But I already paid for that! So you have a mechanic's lien; now what? (Part 2)
Four Practical Points for Avoiding and Responding to Construction Liens
Step 1: Who’s healthy in 2010?
Within the bounds of the Fair Credit and Reporting Act and any state obligations, it is imperative for both owners and general contractors to understand the financial fortitude of the parties doing the work. If you don’t obtain the bonds to protect the project, you need to be aware of what you can do to protect your rights. While you cannot request a complete financial audit, good due diligence will save you time, energy, money, and headaches in the future. Keep an eye out and an ear to the ground for any questionable items or rumblings related to the trades. Has anyone complained of “slow-pay” issues? Are there any “marks” against the contractor on any registration or licensing entity with the state? How timely is the contractor in meeting and agreeing to the terms you proposed (discussed below) that have active and proactive involvement for ensuring that the project remains clear of liens? Where is the contractor’s facility? Will it be condemned because it’s so rundown or has that “almost vacant” look, or is everything shiny and “new,” which in this economy could reflect an overleveraged or overextended trade contractor just waiting to fold if that next job doesn’t come through? While these items alone cannot “tell” you the contractor’s financial status, do not race past any yellow flags – the red ones are just behind it waving in the wind. These precautions are as true for the owner, who can get sideswiped by the general contractor or any of the lower-tier trades or suppliers.
Step 2: Is it time to update your contracts and specifically your right of inspection, payment, and mechanic’s lien provisions?
Do you know what your contract allows you to do at the beginning of the contract term or during the project to avoid liens? Do you have a list of the trades and suppliers (at least the major ones if not everyone) in the contract or within 30 days of its execution? Is your state a “preliminary notice” state such as California or Nevada, or a “surprise” state such as Idaho? Is your contract an “open-book” agreement? Can you communicate with lower-tier trades at any time? Do you have payment provisions relating to timing of payment for lower-tier trades or suppliers in your prime agreement? Do you require a sworn statement for the work performed for prior payment applications and a listing of the trades? Do you have joint pay or direct pay provisions if you have any concern whether those trades might be paid? Can you require waiver and lien releases with each payment (as permitted by law, of course)? Are you allowed to offset payments if you do discover there are some financial or payment concerns?
Step 3: Do you check in on the status of the work?
It is important to both monitor the work to keep up on the status and to communicate with the trades and suppliers on a regular basis to make sure they are being paid. While a few trades may promptly bring a slow pay or non-pay to the owner ’s or general contractor’s attention, many others in this economy will not until the very last minute out of pressure from the nonpaying party or fears of “not playing along” and not getting future work. The key is to allow the owner or general contractor to discover any issue early in the process – early enough so that any money can get to the right party and not the party that disappears with the dollars.
Step 4: Someone’s filing a claim; what do I do?!
There are times when something may slip past you despite the best-laid plans. Do you have a checklist action plan? Does everyone know what to do and what information and documents are required? Many times these claims arise at the most inopportune times and create a “fire drill” atmosphere. Avoid the confusion and rush, and know what you need to get done in your state to avoid a lien on the property or obtain the prompt removal of the lien if one has already been filed. The more information you have in advance, the better decisions you will make during the process and the less money it will cost you to address the issue.
But I already paid for that! So you have a mechanic's lien; now what? (Part 1)
Your project is coming along fine, despite the economy. You’ve weathered the squalls of bids, design changes, agency approval, and credit (mercifully), and now even construction completion is looking good. You can see the finish line through the haze on the horizon, and you’re fairly pleased with how you have pulled everything together with what has been a long haul through the system. You’re in the home stretch. You’re closing down the last items and payment obligations to ensure everything will get done. You didn’t even have to spend much money on legal fees in drafting the contract or during construction (that alone is reason to cheer for your department’s budget). You may just go on a “road show” to tout your expertise about how projects should be run. And then....
You receive a call from your project manager letting you know that a subcontractor says it wasn’t paid and will file a mechanic’s lien in five days if it doesn’t get a check. Well, how could that be? You have a record of payments to the general contractor, but you cannot find a release for those payments. You get two more calls from unpaid trades.... Yet, you feel somewhat confident; after all, the contract says the general contractor “is responsible” and you have that record showing you did pay him. It’s his responsibility to pay all the people he contracted with, right? Well, yes and no (of course!) is the legal answer your construction lawyer will likely give you.
