An owner enters into a contract with CC Construction for an addition to his commercial facility for a total cost of $256,789.  CC construction subcontracts the plumbing to PP Plumbing and agrees...

  1. An owner enters into a contract with CC Construction for an addition to his commercial facility for a total cost of $256,789.  CC construction subcontracts the plumbing to PP Plumbing and agrees to pay PP Plumbing $50,000.  PP Plumbing installs the plumbing but CC Construction never pays it.  The owner makes a final payment to CC Construction of the last of the $256,789 based on CC’s statement that all subcontractors and suppliers have been paid.  Shortly after this, CC Construction goes out of business.  PP Plumbing, not having been paid, files a lien on the facility (how?)  What are the owner’s rights?  Discuss in detail including ways to alleviate problems like this.

Asked on by tsekiteri

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docholl1's profile pic

Stephen Holliday | College Teacher | (Level 1) Distinguished Educator

Posted on

In the scenario you have described here, a lending institution has provided a loan to the general contractor, CC Construction, for the construction of an addition to the facility.  Most subcontractors in most jurisdictions have the right to file a mechanic's lien against the property before they provide their part of the work.  As part of the loan agreement between lender and CC Construction, there is a provision for a series of payments to CC Construction as work is completed known as progress payments, and these are based on verifications by the lender, not CC Construction,  that certain work has been completed.

As part of the verification process, the lender obtains mechanic's lien releases (or, sometimes, conditional releases) from subcontractors who have completed their contracts:

Usually, the owner or bank will require mechanics lien releases from the contractors and material men to be delivered by them or the general contractor before the payment can be made. Typically, the lien releases are delivered in a packet, along with other paperwork providing for proof of performance, and the money is released. (http://www.stimmel-law.com/articles/failure_to_pay_subcontractors.html)

The above summary applies to California construction law, but most jurisdictions protect subcontractors in exactly the same way.  The lender employs construction oversight to insure that payments to the general contractor are made only if the subcontractors release the mechanic's liens related to that part of the contract.  In addition, most jurisdictions have construction law statutes that protect subcontractors by allowing them to sue non-paying contractors in court--in California, for example, the applicable statute is CA Business & Professions Code § 7108.5 Prime building contractors and subcontractors; payment to subcontractors; withholding payments; violation; penalty.

In addition, all prudent lenders hold back at least 5% of the construction funds to insure that all requirements of the construction contract are met, including all required mechanic's lien releases.  That 5 or 10% is not paid to the general contractor until all work is completed and all lien releases have been recorded so that there is no "cloud" on the property's title.  A prudent lender does not rely solely on the general contractor's assurance that all subcontractor's have been paid but requires all lien releases to be properly filed and recorded, and this is verified by the lender.

If the general contractor files bankruptcy, the lender, which often has sufficient staff to manage a construction contract, will either complete the project itself or hire a new general contractor to finish a project.  In either case, however, mechanic's liens usually have priority over other types of liens and are paid out first with the remaining 5 or 10% of the contract's "holdback."

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rienzi's profile pic

rienzi | (Level 1) Valedictorian

Posted on

Without a mechanics lien law in place the plumber would have very few options against the owner. A claim for unjust enrichment perhaps or quasi contract. The owner could rightfully claim a lack of contractual privity. Privity is an important legal principle under the common law. To say that privity has suffered an erosion of monumental dimensions over the last 100 years would be an understatement. But I digress. For the owner his problem rests with a statutory provision that essentially over-wrote the owner's common law protection. That is called a mechanics lien law. Essentially it is a statute that gives to a contractor the right to place a lien on the real property upon which the contractor built an "improvement" (a shed, a house, etc.) I suppose it should have been called the contractors lien law. Anyway, such liens are very powerful they are superior to mortgages (but that is changing). So after a lien is filed for unpaid work, the contractor can execute on his lien and force the sale of the real estate with the improvement on it (that makes it worth more). That forces the bank (if there is one)  to pay off the lien to keep from losing the money they lent the owner. The bank then under the mortgage would go back against the owner if it can. Subcontractors have the same lien protection leaving owner's lack of privity (of contract) defense in the dirt.

But, the mechanics lien laws provide for a waiver to protect the owner and the bank. In fact banks usually require one from the contractor because let's face it they are the ones laying out the bucks. So the owner (and bank if there is one) get the contractor to waive his rights under the mech. lien law and file the waiver at the county clerks office. This latter step is considered as public notice to subcontractors who are then also bound by their contractor's waiver. The alternative is to get a waiver directly from each sub before they step foot on the property. Contractors will generally waive when a bank is lending construction money because the contractor knows a fund for construction is set up. The contractor and the bank then enter a contract that sets forth draws against the fund at certain stages of completion. Without a bank however a contractor would not be advised to waive his rights without some assurance from the owner that secures payment. Pulling the front porch off a house for nonpayment tends to bring the cops. 

Because filing a lien for nonpayment is such a powerful remedy, the courts require very strict adherence to form and procedure. Of course the law is detailed about how the lien paperwork is to be drafted along with what paperwork must be attached (documentation, verifications and notices). And then  appropriately serving the owner. The owners response at this point is attacking the liens failures to strictly follow the statute. If he loses that, stick a fork in him because he is done.

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