Mechanic’s Lien

Landlords routinely hire contractors to work on their properties.  Occasionally, landlords become involved in disputes with contractors regarding unfinished jobs, shoddy workmanship, and other issues. On some of these occasions, landlords feel justified in withholding payments. Usually, such disputes can be resolved in a manner that is acceptable to both the contractor and the landlord. However, landlords who have withheld payment may later find that a mechanic’s lien has been recorded against the subject property. Accordingly, it is of some importance that landlords understand the basics of mechanic’s lien law.

Mechanic’s lien laws are statutes that make possible liens upon real property where that property has been improved and full payment for improvements has not been made. The purpose of the law is to protect providers of labor or material in the event of the insolvency of the owner or a contractor employed by the owner. Laws vary significantly among the states as to the protection provided and the procedures for obtaining it. Accordingly, the laws of the particular state should be consulted whenever a mechanic’s lien is filed against any real property. The discussion which follows relates to general provisions that are found in the mechanic’s lien laws of many states.

Who Is Entitled to Lien?

Persons are entitled to a lien who, by either an express or an implied contract with the owner of real property, agree to:

• Deliver material,  fixtures, apparatus, machinery, forms, or form work to be used in  repairing, altering, or constructing an improvement;
• Fill, sod, or do  landscape work in connection with the same;
• Act as architect,  engineer, or superintendent during the construction of an improvement or  modification thereof; or
• Furnish labor for repairing, altering, or constructing an improvement.

Those who contract with the owner, whether they furnish labor or material or agree to construct or modify an improvement are known as contractors. Thus, practically any contract between the owner and another that has for its purpose
the improvement of real estate gives rise to a lien on the premises in favor of those responsible for the improvement. For example, a contract to attach a permanent fixture to a building or one to beautify a lawn will create a lien in
favor of the contractor.

In addition to contractors, anyone who furnishes labor, materials, or apparatus to contractors, or anyone to whom a distinct part of the contract has been sublet, has a right to a lien. These parties are usually referred to as subcontractors. Subcontractor rights differ slightly from rights of contractors.

In order for a lien for materials to be maintained, the material must be furnished to the contractor or subcontractor. In addition, a record of the material furnished on each job is usually required. This requirement serves two purposes. First, the record is essential to accurately determine the amount of the lien. Second, it is evidence that the contractor is not his own material supplier. If the material is provided on the general credit of the contractor and no record of specific deliveries is kept, title passes to the contractor and he becomes his own supplier. In this case the original material supplier is not entitled to a lien.

The lien of a material supplier arises as soon as the material (e.g., lumber or shingles) is delivered to the premises, while one who supplies equipment or machinery (e.g., a furnace or an elevator) receives a lien only if he can show that the goods delivered became a part of the completed structure.

Failure to understand the law and follow proper procedures can result not only in filing of a lien, but also result in the owner having to pay twice for the same item. For example, if the owner pays a contractor for both materials and labor and the contractor doesn’t pay for materials that were delivered to the job site, the owner may have to pay for the materials in order to minimize potential financial damages. The owner would then try to collect from the contractor who may have since gone out of business or disappeared.

Who Is Subject to a Lien?

Any interest in real estate may be subjected to a lien. That is, a fee simple, life estate, or lease for years may have a lien against it, depending on the nature of the contract. If the fee simple owner contracts for the construction, or authorizes or knowingly permits the improvement to be made, the lien is good against his interest as well as against the improvement. If a lessee, without the consent or knowledge of the owner, contracts for the construction or improvement of the property, the lien arises only upon the interest of the lessee.

For example, as is typical for a commercial lease, tenant A leases space in a strip center from landlord B, with the understanding that A will construct improvements to the interior of the space. Any lien created will affect both the leasehold interest of A and the fee simple ownership of B.  If A had not obtained B‘s permission to make the improvements and B otherwise had no notice of the improvements, the lien would have been created only against the leasehold interest of A. Since commercial leases often provide that the tenant will make certain improvement himself, it behooves the landlord to protect against liens by utilizing a properly placed Notice of Non-Responsibility and by closely monitoring the project.

This can even be an issue for a residential lease if a tenant is allowed to contract for improvements, something that can be an issue when leasing to a handicapped tenant who will be doing improvements that the landlord is required by law to allow. This is also yet another reason why residential leases should always prohibit modifications without prior landlord written approval.