Unfortunately, this scenario is becoming all too common in this lingering depressed construction environment. Tight bids, job or trade failures, and an ailing economy have trapped many owners and general contractors, causing them to potentially pay twice for work they thought was already “clear” and paid for.
Although each state’s laws on mechanic’s liens govern each party’s obligations and rights, in my next post I will provide you with some simple, general guidelines that owners and general contractors should keep in mind at the beginning of each project to help protect against the possibility of such a double payment.
WA Supreme Court Confirms Right to Claim Liens over Improvements on Public Property
It is well known that public property is not lienable in most states, including Washington. However, it has been generally assumed that under Washington’s mechanic’s lien statute (RCW 60.04), improvements constructed on public property are lienable. In Estate of Haselwood v. Bremerton Ice Arena, Inc., No. 80411-7 (June 25, 2009) the Supreme Court of Washington, by a 7-2 majority, issued a decision holding that a subcontractor’s lien attached to an ice arena built on property owned by the City of Bremerton. However, the court noted that, pursuant to RCW 60.04.051, the attachment of a lien to improvements on public land is limited “to the interest of the person who requests the labor or materials, or that person’s agent.” In this case, under the terms of a concession agreement between the city and Bremerton Ice Arena, Inc., the latter party owned the arena for the duration of the concession agreement, while the city retained ownership of the underlying land. Therefore, in determining whether an improvement on public property in Washington is lienable, it is important to inquire into the precise nature of the interest owned by the person that commissions the construction work. The Haselwood Court also held that Washington’s lien priority statute applies to liens over such improvements on public land, such that a mechanic’s lien has priority over a deed of trust where work or professional services commenced or materials were provided prior to the date the deed of trust was recorded. The majority, concurring and dissenting opinions can be read here.
Owner/Developer Insolvencies and the Risks to Contractors
Developer insolvencies are unfortunately becoming more and more common in our current economic climate and often result in partially completed projects being stopped. The consequences to contractors can be significant. A number of recent resort projects illustrate what the contractors and subs can typically expect.
First, the obvious, immediate problem is nonpayment, which in turn requires the contractor to file a lien. After a lien is filed, the contractor has 120 days (in Oregon) to file a lawsuit to foreclose it. The commencement of the foreclosure suit is only the start of what can sometimes turn into a long and drawn-out battle with an uncertain outcome.
If the project involves conventional bank financing, as many do, the biggest battle will be between the contractor and the bank. If the contractor has prepared its lien properly (and mistakes here are common), it will normally have priority over the bank. While in some cases the contractor may be successful in moving the case along quickly, it 's not at all uncommon for such cases to drag on for a year or more, and this will likely be the situation if there are significant priority disputes.
In other economic climates, banks would often step up and pay off the construction liens, once any priority issues were resolved; however, that is not happening as often in the current climate for a number of reasons. First, many banks are dealing with their own insolvency issues, and some are operating under Federal Reserve supervision. Banks in those situations are often incapable of advancing new funds. Second, as a result of the recent significant decline in real estate values, the equity cushion that many banks thought they had when making the loan has disappeared. Absent having any equity to protect, many banks will simply elect to abandon their collateral to the construction lien claimants. And third, participation loans have become more common, with the result that the lender on a particular project might not be an individual bank, but instead a collection of banks, perhaps as many as 40 or 50. Negotiating with a single entity presents a different dynamic from negotiating with a committee.
In the course of the lawsuit, the contractor is obligated to the subs and suppliers. If the subcontracts contain pay-if-paid or pay-when-paid provisions, the general contractor may be protected, though not necessarily. Recent case law has held that a pay-when-paid provision still obligates the general contractor to pay subcontractors within a reasonable period of time and does not permit the general to delay subcontractor payments indefinitely.
