (410-659-1321 or mstover@wcslaw.com) or any member of the Surety and Fidelity Law Practice Group.