Protecting Against The Abusive Lien: Five Steps Toward Safe Construction Lending
In today’s environment, many obstacles present themselves on the road to completion of a successful construction project. One significant obstacle is the mechanics’/materialmen’s lien available to persons who provide work or supply materials in connection with a construction project, pursuant to Nevada’s mechanics’ lien statute, NRS 108.221 -108.246. The purpose of the statute is to afford qualified claimants security with respect to payment for work performed and/or materials supplied on a particular project, and to protect those claimants - typically subcontractors and material suppliers - who do not have a direct contract with the owner or general contractor. While there are certain equitable remedies available in such situations, such as unjust enrichment and quantum meruit, Nevada’s mechanics’ lien statute provides the strongest and most secure recourse in the event of non-payment.
While Nevada’s mechanics’ lien statute is necessary to protect qualified claimants from non-payment, many ambiguities exist in the language of the statute which are problematic. Moreover, the judicial opinions interpreting these ambiguities often contradict one another, thus lending further to the confusion and resulting in more “gray area.” Many contractors use this to their advantage by abusing the protections afforded them by the mechanics’ lien statute, and in so doing, impeding otherwise successful construction projects.
One glaring example of this stems from a recent amendment to the statute allowing a lien claimant to have a lien for amounts due for work performed or “to be performed” or materials furnished or “to be furnished” with respect to the project. The ominous effect of this amendment is that a subcontractor, for example, may be fired from a job by the general contractor before it even steps foot on the jobsite or delivers one two-by-four to the project, and then lien the project for the money it would have received had it not been fired (in legal terms, its “expectancy damages”). This flavor of damages (which was previously only available from the party with which the claimant had a contract) is now purportedly recoverable from the project by way of a lien. The obvious problem with this is that even if the claimant was dismissed from the project for valid reasons, it could divert the general contractor, owner, and lender’s resources from completion of the project to expensive and protracted litigation over a lien for work that was never provided and never benefited the project in any way.
Thus, while the principles behind the mechanics’ lien statute are fair and just, these principles do not always translate in practice. The following protective actions may help defend against abusive and frivolous liens, thereby securing the construction lender’s foothold in a volatile and often dangerous lending landscape.
1. Bonds. One method by which a lender may protect its position vis-à-vis mechanics’ liens is to require the borrower to bond around the lien once it is recorded, or the project as a whole before any liens are recorded, pursuant to NRS 108.2413-108.2425. The bond must be recorded in the office of the recorder in which the lien was recorded (or in the case of a project release, the county in which the project exists) and must otherwise comply with the provisions of NRS 108.2413-108.2425. Once the bond is recorded, the lien immediately releases from the project and attaches to the bond. In the event a bond is properly issued for the entire project, any mechanics’ liens recorded in connection with the property will not encumber the property, but rather, will attach to the bond. Mechanics’ lien bonds are becoming increasingly difficult to obtain, however, as many sureties are becoming reluctant to expose themselves to the risks inherent in today’s construction market.
2. Joint Checks/Lien Releases. A construction lender may also protect itself simply through careful administration of the loan. By taking steps to ensure payment at all levels, the lender is significantly limiting the risk of mechanics’ liens on the project. One way to do this is to require that the borrower issue joint checks and obtain lien releases as progress payments are made. At the outset of the project, anyone providing materials or services to the project is required to provide preliminary notice of their presence on the project. The borrower should compile a list from these notices and make all payments from loan proceeds in the form of joint checks (subject to the limitations of NRS 108.2457) in accordance with the list, in exchange for conditional progress lien releases. At the end of the project, joint checks should be paid out in exchange for unconditional final lien releases. The borrower should be required to ensure that releases are obtained from all “down stream” subcontractors and suppliers.
3. Borrower Representations. In Nevada, a deed of trust lien has priority over mechanics’ liens only to the extent it was recorded prior to any construction by any contractor or supplier having been done on the work of improvement (as defined in NRS 108.22188), even if the mechanics’ lien was recorded after the deed of trust lien. Thus, the prudent lender will require the borrower to represent and warrant in the construction loan agreement, in addition to the lender’s own due diligence, that no labor has been or will be performed, nor material supplied, in connection with the project prior to the recording of the deed of trust. The lender should also require a representation from the borrower that there are no outstanding claims from any contractor, subcontractor, laborer, employee or supplier as of the date of recording of the deed of trust.
4. Secure Future Advances. As construction lending inexorably involves the advancing of funds in periodic installments as construction progresses, the lender must be careful in addressing the priority of funds advanced under the loan agreement in relation to “intervening” liens, or liens that are recorded after the deed of trust was recorded but prior to a particular advance. The Nevada legislature has afforded lenders a “safe harbor” with respect to intervening liens under the provisions of NRS 106.300 -106.400, which provide that the priority of a lien for future advances dates from the time the deed of trust is recorded, regardless of whether the advances are obligatory under the loan agreement securing the deed of trust, or are made at the option of the lender. In order to benefit from this safe harbor, the lender must “opt-in” by ensuring that the deed of trust and the instrument it is securing state clearly that they are to be governed by the provisions of NRS 106.300 to 106.400, among other requirements as set forth therein. Otherwise, courts will look to the applicable common law in determining priority of intervening liens, which, in Nevada, generally holds that a lender has priority over intervening liens for obligatory future advances, but not optional advances.
5. Notices of Completion. A lien claimant in Nevada has ninety (90) days to record a lien from generally the later of (i) the date the project as a whole is completed, or (ii) the date of the last work performed or materials supplied by the lien claimant. However, a lender can shorten this time to forty (40) days, thus limiting its mechanics’ lien exposure, by requiring the borrower to record and serve a Notice of Completion pursuant to NRS 108.228. A Notice of Completion is only effective if it is recorded and served in accordance with the requirements of NRS 108.228.