Improvement of real property should not give the lien holder a right to degrade a prior mortgage. Similarly, the mortgagee should not benefit from increased protection at the expense of the lien holder. Accordingly, an existing mortgage is given a superior lien on the value of the property before the improvements were made. In many states, however, if the improvement or its value can be segregated from the original value, the mechanic’s lien will be superior on the improvement. Where segregation isn’t feasible, laws usually provide for an appraisal method to determine what portion of the proceeds of a foreclosure sale is derived from the improvement.

Perpetuating the Lien

Under the laws of most states the contractor’s lien arises as soon as the contract is entered into. In order to protect the contractor against claims of innocent third parties who might purchase the property or obtain a mortgage thereon, the law provides that the lien must be made a matter of public record within a certain time, usually three to four months after all work is completed.

Failure of the contractor to register his claim as provided by statute will result in the loss of the lien against subsequent bona fide purchasers or encumbrances. However, as between the owner and the contractor, the time limit may be extended somewhat. During the three or four month period, the lien is good against innocent third parties even though it’s not recorded.

To establish their liens, the subcontractors – material suppliers, laborers, and others – must, within a relatively short period of time after they have furnished the last of their materials or labor, either make the liens a matter of public record, or serve written notice thereof on the owner, according to the particular state statute. The period of time provided in most state statutes is 60 days.

Protection for the Owner

Mechanic’s lien laws usually state that the owner will not be liable for more than the contract price, provided he follows certain procedures. Laws also usually provide that it is the duty of the owner, before making any payments to a contractor, to obtain from the contractor a sworn statement setting forth all the creditors and the amounts due, or to become due, to them. It is then the duty of the owner to retain sufficient funds at all times to pay the amounts indicated by
the sworn statement, provided they don’t exceed the contract price. In addition, if any liens have been filed by subcontractors, it is the owner’s duty to retain sufficient money to pay them. The owner is free to pay any balance to the contractor.

If the retained amount is insufficient to pay all the creditors, they share proportionately in the balance, except that most states give priority to claims of laborers. The owner has the right to rely on the truthfulness of the contractor’s sworn statement. If the contractor misstates the facts and obtains a sum greater than that to which he is entitled, the loss falls on the subcontractors rather than on the owner. Under this circumstance, the subcontractors may look only to the contractor for any deficit.

Payments made to a contractor by the owner, without first obtaining a sworn statement, cannot be used to defeat the claims of subcontractors, material suppliers, or laborers. Accordingly, in order to avoid the risk of paying twice for the same work, before making any payment the owner must require the sworn statement and withhold the amount necessary to pay the claims indicated.

If the contractor is willing, the owner may protect himself by stipulating a waiver of lien in the contract. A waiver of lien by the contractor also waives the lien of the subcontractors, as they derive their rights through the contractor. Some states require the owner to record such a contract before subcontractors begin work in order to be effective against the subcontractors.

Finally, an owner is afforded protection by requiring that he be provided lien releases from subcontractors and laborers prior to making payment to the contractor for the work done by those parties.

Judgment

If a lien is filed against a property and payment is not made by the owner the contractor or subcontractor can go to Court to foreclose the lien. Accordingly, a contractor or subcontractor can eventually end up owning the property on which improvements were made. For this reason, if a dispute between a landlord and a contractor can not be resolved, the landlord should seek assistance from a competent attorney who is experienced in defending against mechanic’s liens.

Discussions regarding many contractor issues can be found in our “9 Steps to Avoiding Problems When Hiring a Contractor” course.

Question 1

I began an eviction against a non-paying tenant, but he left prior to my obtaining a judgment. I’m trying to decide whether or not to continue the process to completion when I think the financial condition of the tenant might make him judgment proof. Can you provide some guidance?

Answer 1

Most often the term “judgment proof” is used to describe individuals thought to have no assets. Taken literally, you would not want to waste your time to even file suit against such individuals. Any judgment awarded would likely be difficult if not impossible to collect.

Filing a lawsuit and winning a judgment does no good if the tenant is truly judgment-proof. However, an important consideration is whether the landlord thinks the tenant will stay judgment-proof for the long term. Although it varies among states, judgments are typically good for 5 to 10 years and can be renewed for additional periods, so the chance of collecting a judgment at a future date may be worth the expense of filing the lawsuit today. The debtor may get a good job, marry
money, inherit money, or win the lottery during the years ahead. Furthermore, you are entitled to interest on the unpaid judgment, usually at a far higher rate than you can get investing elsewhere, particularly with current low bank
interest rates. Even the ongoing costs of collecting the judgment may eventually be recoverable.

