Mechanic's liens in a tough economy

Nov. 1, 2011
Mechanic's liens are creatures of state statutes, so they 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

Mechanic's liens can be a great equalizer in the otherwise unequal relationship between project owners (those with the money, or at least the obligation to pay) and contractors (those who want to get paid). The lien gives a contractor assurance that if the project owner doesn’t pay for goods or services, the contractor or supplier 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 still a tough market out there, and many contractors who have filed liens may be finding for the first time that they actually have to ask the question: what happens now?

Mechanic's liens are creatures of state statutes, so they 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 who has a mortgage or other interest in the property is brought into the lawsuit. Some of these foreclosure suits have dozens of participants. Then, 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 selling the property to the highest bidder. The person who buys the property has to pay off the liens ahead of his lien with the sale proceeds. Obviously, this means there better be enough equity in the property or the whole process could be a waste of time and money.

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 to $200, and take several days (or more, depending on the complexity of the title work). Contractors rarely do this before they take a job, 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. It can also give you an idea about whether the property is valuable to cover all the existing liens and still leave enough sales proceeds to cover any mechanic's lien you may need to file.

Who will have priority, me or the lender? Priority determines who gets paid first. So when there is not going to be enough money to pay all, priority 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 to the question of who gets paid first is: it depends. In some states, if the money was borrowed to pay for construction, even a mortgage filed before your mechanic's lien 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, and the funds would be split pro-rata among the lien claimants.

Will the lender want to foreclose? Remember, lower priority liens can get wiped out if there isn't enough money from the sale proceeds to pay all liens. But don't always assume that just because you are behind a bank or other lender in priority that the lender 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 usually means taking a loss. Instead, they will either pressure the property owner to come up with the money to pay you 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? Yes. 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, but the big lender may not be able to justify to the regulators lending its customer any more money to pay you off. The lender may have no choice but to foreclose itself and, if there is not enough money to go around, wipe out lower priority liens.

Despite the problematic real estate market, mechanic's liens still perform their valuable service of assuring a source of payment. But where you are unsure about the ability of your 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 new project.

Michael Callahan is a partner at Stinson Morrison Hecker LLP (the same firm as long-time columnist Susan McGreevy) where he assists clients with all aspects of their construction law needs, including litigation.

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