These suggestions are in no means exhaustive, but rather are just a few examples of how a construction lender may protect the property securing its loan from unwarranted and abusive mechanics’ or materialmen’s liens; thereby limiting the many risks associated with construction lending in the midst of today’s unstable market conditions.
While Nevada’s mechanics’ lien statute is necessary to protect qualified claimants from non-payment, many ambiguities exist in the language of the statute which are problematic. Moreover, the judicial opinions interpreting these ambiguities often contradict one another, thus lending further to the confusion and resulting in more “gray area.” Many contractors use this to their advantage by abusing the protections afforded them by the mechanics’ lien statute, and in so doing, impeding otherwise successful construction projects.
One glaring example of this stems from a recent amendment to the statute allowing a lien claimant to have a lien for amounts due for work performed or “to be performed” or materials furnished or “to be furnished” with respect to the project. The ominous effect of this amendment is that a subcontractor, for example, may be fired from a job by the general contractor before it even steps foot on the jobsite or delivers one two-by-four to the project, and then lien the project for the money it would have received had it not been fired (in legal terms, its “expectancy damages”). This flavor of damages (which was previously only available from the party with which the claimant had a contract) is now purportedly recoverable from the project by way of a lien. The obvious problem with this is that even if the claimant was dismissed from the project for valid reasons, it could divert the general contractor, owner, and lender’s resources from completion of the project to expensive and protracted litigation over a lien for work that was never provided and never benefited the project in any way.
Thus, while the principles behind the mechanics’ lien statute are fair and just, these principles do not always translate in practice. The following protective actions may help defend against abusive and frivolous liens, thereby securing the construction lender’s foothold in a volatile and often dangerous lending landscape.
1. Bonds. One method by which a lender may protect its position vis-à-vis mechanics’ liens is to require the borrower to bond around the lien once it is recorded, or the project as a whole before any liens are recorded, pursuant to NRS 108.2413-108.2425. The bond must be recorded in the office of the recorder in which the lien was recorded (or in the case of a project release, the county in which the project exists) and must otherwise comply with the provisions of NRS 108.2413-108.2425. Once the bond is recorded, the lien immediately releases from the project and attaches to the bond. In the event a bond is properly issued for the entire project, any mechanics’ liens recorded in connection with the property will not encumber the property, but rather, will attach to the bond. Mechanics’ lien bonds are becoming increasingly difficult to obtain, however, as many sureties are becoming reluctant to expose themselves to the risks inherent in today’s construction market.
2. Joint Checks/Lien Releases. A construction lender may also protect itself simply through careful administration of the loan. By taking steps to ensure payment at all levels, the lender is significantly limiting the risk of mechanics’ liens on the project. One way to do this is to require that the borrower issue joint checks and obtain lien releases as progress payments are made. At the outset of the project, anyone providing materials or services to the project is required to provide preliminary notice of their presence on the project. The borrower should compile a list from these notices and make all payments from loan proceeds in the form of joint checks (subject to the limitations of NRS 108.2457) in accordance with the list, in exchange for conditional progress lien releases. At the end of the project, joint checks should be paid out in exchange for unconditional final lien releases. The borrower should be required to ensure that releases are obtained from all “down stream” subcontractors and suppliers.
3. Borrower Representations. In Nevada, a deed of trust lien has priority over mechanics’ liens only to the extent it was recorded prior to any construction by any contractor or supplier having been done on the work of improvement (as defined in NRS 108.22188), even if the mechanics’ lien was recorded after the deed of trust lien. Thus, the prudent lender will require the borrower to represent and warrant in the construction loan agreement, in addition to the lender’s own due diligence, that no labor has been or will be performed, nor material supplied, in connection with the project prior to the recording of the deed of trust. The lender should also require a representation from the borrower that there are no outstanding claims from any contractor, subcontractor, laborer, employee or supplier as of the date of recording of the deed of trust.
4. Secure Future Advances. As construction lending inexorably involves the advancing of funds in periodic installments as construction progresses, the lender must be careful in addressing the priority of funds advanced under the loan agreement in relation to “intervening” liens, or liens that are recorded after the deed of trust was recorded but prior to a particular advance. The Nevada legislature has afforded lenders a “safe harbor” with respect to intervening liens under the provisions of NRS 106.300 -106.400, which provide that the priority of a lien for future advances dates from the time the deed of trust is recorded, regardless of whether the advances are obligatory under the loan agreement securing the deed of trust, or are made at the option of the lender. In order to benefit from this safe harbor, the lender must “opt-in” by ensuring that the deed of trust and the instrument it is securing state clearly that they are to be governed by the provisions of NRS 106.300 to 106.400, among other requirements as set forth therein. Otherwise, courts will look to the applicable common law in determining priority of intervening liens, which, in Nevada, generally holds that a lender has priority over intervening liens for obligatory future advances, but not optional advances.
5. Notices of Completion. A lien claimant in Nevada has ninety (90) days to record a lien from generally the later of (i) the date the project as a whole is completed, or (ii) the date of the last work performed or materials supplied by the lien claimant. However, a lender can shorten this time to forty (40) days, thus limiting its mechanics’ lien exposure, by requiring the borrower to record and serve a Notice of Completion pursuant to NRS 108.228. A Notice of Completion is only effective if it is recorded and served in accordance with the requirements of NRS 108.228.
These suggestions are in no means exhaustive, but rather are just a few examples of how a construction lender may protect the property securing its loan from unwarranted and abusive mechanics’ or materialmen’s liens; thereby limiting the many risks associated with construction lending in the midst of today’s unstable market conditions.
1 comments:
Thanks, Joe. Your blog is very interesting reading. Keep it up!
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