Whether you ever get the money depends in large part on the defendant’s ability to pay and on the landlord’s ingenuity and perseverance. No law forces a person to pay a judgment. The Court will not collect the money for you.  Instead, the laws provide procedures to attempt to ‘execute’ on a judgment. If the defendant really cannot afford to pay the judgment even these procedures will prove useless, at least at the current time.

Once you have a money judgment, common sense does come into play when deciding when and how hard to pursue collection. There are some debtors who will likely never have enough assets to satisfy a judgment, even relatively small judgments. Accordingly, landlords must consider available information, both that related to the original application and recent events, and investigate further regarding the tenant’s financial condition.

Landlords usually have the right to regularly obtain credit reports for tenants and ex-tenants against whom they have judgments. Credit reports provide useful information regarding the debtor.

If your investigations determine that your debtor is dependent upon social security or disability payments, has other judgments against him, is serving a lengthy prison sentence, has IRS liens, or is permanently living in a foreign country, you have a decision to make. Living in another state does not prohibit collection of a judgment, although it can require a bit more effort and expense for collection.

If your decision is to defer collection until a later time, it is important to regularly monitor your debtor’s physical location and financial condition to determine future collection efforts.

A significant benefit of having a judgment is that you may be pleasantly surprised when you are contacted regarding settlement of the judgment because a lender or other landlords demands that your judgment be settled as a condition of making a loan or renting a unit to the debtor.

It is also possible that the judge can order the debtor at a “show cause” hearing to prove to the court that the debtor cannot pay the judgment as ordered. However, the court may grant the debtor an extension of time to pay the judgment. The
extension is only a temporary stay and not a declaration of a permanent status of inability to pay the judgment as ordered.

For significantly more information regarding judgment collection see our eCourse titled “Collecting Judgments” and/or our Mini Training Guide titled “9 Steps to Collecting a Judgment.”

*  *  *   *  *  *

Question 2

When one does significant work on fixing up a rental that includes both items that are usually deductible as an expense and those that should usually be depreciated, how do I determine how to categorize the various tasks?

Answer 2

When you repair a broken or damaged item or replace a minor component of a capital item you can deduct the cost on your tax return for the tax year in which the amount was paid or liability for payment was incurred – e.g., charged to your
credit card.

When you purchase capital items for your property (e.g., a new air conditioner), replace a major component of a capital item (e.g., a new compressor for an air conditioner), or make improvements (e.g., install new tile flooring) the amount
must be capitalized – i.e., a portion is deducted each year over the recovery period as specified by the IRS.

However, the IRS requires that you capitalize the cost of reconditioning, improving, or altering your property as part of a general restoration plan. This applies even if some of the work would by itself usually be classified as repairs. For
example, for the rehab of a unit that includes new carpeting, painting of the interior, new window coverings, and replacement of the kitchen faucet, the cost of the entire project should be classified as a capital improvement even though
replacement of a faucet and often even the painting would usually be classified as a deductible expense when done alone.

*  *  *  *  *  *

Question 3

I recently had a problem regarding a tenant of my rental condo who refused to pay the penalty fee for failing to obey one of the rules & regulation of the association, claiming he was never made aware that the infraction issue was a violation. Other than mentioning the issues at the time of lease signing, how can I best avoid such problems in the future?

Answer 3

Rental of housing that is governed by an association can be significantly affected by HOA rules and many landlords of such property are themselves unaware of some of the issues. It is even possible that an owner cannot rent a property within the community. It is important that owners and tenants obey the rules and regulations of an association. Failure to do so can result in fines and even in liens being filed against the property.  In many states the property can even be foreclosed on if the owner fails to pay such assessments.

Therefore, it is important that prospective tenants be provided information about at least the most important issues covered by association by-laws and rules & regulations even prior to submitting an application because there might be issues that would discourage a prospect from completing an application. Finding out at lease signing that association issues are unacceptable to the tenant would be a waste of time and money for the applicant and the landlord and result in additional vacancy time for the unit.

Ideally, copies of the relevant documentation will be provided along with application forms and it is a good idea to include a statement on the application that the applicant is aware of the association bylaws and rules and regulations.

It is even better to include clauses regarding owner association issues within the lease agreement so that there can be no question that the tenant knew of the issues and agreed to abide by conditions.