Minimizing Risk: Preventing Mechanic’s Liens on Construction ProjectsDownload
This article on mechanic’s liens by partner Matthew B. Millis was published in the current issue of Evansville Business magazine.
Mechanic’s liens are a powerful tool available to ensure payment for those who provide labor or materials for a construction project. By simply recording a sworn statement and notice of intention to hold mechanic’s lien, a contractor, subcontractor, or material supplier can claim a lien and cloud title to the property where the project is being built.
This cloud on title can have devastating impacts. Construction lenders may refuse to fund construction draws until the lien is removed. When funding stops, construction may come to a halt. This can cause delays and lead to cost overruns. If the owner cannot tap its construction loan, it cannot pay its general contractor, which may lead to more liens from downstream subcontractors and suppliers.
This unfortunate chain of events can occur regardless of the validity of the lien. But owners can take steps to prevent or minimize the risk of mechanic’s liens on their next commercial construction project.
The most common way to reduce or even eliminate mechanic’s lien risk is through the use of lien waivers. A lien waiver is a private agreement in which a party surrenders the right to file a lien in exchange for payment. Generally, the lien waiver will contain language indicating the party waives its right to file a lien conditioned upon receipt of payment for its work. In this way, the lien waiver is “conditional” until payment is made, at which time it becomes “unconditional.” If payment is never made, the party waives nothing.
Commercial project owners should require lien waivers before paying their general contractors. Most form construction contracts, such as those issued by the American Institute of Architects (AIA), contain language that gives the owner a right to require lien waivers as a condition of payment. Owners would be well-served to modify such language to specify precisely what form of lien waiver the contractor must provide. To control the content of the lien waiver, owners frequently provide the contractor with a proprietary form required for the project.
Owners may also contractually require, as a condition of payment, that contractors execute an affidavit identifying all subcontractors or suppliers that provided work to the project during the payment cycle and the amounts owed to each. This affidavit should also swear either that the subcontractors and suppliers have been paid or will be paid from the requested payment. If a subcontractor later files a lien, the owner can use a contractor’s affidavit as evidence of payment or as leverage to compel the contractor to pay the subcontractor or take other action to have the lien released.
Other Contractual Protections
Owners should also use their construction contracts to shift the burden of removing any mechanic’s liens filed against the property to the general contractor. The AIA Document A201-2017 General Conditions is a widely used form for commercial construction projects in Indiana. This form specifically requires the contractor to defend and indemnify the owner from all losses or damages arising out of any lien or other claim for payment by any subcontractor or supplier.
For further protection, a project owner could include contractual language requiring the contractor to remove or bond off a mechanic’s lien within a limited period of time. The owner could also contract for the right to withhold payment from the contractor in the amount of the lien (or 150% of the lien) until the lien is removed.
Owners also can require contractors to provide a payment bond, a form of security purchased from an insurance company that provides a guarantee that a contractor will pay the total costs to complete the project. An unpaid subcontractor or supplier can assert a claim against the payment bond. Provided the claimant meets the conditions for payment in the bond, the surety will pay.
A payment bond on a private commercial project does not mean that a subcontractor is prohibited from filing a mechanic’s lien. A mechanic’s lien might still be filed. However, if a suit to foreclose the lien were initiated, the owner could file the payment bond with the court to have the property released from the lien.