Creative Legislative Solutions to Bond off Mechanic’s Liens
Construction and Procurement Law News, Q2 2019
Whether you are the owner or the general contractor, dealing with mechanic’s liens filed by subcontractors or suppliers can be frustrating and, in some cases, present the very real threat of having to pay twice for work or materials. Many states’ lien laws provide that prior payment, whether by owner to contractor or contractor to subcontractor, are not a legal defense to a lien filed by a lower tier subcontractor or supplier who has not been paid. While there may be legal penalties for filing improper or exaggerated liens, when a lien is filed, it causes a ripple effect upstream. It is almost certainly a violation of the owner’s mortgage. In addition, the failure to pay that led to the lien may be a default under the owner/ contractor and contractor/subcontractor agreement. In a sense, as to the clouding effect, it makes no initial difference if the lien is legitimate or illegitimate, because once filed it is a cloud on title and will delay or preclude refinancing, sale, or the approval by a lender of the owner’s next construction draw (which can then delay payment and cause more liens to be filed). (Note that a wrongful lien is punishable via statutory or common law actions, but proving such an allegation takes time, and the cloud remains until the allegations are proved.)
Most states have statutes that allow such liens to be “bonded over,” but that means going to a surety company for the bond, which may require full cash collateral. Bonds not only cost money, but also absorb bond capacity that is then no longer available for other projects until the liens are released. If an owner has to bond off a lien, it normally does not have a relationship with a surety company and has to go through a complete financial disclosure process to qualify for a bond. Finally, some states (Texas and Arkansas, for example) mandate that the amount of the lien bond has to be twice the amount of the filed lien. Such a requirement can cause serious issues, particularly where the underlying lien is arguably invalid.
But, what if there is an existing payment bond already in place for the project, normally provided by the prime contractor (the costs of which were passed through to the owner)? That bond does not prevent the filing of liens, but simply gives the lien claimant another way to try to get paid. Most claimants will make a formal claim against the bond but also assert liens. One answer: States should follow the lead of Tennessee, which allows a copy of an existing payment bond, if it meets certain criteria, to be filed of record in the same place as the filed lien, and the filing of the bond automatically “discharges” the lien of record, just like a separate filed lien bond. No separate lien bond from a surety is needed. While the underlying dispute must still be resolved, at least the cloud on the title to the real property of the project is removed. The owner is happy. The payments continue to be made. The claimant is normally happy to now be able to sue on the payment bond. The Tennessee statute is located at T.C.A. 66-11-142(b).
If your state does not have such a statute, consider lobbying for a change. The local chapters of the various construction trade associations, such as ABC and AGC, may be willing to provide legislative support.