by Marc J. Felezzola, Esq., Babst Calland
Although every subcontractor begins a project with full expectations of a successful project for which it will receive timely payment, the reality is that some projects encounter financial difficulties. Fortunately, the law provides subcontractors with security against those difficulties in the form of mechanic’s lien or payment bond rights (or sometimes both). This security is not absolute, however, and there are many potential pitfalls along the way about which subcontractors should be aware to ensure their right to the security provided by a lien and/or payment bond is not inadvertently lost. This article provides a general overview of the potential ways in which a subcontractor may lose its payment security during a construction project and provides some general guidance on how to avoid them.
The general concept underpinning a mechanic’s lien is that construction of a building or other structure improves the value of the real estate on which the building or structure is constructed, and therefore, those who furnish the labor and materials for the construction (collectively, “constructors”) should be allowed to put a lien on the title to the property as security for payment for their work. Importantly, the lien is against the property itself rather than the property owner, and therefore, the property serves as the collateral securing the debt owed to the constructor. Thus, in the event of nonpayment, a constructor with a mechanic’s lien can foreclose on the lien and force the sale of the property. The proceeds from that sale will then be used to pay the debt owed the constructor.
This mechanism of providing constructors security works well for privately owned property, where a change in ownership will not have a significant detriment to the general public. However, publically owned property presents a different situation. Take an elementary school for example. If an unpaid constructor were allowed to lien and sell the elementary school, to recover an unpaid debt, the sale would (or at least could) deprive the community of its school, resulting in a significant loss to the general public, not just the public owner. Thus, states and the federal government have enacted laws requiring posting of performance and payment bonds for virtually all public construction projects. A performance bond protects the public owner (and the public generally) from contractor default, whereas a payment bond serves as alternative security replacing their mechanic’s lien rights in the event of nonpayment. (Although all states have some form of statute requiring payment bonds for public projects, some states also allow a subcontractor to file a lien against the public funds earmarked for paying for the project.)
Thus, generally speaking a subcontractor or material supplier (collectively, a “subcontractor”) always should have security for the work it performs. For a private project, that security comes in the form of a mechanic’s lien. For a public project, the security generally comes in the form of a payment bond. This security, however, is not absolute, and if one is not cautious, it can be lost before the subcontractor or material supplier ever mobilizes or makes its first delivery to the job site. Thus, a contractor must be careful at to preserve its rights at the time of contract formation, mobilization, and completion of the project.
Contract Formation: Do Not Waive Lien Rights in Your Subcontract and/or Confirm Requisite Bond Has Been Posted
Virtually every subcontractor has received a subcontract or purchase order with language purporting to waive all of its mechanic’s lien rights against the project. This type of lien wiaver is often referred to as a “blanket lien waiver” or “upfront lien waiver” because it covers work before it is performed and states something like “subcontractor hereby waives and releases any and all liens or right of liens or mechanic’s liens for any labor or materials furnished under this subcontract.”
Blanket lien waivers are enforceable in approximately 20 states, and in those states, signing a subcontract with a blanket lien waiver will automatically deprive a subcontractor of mechanic’s lien rights all of its work. Thus, in states where blanket lien waivers are valid, subcontractors who sign contracts containing them will have no payment security for their work unless the project is bonded.
It is much less common for a subcontractor to lose its payment bond rights before starting a project. However, although all states have some law requiring prime contractors to post payment bonds as security for subcontractor work, not all of those laws provide consequences in the event the prime contractor does not actually post a payment bond. For example, although Pennsylvania law requires payment bonds for all public projects, the law provides no penalty in the event the prime contractor simply fails to post the requisite payment bond, and Pennsylvania courts have held a subcontractor has no redress against the government for failing to ensure the required bond was posted. Thus, at least in Pennsylvania, a subcontractor working on a public project may find itself working without payment security despite laws requiring payment bonds. Therefore, subcontractors should always obtain a copy of the payment bond for a public project before commencing work to make sure it has the alternative security required by law.