Assuming the general succeeds in being awarded a judgment in the lawsuit, the next step is to schedule a foreclosure sale, and this can be done within approximately two to three months after a judgment is entered. If the bank has not stepped up and paid subcontractors by the time the foreclosure sale is scheduled, there is a good chance that it will not do so and will instead allow the sale to go forward. If the sheriff’s sale takes place, the bank is still protected, because it can later exercise its redemption rights to acquire the property for the amount that was bid at the sale.
However, if the owner believes there is equity in the project, and most owners are optimistic that there is, even in the face of an appraisal to the contrary, the owner will file a bankruptcy petition in time to prevent the sale. If the owner is a single-asset limited liability company, which is how many development projects are set up, a bankruptcy filing is an easy decision. Typically, the owner will wait until only a day or a few days prior to the scheduled foreclosure sale to file the petition.
In bankruptcy, the owner will likely propose a plan of reorganization that involves delaying completion of the project for a few years until the economy turns around, which will, in theory, give the owner time to locate new financing, complete the project, and pay everyone off. All of this, of course, means three, four, or maybe five years of delay in the contractor getting paid. Many contractors simply cannot wait that long.
The contractor can do a number of things to prevent this situation from happening. First, the contractor can investigate the owner’s financial condition before starting work. This might involve asking for financial statements, requesting confirmation from the lender that the financing has been approved, and ordering a Dunn & Bradstreet report. If there are concerns, the contractor should request that the owner post a payment bond. Second, the contractor should include strong language in the contract allowing it to stop work for nonpayment and to demand financial assurances in the event it has reason to question the owner’s solvency. Third, assuming that it has included strong language in its contract, the contractor should exercise its right to stop work promptly in the event of nonpayment. Fourth, the contractor should insert pay-if-paid provisions in its subcontracts. And finally, the contractor should act promptly and cautiously in filing its lien.
More than anything else, payment defaults can cause contractors significant delays. Anticipating payment issues at the contracting stage and monitoring the issues closely during performance are critical.
Common Lien Mistakes
While the technical requirements for preparing and filing liens offer countless opportunities for mistakes, two in particular seem to predominate. The first is the failure to properly calculate the 75-day period for filing the lien. The 75-day period begins to run from the earlier of (i) the day the contractor or supplier ceased to provide labor or materials or (ii) the completion of construction. When relying upon the second prong (the completion of construction), contractors often mistakenly calculate the 75-day period from the last day they performed work on the project. Oregon courts have held that, for purposes of the lien statute, “completion of construction” refers to substantial completion, not final completion and not punch-list work. Accordingly, the 75-day period may be running while the contractor is still on site getting the project to final completion.
Contractors are also occasionally tripped up in calculating the 75-day period on projects that have been stopped, perhaps because the owner has temporarily run out of money. They sometimes mistakenly assume that the 75-day period has not started to run yet because the project has not been completed. ORS 87.045 provides that where work on a project has ceased, it shall be deemed completed 75 days after cessation. Accordingly, when work on an uncompleted project stops for an extended period, liens need to be filed within 150 days (the project will be deemed completed 75 days after work stops, and the lien then needs to be filed within 75 days thereafter).
The second-most common mistake with liens is the failure to segregate materials and labor, combined with the failure to serve a notice of right to lien. While an Oregon lien for labor has priority over a prior recorded lien (the most concerning one being a bank’s trust deed), a lien for materials generally has priority over a prior lien only if the supplier provided a notice of right to lien within eight days of delivering materials (the notice only protects materials provided within eight days of the notice). While material suppliers do a good job of providing notices of right to lien, contractors and subcontractors often do not, even though they are providing both labor and materials. Oregon courts have held that where a contractor has failed to provide a notice of right to lien, and has subsequently failed to segregate the labor and materials in the lien, the entire lien will be treated as if it were for materials, which results in its being subordinate to any prior liens. In most cases, for practical purposes, this will render the lien worthless. If the notice of right to lien has not been given, but the materials and labor are segregated, at least the claimant has preserved its priority for the labor portion of the lien.
Our best practical advice about liens is to not wait until the 75th day to file, but to instead file well before the deadline. We’ve seen many liens disqualified because someone was unfortunately wrong about when the 75-day period started to run. Likewise, we always advise segregating labor and materials when preparing a lien. A lien without priority is often the equivalent of having no lien at all.
