Cross Examination: Accelerating Collections with Mechanic's Liens
Powerful, but dangerous weapons.
Disclaimer: This article is intended for general information purposes and is not intended to be legal advice. Legal issues should be presented to qualified counsel licensed to practice law in the jurisdiction where the events occurred.
Mechanic’s liens are unquestionably the most powerful, and most poorly-understood collections weapons available to contractors. But like any weapon, they are dangerous, and can backfire on the unwary and the inexperienced.
Contractors with liens get paid the most and get paid the fastest, because liens cloud the title to real property, and allow a foreclosure (sale) of the property to pay the lienholder. The rules are complex and must be followed closely. Unlike other areas of the law, there is little or no margin for error here. So contractors should not attempt to prepare them or record them unless they are extremely well-versed in the technical requirements and study the law regularly to stay abreast of changes in the rules. Experienced lawyers and lien services prepare liens for small fees.
What is a Mechanic’s Lien?
Generally, a lien is a legal hold on property as security for a debt. Liens come in several forms, including judgment liens, mortgage liens and possessory liens. A party who takes possession of a piece of personal property has a possessory lien for the value of services rendered upon the property, allowing the party to retain possession of the property until the fees are paid. Ultimately, the party may sell the property if no payment is received. That is a highly effective strategy for companies that pack, handle, restore, and store contents after a fire or flood. But once the contractor is paid for the contents, they must be released, even if there is a past due balance for other parts of the job, such as structural repairs.
Generally, a lien is a legal hold on property as security for a debt.
A mechanic’s lien is an encumbrance on real property, but it is not a possessory lien because it is not based on physical possession of the property. A mechanic’s lien is the right to charge a property with the payment for labor and material lawfully used to improve it. The property becomes security for the debt, which provides protection for the contractor in the event the owner declares bankruptcy. In that case, the contractor becomes a secured creditor.
Contractors rarely receive much respect in the eyes of the law, but mechanic’s lien laws are an important exception. State constitutions boldly proclaim contractors’ rights to mechanic’s liens. They are the only creditor’s remedy that stems from a constitutional mandate. The mechanic’s lien law in California was established in 1872.
The Goal of Mechanic’s Lien Laws
Mechanic’s lien laws are designed to prevent unjust enrichment of a property owner at the expense of a laborer or material supplier. Courts have uniformly classified the mechanic’s lien laws as remedial legislation, to be liberally construed for the protection of laborers and materialmen.
What is Lienable?
Mechanic’s liens only attach to privately-owned real property, not public property. Real property consists of land and its fixtures. A fixture is an item affixed to a piece of property that cannot be removed by hand, i.e., it requires one or more tools. That means that the amount of a mechanic’s lien cannot include a balance due for pack-outs or contents restoration. Possessory liens are available in that scenario.
Mechanic’s lien laws are designed to prevent unjust enrichment of a property owner at the expense of a laborer or material supplier.
What Notices are Required?
Notice requirements are poorly understood, and trip up restorers frequently. Several different types of notices may be required, depending on the nature of the job and the contractor’s relationship with the property owner. When in doubt, consult a legal professional.
Notice of Mechanics’ Lien Laws.
Many states, such as California, require a notice of mechanic’s lien laws in home improvement contracts—not commercial contracts. These notices are not liens, “lien notices” or “pre-liens.” They are like primers on the law. They consist of generic disclosures warning owners that if they do not pay, their property may be subject to foreclosure. They also warn owners that if they do not pay subcontractors or material suppliers directly, they may need to pay twice if the prime contractor does not pay the subcontractors or material suppliers. In other words, the owner could pay the prime contractor in full in a timely manner and still face a foreclosure sale of the property. That is why some states require contractors to provide updated lists of their subcontractors and material suppliers upon request from the owner.
Preliminary Notice of Lien.
A preliminary notice of lien, sometimes referred to as a “pre-lien” or “20-day notice,” must be served on the owner by a contractor or material supplier that is not under contract with the owner, if the contractor or supplier wishes to reserve lien rights. Although contractors frequently claim they do so, there is no such thing as “pre-liening” a property, because a pre-lien is not a lien and it is not recorded. It is only a notice that a party has provided labor or material for the property and will have right to record a lien in the future if full payment is not received. Therefore, this type of notice performs a similar function to the lien law notice described above, but those notices are in contracts signed by the owner, whereas the owner does not sign a subcontract and may be unaware of the existence of a subcontractor who holds rights against the property. The preliminary notice provides this important disclosure.
Preliminary notices in many states, such as California, must be served on the owner within 20 days of commencement of the subcontractor’s services or the material supplier’s provision of materials. The 20-day deadline is frequently overlooked. A preliminary notice that is served late is still valid, but only for amounts due for services or materials supplied during a period starting 20 days before the notice is served. In other words, subcontractors and material suppliers that serve preliminary notices more than 20 days after the conclusion of services have no lien rights whatsoever.
Notice of Lien.