Commencing Work: Adhere to All Preliminary Notice Requirements
Avoiding blanket lien waivers and ensuring the prime contractor posted the requisite bond is often only the first step in ensuring a subcontractor will have payment security for its work. In fact, in many states, a subcontractor can still lose its payment security very early in the project by failing to provide statutorily required preliminary notice of its work on the project.
Increasingly, states are enacting requirements that subcontractors (or at least second-tier subcontractors) and material suppliers provide notice (often in the form of a “notice of furnishing”) prior to or soon after commencing work on a project. Preliminary notices are intended to alert the project owner, prime contractor, and/or surety of the lower tier subcontractors who are contributing to the project. The purpose behind these requirements is a good one—if the owner is aware of the lower-tier subcontractors, it can make sure they are receiving timely payment for their work (usually by requiring the prime to provide partial lien waivers from lower tier subcontractors before issuing the next progress payment). However, consequence of these requirements is that the subcontractor’s failure to provide them often results in the loss of mechanic’s lien or payment bond rights.
Thus, it is absolutely imperative that subcontractors check the laws of the state where the project is being built prior to commencing work on the project to check for and ensure compliance with any preliminary notice requirements. Doing so will ensure the subcontractor preserves its mechanic’s lien or payment bond rights for the project.
Foundation of ASA Publishes Updated Lien & Bond Claims in the 50 States
by American Subcontractors Association
Construction subcontractors and suppliers rely on mechanic’s lien and payment bonds to assure their payment. To help you learn your lien and bond rights in the states in which your company does business, the Foundation of ASA has updated its Lien & Bond Claims in the 50 States, a downloadable manual which outlines the lien and bond laws in each state and the District Columbia.
A mechanic’s lien is a claim against property to secure a debt, such as a debt owed to a construction subcontractor for the value of work performed and materials furnished on a construction project. A payment bond, which is required on most public construction, assures the owner that the prime contractor will pay its subcontractors and suppliers.
The FASA manual provides a summary of the basic requirements of each state’s lien and bond laws, including who is covered; critical deadlines for notices, claims and suits; filing procedures; and more.
The summary of laws was prepared by Donald W. Gregory, Esq., and Eric B. Travers, Esq., Kegler, Brown, Hill and Ritter, Columbus, Ohio, ASA’s general counsel, with input from attorneys from around the country.
FASA Lien & Bond Claims in the 50 States (Item #3006) is $55 for ASA members and $80 for nonmembers.
Punching-Out: Meet All Notice and Filing Deadlines
Finally, every state’s lien or bond law sets forth detailed requirements for how and when to perfect a mechanic’s lien or payment bond claim. These requirements vary from state to state, but they typically include some or all of the following: a requirement that second-tier (and lower) subcontractors provide some advanced notice to the owner, prime contractor, and/or surety prior to filing or recording a claim; a formal filing or recording of a claim with the court or recorder’s office; initiation of legal proceedings to prosecute or foreclose on the claim. Each step in the process will usually have its own deadline and failure to meet every deadline will likely result in a loss of the payment security.
Again, no two states are identical, so it is imperative to check the law of the state where the project is located at the time a subcontractor is completing its work to determine the applicable requirements for perfecting their lien or payment bond claim. Although there is no substitute for checking the current statutes, the ASA’s Web site, www.asaonline.com, is a valuable resource for subcontractors and contains information about each state’s mechanic’s lien and payment bond claim perfection requirements.
Marc J. Felezzola, Esq., is chapter attorney for ASA of Western Pennsylvania, as well as an associate attorney in the Litigation and Construction Services practice groups of Babst Calland, a full-service law firm headquartered in Pittsburgh, Pa. Felezzola has extensive experience drafting and negotiating construction contracts, as well as litigating construction cases involving mechanic’s lien claims, prompt payment act claims, construction bid protests, construction defect claims, differing site condition claims, delay and inefficiency claims, payment and performance bond claims, and payment and contract performance disputes. Felezzola can be reached at (412) 773-8705 or firstname.lastname@example.org.