Punchlist Commentary: Protection for Contractors Through Mechanics Liens

By Samuel H. Levine
Partner, Arnstein & Lehr LLP

Today’s volatile market conditions present unique challenges and situations because developers are out of funds, lenders are refusing to lend, sales activity has plummeted and construction activity has halted.

Consider the following example, which has become all too common in today’s environment. A condominium conversion loses sales momentum halfway through the project and abruptly halts construction. With the developer out of funds and facing bankruptcy and its lender considering foreclosing on the unsold units, how can trade contractors protect themselves and ensure they will be paid for labor and materials already rendered to the property?

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In the current economic climate, we are seeing more and more contractors asserting their rights through mechanics lien claims as a vehicle for payment. A mechanics lien is a lien by someone who furnishes labor, materials or services for the benefit of the project. Mechanics lien statutes carefully balance the rights of owners, original or general contractors, subcontractors and lenders. However, a properly perfected claim for lien can provide leverage for the trade contractor to collect amounts owed it.

In filing a mechanics lien claim, contractors must act swiftly and aggressively in asserting their rights. If a trade contractor is not being paid, chances are that other trade contractors and the lender are also not being paid and asserting claims against the real estate, the owner and the developer. The decline in real estate values ultimately means there is less equity available to support all of these claims.

The first step is for trade contractors to notify the owner and the lender of a claim. In some states if an owner receives a statutory notice, it must withhold the amount claimed in the notice. Notice is especially important when a trade contractor does not appear on an application for payment or on a contractor’s sworn statement. Notice also puts the developer and lender on notice of a claim. The lender can then assert pressure against the developer or settle directly with the lien claimant so that it can protect its own interest. A lender will often settle in this manner as lenders do not want the mechanics lien claim to impede their own ability to foreclose a mortgage.

Second, the contractor needs to record a proper claim for mechanics lien. Care needs to be taken in drafting a claim for mechanics lien. Since they are a special right given to a contractor by statute, they are strictly construed. Dates of work and the description of the real estate liened have to be accurate. When multiple properties are involved, the claim may have to be allocated against each property.

It is important that contractors and trade subcontractors avail themselves of all possible remedies. Besides asserting a claim for mechanics lien, a trade contractor may have a claim against the party with whom he contracted based on breach of the construction contract. The breach is the failure to make payment.

There are also potential actions against a surety, on a payment or bond in connection with a project. Surety bonds are frequently used by a general contactor or developer in order to obtain a contract .to builds a project. The general contractor or developer may provide a payment bond, a form of surety bond, to ensure that subcontractors or suppliers are paid .for work done.

Finally, a contractor cannot ignore or be intimated by a bankruptcy. Some states, such as Illinois, require that a contractor perfect its claim for mechanics lien by serving its notices and recording its claim for lien despite notice of bankruptcy. The reason is that the claim relates back to the construction contract, which predates the bankruptcy. However, suit cannot be filed without permission of the bankruptcy court. It is important that a lien claimant pay attention to the bankruptcy proceedings, which may provide an opportunity for real estate to be sold free and clear of liens with the proceeds of the sale providing a fund for payment of claims.

A mechanics lien is not a substitute for good credit practices. However, when a project goes under, it provides an essential leverage to secure payment from the developer.

Samuel H. Levine is a partner in the Litigation and Real Estate Practice Groups at Arnstein & Lehr LLP. He has extensive experience in the area of real estate and construction litigation, with an emphasis on mechanics lien cases. He can be reached at: shlevine@arnstein.com.