Within the last year the Michigan Court of Appeals has issued at least two opinions that expand the definition of “improvement” under the Michigan Construction Lien Act, MCL 570.1191 et seq. (the “Act”), to any physical change to the property, even when such work relates to preconstruction work such as well testing and drilling.  In E.T. MacKenzie Co. v. Sutton Place-Raisin Twp., L.L.C., unpublished opinion per curiam of the Michigan Court of Appeals, issued November 22, 2011, Docket No. 297864 (2011 WL 6186822) and Mich. Pipe & Valve-Lansing, Inc. v. Hebeler Enterprises, Inc., 292 Mich. App. 479; ___ N.W.2d ___ (Mich. Ct. App. May 3, 2011), the Michigan Court of Appeals held that well testing and drilling constituted the first actual physical improvement to the subject property under the Act.  As such, when the secured lender subsequently advanced funds and recorded its mortgage on the real estate, the secured lender was subordinate in priority to a construction lien claimant who performed services after the secured lender’s mortgage was recorded.   

Under the Act, a construction lien has priority over all other liens or interests that are recorded after the first physical improvement.  MCL 570.1119(3).  The “first actual improvement” is considered to be an actual physical change or alteration “which is readily visible and of a kind that would alert a person upon reasonable inspection of the existence of an improvement.”  MCL § 570.1103(1).  However, as part of a so-called “due diligence exception,” the first actual improvement excludes “labor that which is provided in preparation for that change or alteration, such as surveying, soil boring and testing. . .”  Id.   

In Mich. Pipe, a contractor installed a test well in order to obtain a water sample from the aquifer below the real estate.  The PVC pipes installed by the subcontractor extended only one foot above ground. The lender argued that because the well was installed only to test the real estate in preparation for an improvement, the installation itself was not an actual physical improvement.   The Mich. Pipe court disagreed and explained that the inquiry is whether the work results in a “permanent presence” on the property, not whether the work itself constitutes a form of testing.  Because the drilling of the well in Mich. Pipe resulted in a permanent presence, the court held that the due diligence exception was not implicated.   

Applying a similar rationale, the E.T. MacKenzie court found that because the test wells extended five feet above the ground, they were readily visible and of a kind that would alert a person upon reasonable inspection of the existence of an improvement.  Thus, the court held that the wells constituted the first actual physical improvement to the real estate.  The court emphasized that the wells were permanent and visible due to the five foot high PVC pipe, even if the pipes were sporadically located on 29 acres of real estate.  Because the lender’s mortgage was recorded after the first actual physical improvement, the court held it was subordinate to the plaintiff’s construction lien.   

The Court of Appeals’ liberal construction of what constitutes an “improvement” under the Act has a significant impact on lien priorities and places the onus on owners and lenders to thoroughly inspect every inch of the mortgaged property to verify whether any work has been done on the project prior to recordation of the mortgage.    

The decisions in Mich. Pipe. and E.T. MacKenzie opened the door for the plaintiff in William J. Langland Clearing, Inc. v. Rizzo, unpublished opinion per curiam of the Michigan Court of Appeals, issued February 14, 2012, Docket No. 300402 (2012 WL 470187) to argue that surveying, which included the installation of stakes and visible markings and tags on the mortgaged property, constituted a physical improvement for purposes of the Act.  The court in Rizzo, however, rejected the plaintiff’s attempt to extend physical improvements to pre-construction surveying services noting that the Act specifically identifies surveying as falling within the “due diligence” exception discussed above.  

The recent decisions in E.T. MacKenzie, Mich. Pipe and Rizzo serve as an important reminder to mortgage lenders to ensure that no physical improvements have been made to the mortgaged real estate prior to the recordation of the lender’s mortgage.  It is therefore imperative that the lender physically inspect the real estate and any pre-construction filings or applications at the local, county and state level related to the real estate.  Lenders should also realize that even though a mortgagee may not own the property, the “first actual physical improvement” may have nonetheless occurred in furtherance of a construction project.  By contrast, contractors, subcontractors and material suppliers should take every precaution to protect their lien rights on financially troubled projects as they may ultimately take priority over mortgage interests asserted by the lender.