I have had many columns that touch on the various nuances of mechanic's liens because mechanic's liens are an essential part of the fabric of the world of construction - at least in the U.S. The lien gives a contractor assurance that if the buyer doesn't pay for goods or services the seller can resort to having the property sold to pay for them. In the vast majority of cases, the buyer does pay and no lien is ever filed, and even if a lien is filed, it is almost always resolved and a foreclosure never happens. But it is a tough, tough market out there, and many sellers who filed liens may be finding for the first time that they actually have to ask the question: What happens now?
Of course, being creatures of state law, mechanic's liens vary tremendously as to who has rights, how they are protected and how they are enforced. But there are some issues that are common to many states' schemes for liens that we can consider:
How does a lien foreclosure work, generally?
Generally, a lawsuit is filed to foreclose on the lien. Everyone who has filed a lien or has any other mortgage or interest is brought into the lawsuit (some of these foreclosure suits have dozens of defendants). A judge or jury decides how much each claimant is legitimately owed and enters a judgment for that amount. The lien is then foreclosed by being sold to the highest bidder. The person who buys it has to pay off the liens ahead of him.
How do I know if there are other liens or mortgages on the property?
The way to know this up front is to spend the money for an Ownership & Encumbrance Report. In most states, this will cost you $100-$200 and take several days or more, depending on the complexity of the title work. Seldom do I see a contractor taking this step, but for those who do it allows them to know before agreeing to do the work whether there are already mortgages ahead of them. Depending on the state, it may give enough detail to let you know if enough money has been borrowed to really cover the cost of construction. It will certainly tell you if there are other liens or judgments which might tell you a lot about the credit of your customer.
Who will have priority - me or the lender?
Priority means “who gets paid first?” Where there is not going to be enough money to pay all, this is a big deal. In fact, if your lawyer advises you that you are behind other lenders, it may not be worth spending the money to even file a lien, let alone foreclose. The answer is: It depends.
In some states, if the money was borrowed to pay for construction, even a mortgage filed before yours will not have priority over a mechanic's lien. In other states, the “first in time” rule is strictly applied. If you take lien rights seriously and want them available as security for payment, it would be in your interests to have your attorney fully explain how the law will operate in every state where you will be working.
What if there are other contractors who have filed liens?
In most states, multiple valid liens are treated equally, even if one is filed before the others. In this case, if the property were sold and not enough money was generated to pay everyone, the court would decide who was legitimately entitled to how much. The funds would be split pro-rata among the claimants.
Will the lender want to foreclose?
Don't always assume that just because you are behind a lender in priority and make noise about foreclosing that the lending will foreclose ahead of you and wipe out your lien. Commercial loans are generated by employees of lenders, who get evaluated on the quality of the loans that they make. Lenders are often regulated by federal or state agencies.
Neither the loan officer nor the loan committee of the lender want to have to report that they had to foreclose on a loan, which inevitably means taking a loss. Instead, they will either pressure the property owner to come up with the money to pay you (since he signed his life away to get the loan), or lend him more money with which to pay you. The big mortgage on the property will generally be a lot more than the amount of your lien, so this frequently works.
Have the rules changed with the tough real estate market?
They sure have. Now that many properties are not worth as much as the liens/mortgages against them, not only do your lien rights not count for as much, the big lender may not be able to justify to the regulators that it's worthwhile lending its customer any more money to pay you off. The lender may have no choice but to foreclose itself and wipe you out.
Despite what you read in the papers, most real estate and construction work is doing just fine, and liens still perform their valuable service of assuring a source of payment. Where a contractor or vendor is unsure about the ability of its customer to pay or of the value of pursuing a lien, it would be wise to do some “due diligence” about the property, the lender and the applicable laws before investing your time and money in a project that could go under, leaving you with nowhere to go to get paid.
Susan McGreevy is a partner at Stinson, Morrison, Hecker LLP, Kansas City, Mo., 816/842-4800, e-mail [email protected].