Understanding how lien rights work and how to accurately track lien documentation is essential for developers.
Most real estate developers and investors have at least a basic understanding of what a mechanic’s lien is and that contractor’s lien rights can pose a financial risk to a project, if not properly managed. Whether you have a contractor remodel your guest bathroom or hire a firm to develop a new multifamily complex, the mechanic’s lien and the associated rights, rules, and regulations hold sway over the financial status of your project.
Understanding how these lien rights work and how to accurately track lien documentation during the construction process is essential for any developer. Developers are aided in this process by construction lenders and other third-party servicers, but it is always beneficial for a developer to maintain an understanding of the process as well.
What Is a Mechanic’s Lien?
A mechanic’s lien is a legal tool that guarantees tradesmen will be paid for completed work by granting them an interest in the value of the property. Although original mechanic’s lien legislation likely drew inspiration from similar European civil laws, the modern form and complexity of the mechanic’s lien are a uniquely American creation.
Mechanic’s lien laws are regulated at the state level, and each state has its own set of rules and regulations governing the mechanism of lien rights. Generally speaking, each state will have rules regarding who has lien rights, what notices must be submitted, forms required for lien releases, and deadlines for officially filing a lien against a property. Typically, lien rights are assigned to any contractors, subcontractors, suppliers, equipment renters, laborers, or other tradesmen that provide materials or labor for the completion of a project.
What Are Lien Releases?
When work on a project is completed and paid for, it is important as the owner to secure a release from the tradesman for the value of what has been paid. Essentially, as you pay for the completed work, the contractor and other tradesmen no longer have the right to claim that value against your property.
Laws regarding the release of these rights vary by state, but for most the process will involve the collection of lien releases or waivers. It is important as an owner to methodically collect and record these releases throughout the project to ensure you cannot have a lien filed against your property for work that was properly paid for.
There are two types of lien releases: conditional and unconditional. A conditional lien release is included with the initial payment application and states the tradesmen will waive their lien rights to the specified value once payment is issued. An unconditional release, on the other hand, states the payment has been received and the tradesman unconditionally waives all rights to make a claim against the property for the specified value. The process of collecting and tracking these releases across multiple payment applications can be tedious, but it is a necessary part of managing the risk on your project. For larger projects, it is beneficial to engage a third-party firm to aid in this process, especially if you are a sole developer who does not have available staff to manage document processing.
What to Watch For
Depending on the state in which the project is located, nearly all subcontractors and suppliers have individual lien rights, separate from those of the prime contractor. The prime contractor is unable to release lien rights for any subcontractors, and individual releases need to be collected to ensure the contractor is properly issuing funds to the other tradesmen working on the site.
It is possible for a subcontractor to place a lien against the property for work they never received payment for, even though the owner paid the contractor. Collecting individual lien releases from all trades working on the project ensures payments disbursed to the prime contractor are properly distributed to subcontractors. To help mitigate this risk, include a clause in the construction contract requiring the contractor to submit lien releases from all trades on-site with each payment application. Ultimately, as the owner, you control the purse for the project and can use that leverage to ensure all documentation is properly submitted with each payment application from the contractor.
Time Limits on Lien Rights
As originally written, many mechanic’s lien laws did not include specific time limits on when a tradesman could file a lien against a property for unpaid work. This created significant risk for developers because a lien could potentially be filed years later, leading to a legal quagmire while the developer attempted to prove records of payment.
Modern lien rights laws have been updated and generally require that a lien for nonpayment be filed a set number of days after the completion of the project or after a specific tradesman finishes their portion of the work on-site. This is important to keep in mind for both real estate investors and developers.
If you intend to purchase a property that has recently had construction completed on-site, review the state’s lien rights timelines to ensure no tradesman can file a lien against the property after you have purchased it.
Mechanic’s Lien Rights, a Partnership
Mechanic’s lien laws can be convoluted and challenging to understand, especially for developers pursuing projects across multiple states. Even so, every investor or developer should maintain an understanding of the principal concepts of lien rights, so they are not caught unawares by a lien filed against their property.
These rights are enshrined in state laws with good reason. Without these laws, tradesmen might not be willing to offer their services on a project without a guarantee of payment. The legal guarantee of an equitable stake in the property’s value allows tradesmen to perform their work knowing they will be fairly compensated. Ultimately, development can only succeed as a partnership between capital holders and tradesmen. Legal tools such as the mechanic’s lien ensure those partnerships can move forward with all parties on equal footing.