Know Your Lien Rights

 OP CIVILBy Michael Kurzman

Construction lien laws are flawed. If your construction company is not careful, an unscrupulous developer may try to leverage that flaw in order to strip you of your construction lien and leave you without payment for labor, services, material and equipment provided to a construction project. 

Many in the industry believe that if they properly perfect their construction lien rights, the value of their labor, services and materials is protected. Unfortunately, sometimes this is a false sense of security. Your company’s ability to transform your construction lien rights into actual dollars in your bank account is often directly related to the equity in the property, and on a typical project, there may not be significant equity.

The best way to minimize risk during a project is to use other people’s money. Savvy developers know this all too well, and most will try and develop a project with as little of their own money as possible. To assist in this endeavor, developers will turn to banks to borrow money for the construction. Banks will always make sure their money is protected prior to releasing any funds. To do this, the banks will record a mortgage on the project securing their construction loan. This occurs prior to the notice of commencement being recorded and prior to you beginning to work on the site. This ensures that in the event of a default on the construction loan, the bank will be in first position on the project.

What does that mean in laymen’s terms to the contractors, subcontractors and material suppliers providing labor, services and materials to the site? It means that anyone who performs work on the project is in a subordinate position to the bank. If there is a problem, the bank gets repaid before you get paid. Even if you have a lien on the property for work performed, you can only get paid if the property gets sold for enough money to pay off the bank first, and you second.

Lost Funds

Let’s take the example of a condominium project with a $75 million construction loan on the project. Presume your prime contract is for $80 million. Further presume that after working on the project for six months, the owner / developer stops paying you. At that point, you are owed about $2 million for your work, so you go to your trusted construction attorney who then prepares your construction claim of lien that is then recorded against the project. You rest easy that night knowing your $2 million is secured by the real property. But is it?

Let’s further presume that the developer did not realize the sales of the condominium units that it anticipated and as a result, aside from being unable to the pay you, the developer is also unable to make the required payments on the construction loan. In this scenario, the bank will file a foreclosure against the property and name you and the developer as defendants, asserting that the bank’s position is superior to the rights of the developer and superior to your construction claim of lien.

Assuming the litigation proceeds to final judgment, the project will eventually be auctioned for sale. If there is not enough money from the sale to repay the bank in full, your construction claim of lien for work performed will be unsatisfied and extinguished, with the new owner of the property getting the property free and clear of your construction claim of lien. In this example, the developer loses the project to the purchaser at auction, and you are left unpaid for work performed. You can sue the developer, but they are typically single-purpose entities and their only asset is typically the land, which they just lost to the bank or the purchaser at auction. Thus, your construction claim of lien is extinguished, the developer loses the land, and you don’t get paid.

Exploiting the Flaw

Recently, a developer tried to use this flaw to its advantage in Florida by trying to extinguish a contractor’s construction claim of lien. The contractor performed work, was unpaid and recorded a construction claim of lien against the developer’s real property. The property was subject to a prior construction loan that had priority over the contractor’s construction lien. In an effort to try and avoid paying the contractor, the same people that owned the developer entity created a new developer entity and “purchased” the construction loan from the bank by paying off the construction loan lender, which the developer was obligated to do anyway under the loan and personal guarantees. 

Now owning the paper on the construction loan, the new developer entity foreclosed on the construction loan, which they now owned, against the initial developer entity; in effect, foreclosing on themselves. The foreclosure extinguished the contractor’s inferior position construction claim of lien, and transferred the real property through the foreclosure process from the original developer entity to the new developer-created entity. Thus, the contractor’s lien was extinguished, the entity that owed money to the contractor was rendered judgment proof because it lost its only asset, and the newly created developer entity ended up with title to the property.

The difference here from the previous example, is that while the original developer entity lost the property to the new developer entity, the new developer entity was owned by the same people as the original developer entity. The same people ended up owning the land, only they now owned the land improved by the contractor but free and clear of the contractor’s construction claim of lien, without having paid the contractor for its labor services and materials.

Fortunately for the contractor and the construction industry, the District Court of Appeals saw the inequity in this transaction and reversed the summary judgment granting foreclosure.

For contractors, the lesson is to be cautious of the developers that you contract with. Ask questions about the amount of the construction loan and how much equity the developer has in the project. Understand that even a properly perfected construction lien may not always protect you and therefore, sometimes your ability to get paid is only as strong as the credit of the people or entity that hired you. Be cautious out there – it’s a tricky world.

Michael Kurzman is a partner at the law firm of Weiss Serota Helfman Cole & Bierman. He can be reached at mkurzman@wsh-law.com

Corporate Head Office

Construction Today Magazine

Cringleford Business Centre
Intwood Road
Cringleford, Norwich, UK
NR4 6AU

Click here for a full list of contacts.

North American Office

Construction Today Magazine

Finelight Media
207 E. Ohio Street Suite 351
Chicago, IL 60611

Click here for a full list of contacts.

Back To Top