New Law Limits Broad Form Lien Waivers in Construction Projects
Lien rights can be one of a contractor's most important means of securing payment on any private construction project in North Carolina.
Under Chapter 44A of the North Carolina Statutes, contractors that contract directly with a project owner have a right to assert a lien on the subject real property to secure payment for amounts owed for work performed. First-, second-, and third-tier subcontractors can enforce the claim of lien on real property of the contractor through subrogation. The lien on real property is a form of security for the debt. If a contractor prevails on its lien claim, the property can be sold to pay that debt.
An important aspect of North Carolina's lien statutes is that the effective date of a lien on real property relates back to the contractor's date of first furnishing of labor or materials to the project. This relation-back can often lead to a contractor's lien on real property having priority over the owner's lender's deed of trust. Establishing this priority can mean the difference between being paid and not.
For these reasons, lien waivers have long been used in construction projects as a means of reducing the risk of lien claims. Typically, an owner (or in the case of a subcontractor, a general contractor) wants to get lien rights waived. General contractors and subcontractors, on the other hand, want their lien rights preserved.
It has long been the law in North Carolina that a contractor or subcontractor could not be required to waive lien rights in advance (or prospectively) as part of entering into a contract for the improvement of real property. In other words, any provisions in a construction contract, which required the waiver of all lien rights, have long been void and unenforceable. Frequently, however, an owner (or in the case of a subcontractor, a general contractor) will use the withholding of a progress payment as leverage to extract broad lien waivers that go beyond the progress payment for which payment is being made.
The North Carolina General Assembly recently passed a new law, N.C. Gen. Stat. § 22B-5, which is specifically aimed at restricting an owner's (or in the case of a subcontractor, a general contractor's) ability to require broad form lien waivers in exchange for progress payments. The new statute is effectively an extension of the prior statute that prohibited prospective lien waivers in construction contracts and furthered the protection that the prior statute was intended to provide.
The new statute provides:
Provisions in lien waivers, releases, construction agreements as defined in G.S. 22B-1(f)(1), or design professional agreements as defined in G.S. 22B-1(f)(5) purporting to require a promisor to submit a waiver or release of liens or claims as a condition of receiving interim or progress payments due from a promisee under a construction agreement or design professional agreement are void and unenforceable unless limited to the specific interim or progress payment actually received by the promisor in exchange for the lien waiver.
The statute is aimed at preventing an owner or contractor from using an interim lien waiver for a progress payment as a means of obtaining a release of lien rights or claims for payment for work to be performed in the future. In other words, preventing interim lien waivers from being used to waive lien rights and claims prospectively.
The new statute also takes away from the owner or general contractor the right to withhold payment from a lower-tier party because they refuse to provide a broad form lien waiver. Frequently, owners would contractually require broad form lien waivers as a condition for making progress payments. If the contractor refused to provide the lien waiver, the owner could withhold payment. Prior to the new statute, those contractual requirements were arguably enforceable and not uncommon. This was a powerful tool for owners and general contractors to extract broad form lien waivers from lower-tier parties. The new statute now prevents that and is a very important change in the context of progress payments.
However, there are some questions raised by the new statute that are not specifically answered by the plain text of the statute. For instance, most lien waivers are drafted such that a contractor or subcontractor waives lien rights for work performed up to the date of the lien waiver. This serves an important function in that it helps to identify claims early in the process of construction instead of at the end of a project.
At the time the lien waiver is provided, the contractor or subcontractor should identify any outstanding claims, so they are preserved and not subject to the interim lien waiver. If a contractor has a claim for change order work that has not been paid, that claim should be identified and reserved in the interim lien waiver. If there are no such claims, the contractor or subcontractor can simply sign the lien waiver. This helps manage disputes and costs and avoids the scenario of a contractor or subcontractor coming forward with numerous claims for change orders at the end of a project.
The new statute, however, states that any lien waiver is void and unenforceable unless "limited to the specific interim or progress payment actually received." It does not expressly describe whether a lien waiver can be used to release lien rights or claims for all work performed up to the date of the lien waiver in exchange for that payment. A potential problem can arise if the interim lien waiver is not provided until after the application for the progress payment has been made, and additional work has been performed for which payment has not been formally requested. Care should be taken to make sure that the language in the lien waiver properly reflects the work for which the lien is being waived.
I believe the intent and more reasonable interpretation is that the statute is meant to prevent lien waivers from releasing future lien rights and claims for payment. Under the new statute, an owner is prohibited from requiring a contractor to sign a lien waiver in exchange for its first progress payment or any progress payment (other than the final payment) that waives any and all lien rights on the project. Indeed, that would be consistent with the intent of the prior statute, which prohibited prospective lien waivers when entering into a construction contract.
In addition, the new statute does not expressly describe whether it applies to payment bond claims on public projects (Article 3 of Chapter 44A of the North Carolina General Statutes). This is an important issue because payment bond rights essentially take the place of lien rights in the context of public projects and can be waived through waivers and releases. The text of the new statute does indicate it applies to waivers of liens or "claims." Presumably, the term claims are broad enough such that the new statute would also apply to waivers of payment bond claims given in exchange for progress payments on public projects.
Lien waivers are important documents. They operate to waive what can be a general contractor's or subcontractor's most important rights – the right to be paid for work performed – on private projects. It would seem that there are lien waivers in form libraries that are now invalid because they contain language that offends the new statute. The fix may be as straightforward as removing the offending language, but the lien waivers should be reviewed in light of this new statute.
Owners, contractors, and lenders should take care to ensure lien waivers are enforceable under the new statute. If a lien waiver overreaches, it could be void in its entirety in light of the new statute. Ward and Smith's construction law practice group has a team experienced in drafting, interpreting, and negotiating these documents that can assist in navigating this new statute.