It should go without saying that a property owner should receive a copy of lien recorded against the property, but this never occurs to some contactors, so certain states, such as California, require a special “notice of lien” to be served once a claim of lien has been recorded. This is not a pre-lien, a 20-day notice or a notice of lien rights. The notice of lien must be served on the owner by mail with a copy of the claim of lien and a proof of service. This proof of service is a sworn statement, made under the penalty of perjury, that the party recording the lien mailed a copy of the lien claim to the property owner. It often triggers payment.
Notice of Pendency of Action.
Complicating matters further is yet another notice requirement that applies when a lawsuit has been filed to foreclose on a lien. This is called a “notice of pendency of action” or lis pendens. The lis pendens is recorded with the county and constitutes notice that a legal action is pending against the title to the property. A mechanic’s lien may not appear on a title report, but a lis pendens is more likely to appear, which could trigger attention that leads to a payment to the lienholder from a sale of the property to a third party.
Notice of Intent to Lien.
Savvy contractors send a letter to the property owner with a friendly notice that an invoice has not been paid and that if it is not paid promptly, the law requires the contractor to record a claim of lien to protect the contractor’s constitutional rights. This is just a glorified collections letter, ideally entitled “notice of intent to lien.” To be clear, this is not a pre-lien, or a notice of lien. Unlike the other four types of notices described above, there is no legal requirement to send this notice. It is a simply a good business practice and a helpful collection tool.
When to Record a Mechanic’s Lien
The biggest lien error made by restorers is the failure to timely record the claim of lien. In many states, the claim must be recorded within 90 days of substantial completion of the work. The deadline is rigid and is often blown, so compliance with it is the first thing checked by experienced attorneys representing property owners. If it is recorded late, the lien rights disappear automatically by operation of law. Recording an untimely claim of lien subjects the contractor to significant liability for slander of title, monetary damages, and a claim for reimbursement of the owner’s attorneys’ fees. But even if lien rights have expired, the contractor can still file suit for breach of contract and quai-contract.
For purposes of determining the deadline, “substantial completion” is a term of art. Its legal definition varies from state to state. Substantial completion can occur when a number of different events take place, and contractors should seek legal advice to determine the applicable deadline. “Substantial completion” does not require actual completion. For example, for purposes of lien claims, an incomplete project may be deemed “substantially complete” in the eyes of the law if no work has been performed for an extended period of time, e.g., 60 days. In most restoration cases, it occurs when the property is in a condition in which it can be used for its intended purpose. For example, food can be cooked in the kitchen, showers can be taken in the bathrooms and bedrooms can be used for sleeping. Therefore, substantial completion occurs before punch list items have been completed. It usually occurs on the last day the contractor was on site performing substantial work.
Since it can be affected by a number of different events, the date of substantial completion can be debatable—and in close cases, that debate can lead to extensive litigation. So contractors are well-advised to err on the side of caution and be very conservative in calculating the deadlines, using the very earliest possible date as a deadline, and planning to record a month or so before that date.
It is also possible to record a lien too early because it can poison the relationship with the owner. Some contractors record liens on every job, which is bad for public relations and a waste of time, money and energy. The better practice is to gradually escalate collections efforts with calls, emails and letters warning about the effects of a lien.
When NOT to Record a Mechanic’s Lien
Of course, a lien claim should never be recorded past the deadline because it will turn the contractor from the hunter into the hunted. If a job has not gone fairly smoothly, or there are significant workmanship issues, recording a lien claim might only make a bad situation worse. Owners’ attorneys love to tell juries: “they did a shoddy job and then liened the property.”
Surprisingly, in some jurisdictions, a contractor that fails to provide a notice of lien rights and fails to execute a written contract as required by home improvement laws may nonetheless have the right to record a mechanic’s lien. But doing so is not advised. The violation of the home improvement law will subject the contractor’s license to disciplinary action. The harm from that action can be many orders of magnitude worse than the loss of the lien rights.
How to Turn a Mechanic’s Lien into Money
Contrary to popular belief, the initial document recorded to assert the right to a mechanic’s lien is not actually a lien, despite the fact that many of the forms are titled “Mechanic’s Lien.” Instead, these initial filings are claims of liens that must be adjudicated to become legally-enforceable liens.
The lien is “perfected” by filing a lawsuit to foreclose on the lien. The lawsuit must generally be filed within 90 days of the date the claim of lien was recorded. Note that the deadlines are based on 90-day periods, and not (as some contractors have learned the hard way) on “three months.”
In a lien foreclosure lawsuit, the burden is on the claimant to show that work was done to improve the property pursuant to an agreement, to show the value of the work and to prove the balance due. When a judgment is entered in favor of the claimant, a foreclosure sale is ordered. The sale proceeds are paid to the senior lienholders, e.g., mortgage lenders, first, and then to the lien claimant. Leftover proceeds are paid to the owner.
When property owners receive the required notice of the lien, they usually stand up and take notice and suddenly become motivated to pay. For this reason, it is very rare for restorers’ lien foreclosure lawsuits to actually go to trial. The threat of a potential foreclosure sale frequently makes the difference between getting paid and working for free. And the existence of the lien also motivates mortgage companies to release insurance loss proceeds to clean up the title to their collateral.