Construction is, economically speaking, a cyclical business. When the economy is good, the construction market thrives; when the economy takes a downturn, the construction market suffers. Following the recent economic boom that fed an almost unprecedented amount of construction, the U.S. economy has taken a nosedive that has brought with it a precipitous drop in the construction market. As more and more contractors find it difficult to meet their financial obligations, many are using funds paid on one project to cover financial obligations on another.
Although many contractors continue to hold out hope that economic conditions will improve, the enormous increase in the number of mechanics lien foreclosures suggests otherwise. As contractors succumb to economic stress, unpaid subcontractors, suppliers and materialmen (collectively referred to as “subcontractors”) begin their efforts to secure payment of past due amounts. One of the most effective methods is to record a mechanics lien claim against the property on which the project is located, leaving property owners at risk.
Most owners would assume that if they have paid the contractor everything the contractor is owed, they should be protected from the lien claims of the contractor’s unpaid subcontractors. Unfortunately, that is not necessarily the case. Under the Illinois Mechanics Lien Act, payment alone is not sufficient protection. In fact, if the only defense to a lien claim is payment, the owner may be required to pay the contractor more than the total amount it had agreed to contractually. This is, perhaps, the single greatest risk to an owner on a construction project today.
What Is a Mechanics Lien?
“Much like a mortgage,” explains James M. Dash, a Principal in the Construction Law practice at Much Shelist, “a mechanics lien is an interest in property that secures the payment of certain types of debts relating to work performed on real estate.” There are, however, some critical differences. Adds Dash, “A mortgage, for example, constitutes an agreement in which the parties decide the terms within the bounds of the law, while a mechanics lien does not require an agreement because it is imposed by statute.”
Generally speaking, two categories of people are entitled to a lien: those who improve real estate; and those trades that are specifically identified in Section 1(b) of the act as being entitled to a lien. They include those furnishing material, fixtures, apparatus or machinery, forms or form work used in the process of construction where cement, concrete or like material is used; those providing fill, sod, excavation or landscape work; those performing services such as architects, structural engineers, professional engineers, land surveyors and property managers; and those furnishing or performing labor or services such as superintendents, time keepers, laborers or other similar individuals.
Protection from the Outset: A Brief Q&A
Q: Given the multitude of parties that are entitled to record a lien against a property, how can owners best protect themselves?
A: According to Section 21(b) of the act, the owner cannot be made to pay an amount greater than it originally agreed to pay the contractor unless the owner violates a subcontractor’s rights and interests by making payment without complying with the act’s requirements.
Q: What then constitutes a violation of rights and interests?
A: According to Section 32 of the act, the owner shall not make any payment to the contractor without exercising the owner’s rights under Section 5 of the act.
Q: What is the simplest way to avoid financial penalties?
A: Based on Sections 21(b) and 32 of the act, owners may be able to protect themselves by complying with Section 5 of the act, which states that before payment is made, the contractor must give the owner and the owner must require the contractor to give the owner a written statement, under oath or verified by affidavit, of the names and addresses of all parties furnishing labor, services, material, fixtures, apparatus or machinery, forms or form work that all sets forth the amounts due or to become due to each. This is what is commonly referred to as a Section 5 “Contractor’s Affidavit.”
Cautious owners should make no payments until the contractor provides a fully compliant version of this document. In fact, Illinois courts have held that owners who have requested a Contractor’s Affidavit have no obligation to pay the contractor unless and until the contractor complies.
In many cases, owners mistakenly believe they are in compliance because the contractor provided an application for payment containing a “schedule of values” that identifies each trade category and the amount due or to become due under each line item. However, the typical schedule of values only identifies the trade category generally (e.g., concrete) rather than specifically setting forth the name and address of the subcontractor performing that particular trade. Other times, a trade category (e.g., steel) may include multiple subcontractors (e.g., a fabricator and an erector). Thus, a schedule of values is not useful for protecting an owner.
There is one important point to keep in mind: failure to obtain a Contractor’s Affidavit does not necessarily spell disaster. Illinois courts have held that when an owner fails to obtain a Contractor’s Affidavit and the subcontractor fails to provide the requisite 90-day notice, the subcontractor’s lien is invalid. In other words, where both parties fail to comply with the act, the tie goes to the property owner.
The Waiver of Lien
In the context of a typical construction project, a subcontractor is contractually required to waive its lien rights as part of the payment process. Generally, the subcontractor tenders its lien waiver to the contractor, who then tenders it to the owner as part of the contractor’s payment request. However, unlike Contractor’s Affidavits, lien waivers are not mentioned in the act; rather, they are purely a creation of custom and agreement between the owner and the contractor. In other words, the act does not require that the owner obtain lien waivers to protect itself from a subcontractor lien claim. This is not to say, however, that the owner should not request waivers of lien. In defending against a subcontractor’s mechanics lien claim, the lien waiver may be a valuable piece of evidence.
However, the waiver may not be the shield that the owner expects. Until fairly recently, courts strictly construed lien waivers to bar a subcontractor’s lien claim even though the subcontractor received no payment in exchange for the waiver. Today, however, courts are likely to take into consideration all of the facts of a case before finding that a lien waiver bars a subcontractor’s lien claim. These facts may include custom and practice in the industry (e.g., the well-known fact that subcontractors tender lien waivers before payment is made) and whether the owner innocently relied upon the waiver in making payment to the contractor.
Other Defenses to a Lien Claim
Assuming that the owner has failed to obtain a compliant Contractor’s Affidavit or lien waivers, all is not lost. Following are some common defenses:
- The subcontractor failed to serve its notice of claim for lien with 90 days after its last date of work.
- The subcontractor failed to file a lawsuit to foreclose its lien claim within two years from its last date of work.
- There are defects in the form of the lien such as a misidentification of the owner and the contractor, an incorrect description of the contract or an incorrect legal description.
- The subcontractor recorded a lien containing amounts for non-lienable services or materials.
Although these defenses may be available to defeat a subcontractor’s lien, they are no substitute for a compliant Contractor’s Affidavit.
A Lien Has Been Recorded–Now What?
Once a lien has been recorded, it becomes a cloud on the owner’s title. Moreover, once the owner receives notice of the lien, the act advises the owner to hold back sufficient funds to pay the lien. Further, if a construction lender is involved, the lender will likely refuse to further fund the loan unless adequate security is provided to cover the lien (typically 150% of the value of the lien). What then is an owner to do?
- Under Section 34 of the act, an owner can send the subcontractor a written notice demanding that the subcontractor foreclose its lien within 30 days of the receipt of the demand or otherwise forfeit its lien rights.
- If the subcontractor fails to file suit within 30 days, the lien is no longer valid.
- Once the lien is invalidated, Section 35 of the act provides that if the subcontractor then fails to provide a release of lien within 10 days after written demand for the release, the subcontractor will be liable for a penalty of $2,500 plus costs and reasonable attorneys’ fees incurred in connection with an action brought by the owner to remove the lien from the title.