First Natinal Bank of Conway v. Conway Sheet Metal Co.

Citations: 244 Ark. 963; 428 S.W.2d 293; 1968 Ark. LEXIS 1447Docket: 5-4504

Court: Supreme Court of Arkansas; May 27, 1968; Arkansas; State Supreme Court

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T. C. Construction Company owned Lot 8, Heritage Subdivision, which was mortgaged to Capitol Savings and Loan Association, allowing for release upon payment of $2,000. On January 31, 1966, T. C. sold Lot 8 to John W. Fent and his wife for $2,900, with First National Bank of Conway financing the purchase. The bank loaned $2,900, of which $2,000 was used to release the lot from the mortgage, and $900 was deposited to T. C.’s account. The bank officer was aware of the loan's intended use. On February 2, 1966, the Fents mortgaged Lot 8 to the bank for $12,900, designated for constructing a residence, receiving $10,000 over time for contractor payments. Following the Fents' financial difficulties, Conway Sheet Metal Company and other subcontractors filed foreclosure suits, while the bank sought to foreclose its mortgage. The court initially upheld the bank's mortgage as superior to all liens.

Subsequently, following a legal precedent, the Chancery Court vacated its earlier order concerning lien priority. On May 19, a new decree was issued, ordering: the payment of all costs; the bank to receive $13,666.98 (including $10,000 for construction, $2,000 for the mortgage release, and $1,666.98 for interest and fees); and Conway Sheet Metal Company to receive $1,133.49 from its established lien. This company would share in any remaining funds after the bank's claims, proportionate to its total lien claim of $1,472.06, amounting to 77% of that claim. The decree mandated that remaining funds would go to the bank for the Fents' indebtedness. The bank appealed the decree, while Conway Sheet Metal Company cross-appealed the bank’s first lien status on amounts exceeding the $10,000 advanced for construction.

The bank's priority on the $10,000 advanced for construction is undisputed, as the mortgage was recorded prior to construction and the bank fulfilled its obligation to advance that amount. The litigation concerns two additional amounts: $2,000 for the release of a lot and $900 paid to the seller of the lot. The appellant claims entitlement to the total of $2,900, while the appellee seeks priority over both the $900 and the $2,000. The central issue is whether a construction mortgagee can reallocate part of the funds for purposes other than construction and still maintain the same priority protections.

The appellant cites Ashdown Hardware Company v. Hughes to support its position, emphasizing that the purpose of the funds is critical. However, Hughes is distinguishable because it specifically identified amounts intended for retiring an existing mortgage, while the current mortgage explicitly states that the full $12,900 is designated solely for constructing a residence. The mortgage obligates the bank to make loans for construction as work progresses, contrasting with the Hughes case where only part of the funds were designated for construction.

In Planters Lumber Company, Inc. v. The Wilson Company, Inc., the court ruled that a lender could not assert priority over withheld amounts not utilized for construction. The appellant attempts to differentiate its case by noting it did advance the $2,900 for the lot purchase, unlike Wilson, which did not advance funds for the lots. Despite this, the underlying principle remains that construction funds must be used for the specified purpose to ensure priority over lien holders. This requirement is deemed fair, as it allows materialmen and laborers to ascertain how much funding is available for a project and to monitor expenditures as work progresses.

The purpose clauses in the current case and the Wilson case are nearly identical. The appellant claims that a ruling against them would significantly harm the building industry and the state's well-being, asserting that the decision's impact would be long-lasting. However, the court disagrees, noting that the bank has multiple options for ensuring its protection, as previously discussed in the Hughes case. One suggested method is for the mortgage to specify that part of the funds has been or will be used to settle existing debts, thereby providing full protection for the total amount involved. Consequently, the court determined that it erred in granting the bank priority for funds beyond the $10,000 allocated for construction. The court affirms the decree regarding the $900.00 on direct appeal, reverses the decree concerning the $2,000.00 on cross-appeal, and remands the case for a decree consistent with this opinion. Justice Fogleman dissents.