Fraudulent Inducement Voids Arbitration Clause

In Chris Keefe Bldrs, Inc. v. Hazzard, a general contractor filed a mechanic’s lien for unpaid contract amounts.  The general contractor then proceeded to enforce the mechanic’s lien by commencing a foreclosure action.  The property owners responded by filing a motion to stay the action to enforce the mechanic’s lien and to compel arbitration as required in the construction contract.  The foreclosure action was eventually stayed and the parties went forward with the arbitration where the contractor was eventually awarded $122,606.82.

The general contractor then sought two forms of alternative relief: 1) he sought to void the arbitration clause in the contract by claiming fraud in the inducement; or 2) alternatively he sought to confirm his arbitration award.  The Appellate Division agreed that evidence was presented to warrant a fraudulent inducement claim (the owners defaulted by that point so the complaint was deemed admitted) and vacated the order compelling arbitration.  The issue of whether the general contractor could then proceed to enforce its mechanic’s lien (successfully) was not addressed by the court because there was an interesting issue with the mortgage holders that required a trial.

Apparently the mortgage holders claim that a letter submitted to them prior to loan disbursement indicated that the general contractor’s lien had been satisfied and would be removed (this letter was purportedly written by the general contractor).  Based on this letter, the lenders apparently disbursed the loan proceeds despite the fact that the lien still remained on the property.  The general contractor, of course, claims that he never wrote such a letter and it appears undisputed that mechanic’s lien was never actually removed of record.  The lenders claim they detrimentally relied on the letter and therefore should not be punished and the general contractor claims he didn’t prepare the allegedly fraudulent letter so he should not be prejudiced either.  Hopefully this case results in further motion practice and/or a written decision that will give us some details on how this scenario plays out.

One interesting question is why the lenders would disburse funds when a mechanic’s lien is still of record against the subject property?  The usual course of action (in my experience) is for the lender to insist that the mechanic’s lien be officially discharged of record prior to disbursing the funds.  This is usually accomplished by the filing of a satisfaction and presenting the lender (or the title company) with a copy of the satisfaction bearing the stamp of the County Clerk.  Alternatively, if filing cannot be achieved before closing then the title company may agree to hold a certain amount in escrow (sufficient to satisfy the lien) pending discharge of the mechanic’s lien and then the closing can proceed without delay.  Another option would have been to file a discharge bond and then the lien would not have been an issue for closing on the loan.  In any event, none of these things apparently happened and the lenders relied on the letter so we are left with these interesting cases to discuss.

Vincent T. Pallaci is a partner at the New York law firm of Kushnick Pallaci, PLLC where his practice focuses primarily on the area of construction law.  He can be reached at (631) 752-7100 or vtp@kushnicklaw.com

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